We will call the meeting to order.
Welcome to meeting number 36, panel number one, of the House of Commons Standing Committee on Finance.
Pursuant to our order of reference from the House, we are meeting on the government's response to the COVID-19 pandemic.
Today's meeting is taking place by video conference and the proceedings will be made available via the House of Commons website.
For committee members, we've had lots of reading material for this meeting today: the COVID-19 report, which is getting longer by the week, and the report of the Canada Pension Plan Investment Board.
We're fortunate to welcome to the committee today, on behalf of the Canada Pension Plan Investment Board, Mr. Machin, president and CEO; and Michel Leduc, senior managing director and global head of public affairs and communications.
Mr. Machin, welcome, and thank you for coming. The floor is yours.
Good afternoon, Mr. Chair and committee members.
I'd like to start my remarks by commending members of Parliament for your dedicated public service in response to the COVID-19 pandemic. I recognize these are difficult times for many of your constituents. When faced with a crisis of this scale, your role as elected representatives becomes even more important.
My name is Mark Machin. I am the president and CEO of CPP Investments, and I am accompanied once again by my colleague Michel Leduc, who is our senior managing director and global head of public affairs and communications.
This is our fourth time appearing together before the House of Commons Standing Committee on Finance.
It is great to see some familiar faces, and I look forward to meeting the newest members of the committee. I am disappointed we are unable to meet in person this year, but I am also grateful that we can do this virtually.
CPP Investments has a critical mission, which is to help ensure Canadians have a strong foundation of financial security in retirement. To do so, we invest the assets of the CPP with a clear objective: to maximize returns without undue risk of loss, taking into account the factors that may affect the funding of the plan.
We're governed by federal legislation, the Canada Pension Plan Investment Board Act, or the CPPIB Act. Passed by Parliament in 1997, the decisions made by policy-makers at that time set us on the path to becoming the organization we are today. As outlined in the CPPIB Act, the assets of the fund are managed in the best interests of the Canadian contributors and beneficiaries who participate in the CPP. These assets are strictly segregated from government funds, secured and managed professionally, exclusively to pay earned benefits among contributors.
CPP Investments operates at arm’s length from federal and provincial governments with the oversight of an independent, highly qualified professional board of directors. Management reports not to governments but to our board of directors. Any amendments to the CPPIB Act require the consent of at least two-thirds of the provinces that participate in the CPP, representing two-thirds of the population. CPP Investments is a strong believer in the value of public accountability and transparency. Our act holds us to rigorous accountability requirements, but we also go beyond our legislated requirements and make every effort to ensure federal and provincial stewards, as well as Canadians, are kept informed of our activities.
Our approach to meet the fund’s investment objectives has a dual focus. It is designed to achieve long-term total fund returns that will best sustain the CPP and pay pensions, and to generate returns above what could be achieved through a low-cost, passive investment strategy.
To succeed in highly competitive global financial markets, an investor must have and make good use of its comparative advantages. The enduring nature of the fund, our governance, talent, culture and strategic choices drive our global competitiveness. Our investment strategy is designed to deliver a highly diversified portfolio that will maximize long-term returns without incurring undue risk. We are invested globally across public equities, private equities, bonds, private debt, real estate, infrastructure and other areas.
Today, more than 20 years after receiving our first $12 million of net inflows from contributions to invest, the fund has surpassed $400 billion and is among the world’s top pension funds. Our governance structure and clarity of mandate are internationally recognized as a leading example, for other countries to emulate, of sound management of national retirement plans.
This has been a challenging few months. The health and social impacts of the COVID-19 pandemic upended the personal and working lives of Canadians and billions of people around the world. The COVID-19 pandemic threw the global economy and financial markets into turmoil. Volatility repeatedly spiked to near historic highs. The Dow Jones had the most challenging first quarter in its 135-year history, dropping 23%. Canada's main public exchange suffered its biggest drop in eight decades. The Canadian dollar slumped to multi-year lows. This all happened during the last few weeks of our fiscal year.
For institutional investors, market conditions such as these will test both investment skill and organizational strength. While preventing losses does not receive the same recognition as delivering stronger returns, it is equally important, if not more so.
While the specific threat of the COVID-19 pandemic was something few of us could have fully predicted, the likelihood of a global event leading to market turmoil was something we could prepare for, and thankfully we did. The label “radical uncertainty” appropriately describes the impact of the global pandemic. However, we designed our investment portfolio to be resilient throughout wide-ranging economic conditions, including in the face of severe or radical uncertainty. Diversification through active management, when planned and executed effectively, is the most powerful shield to strengthen financial resilience. The execution of our strategy demonstrably placed the fund in a safe harbour.
From an operational perspective, preparation is the key to effective response to a crisis. In recent years, we advanced our readiness by developing financial crisis, business continuity and pandemic response plans. Plans were necessary, yet insufficient. We conducted multiple realistic exercises to put our plans into practice. We enhanced our risk management framework, asset valuation processes, and our digital and information technology capabilities.
That foresight proved to be invaluable. Once COVID-19 began to spread, we were able to act swiftly. We went from nine offices globally to 1,800 individual home offices in a matter of days. Our board of directors, senior management team, investment departments and core services rallied to guide the fund through the crisis and to help protect one of the core pillars of Canada's overall retirement security system.
Through those efforts, I'm privileged to report to Canadians and this committee that the CPP fund is sound. At the end of fiscal 2020, the fund reached $409.6 billion. Let me break that down.
We started the fiscal year at $392 billion and added $12.1 billion in net income after all costs. Despite the devastating market conditions in our fourth quarter, this represents a net annual return of 3.1% after all costs. Our increase in net assets also included $5.5 billion in net contributions received. This 3.1% fiscal year return is down from the 12.6% return we achieved during the 2019 calendar year, and that demonstrates the impact the last few weeks of our fourth quarter had on our reported performance on March 31, 2020. In reporting on a fiscal year basis, we added an extremely difficult 90-day period and dropped our fiscal 2019 Q4 results, which were very solid.
These reported numbers are superficial because, one, we don't plan, implement or invest with a view to any 90-day window and, two, no CPP benefit is determined by quarters. As a manager of a fund with an exceptionally long investment horizon, I know long-term performance is what matters most and what ultimately helps pay pensions today and tomorrow. I'll get to the relevant measures in a moment.
While our recent returns were impacted by the COVID-19 crisis, our strategy sheltered the fund from the larger losses that our benchmarks faced. Those benchmarks indicate what would have been achieved through a passive investment strategy. This fiscal year we generated an additional $23.5 billion for the fund in dollar value added, or DVA, as a result of active management.
Turning to more relevant time periods, over the last decade we generated close to $57 billion in DVA for the fund. At the end of last month, on May 31, our 10-year return was 10.4%. Over the last decade, we generated nearly one-quarter of a trillion dollars in net investment income after all costs.
Due to the recent volatility in financial markets, some of your constituents have likely expressed concerns about their personal retirement savings. We hope that these results will provide some reassurance that a key pillar of the Canadian retirement system, the CPP, will be available for them when they retire. But you don't need to believe me. Every three years, the office of the chief actuary conducts an independent review of the sustainability of the CPP over the next 75 years. The most recent actuarial review of the CPP was released in December 2019.
Okay, then maybe I will thank the committee for its patience.
I think it's important to re-emphasize that point. You don't have to believe me necessarily on the sustainability of the CPP. It's important to recognize that every three years the office of the chief actuary conducts an independent review of the sustainability of the CPP over the next 75 years. The most recent actuarial review of the CPP was released in December 2019. That report concluded that the CPP will be sustainable over the next 75 years. While the report was produced prior to the COVID-19 pandemic, it does account for financial market volatility and changes to long-term demographic trends, as well as other factors.
A key assumption in the report is that the base CPP will earn an average annual net real rate of return of 3.95% over the 75 years covered by the report. The corresponding assumption for the more conservatively invested additional CPP is an average annual net real rate of return of 3.38%. As of this year, our average annual real rate of return over a 10-year period is 8.1%.
The review also showed that investment income in the base CPP account was 107% higher than expected over the three years since the previous review. Of the total $41 billion by which the fund's assets grew more quickly than expected, $39 billion came from higher than expected investment income.
I may just turn to one last topic. I will skip over part of my prepared remarks, given the delay, but the last thing I want to touch on is our approach to environmental, social and governance factors, or ESG.
We're always looking for ways to evolve as an organization, and this extends to our approach to ESG. We consider ESG factors when calibrating a portfolio over the long term and evaluating investment opportunities, understanding the approach of our partners, and engaging with companies to seek improvements in business practices and disclosure. Being an engaged owner can enhance the long-term performance of the companies in which we invest.
Climate change and the gradual transition to the low-carbon environment will also continue to influence the world we live in. We have committed to being a leader among asset owners in understanding the risks posed and opportunities presented by climate change. We've developed and continue to improve our systems and processes to ensure we fully understand the risks and opportunities presented by climate change. We do this in accordance with the existing legislative provisions in the CPPIB Act and our investment objectives.
With that, I will conclude my remarks. Both Michel and I welcome the opportunity to discuss how we invest the funds entrusted to us and our role in helping to ensure that the CPP remains sustainable for future generations.
We look forward to your questions.
Thank you for the question.
There are really two reasons that we invest in China. The first is that it is a very large market. It is the second-largest capital market in the world, and therefore it is one that we can diversify into. It's one that is, in many ways, uncorrelated with the rest of the world and, arguably, increasingly uncorrelated with the rest of the world.
From a portfolio construction point of view, that is quite valuable because when there's turmoil in other major markets, there may not be turmoil in that market, and vice versa. The diversification benefit is the most powerful factor that encourages us to continue to have some exposure to that market, given that it's the second biggest market.
The second reason that we invest is alpha, or what we call outperformance relative to an index. That's very hard to come by, but it's incredibly valuable for a portfolio. If you can pick the right stock over the wrong stock, if you can pick Alibaba over Luckin Coffee—which some of you will have seen was a debacle and faced delisting from the U.S. exchange just recently—the right building over the wrong building, the right company over the wrong company or the right fund over the wrong fund, there's a huge amount of value. There's a lot of research showing how much alpha, how much value, there is in that, and it's much more than in developed markets.
Those are really the two reasons we invest in the market, and so far it has performed well for us. The Chinese investments over the fiscal year were up almost 10% and performed well. Again, if you look at the performance, just in March for example, the Chinese market was essentially flat in comparison to where the U.S. markets and North American markets were trading at that point. There are the reasons.
Having said that, we have two sides to our mandate, maximizing returns without undue risk. It's very important for us to thoroughly understand all the risks of investing in any market, not just at an individual security level or an individual company level but also the risks of the market overall and where they might be going. We spend a lot of time understanding those risks.
Thank you for the excellent questions and ones that we wrestle with all the time.
I think it's really interesting. If you look at the real estate portfolio and the real estate industry, there are certain parts of it that have really benefited in some ways from the pandemic. For example, I hesitate to say this seeing as I was cut off on another go, but data centres and broadband have been an area that has really benefited. Anything involved with e-commerce and home delivery and logistics has really benefited. Those areas are booming. At the other end of the spectrum, you have hotels and hospitality and also shopping malls, and they've been really hard hit. In the middle you have offices, which I'll come back to.
On the hospitality side, we have very little exposure to hospitality. We don't invest in hotels and the equity of hotels. We've had that as an investment strategy for many years. We never liked hospitality as an area to invest in.
Shopping malls we do have exposure to in Canada, North America and Europe and around the world, and they have been hard hit. We tend to invest with very strong partners and in what we think are the destination malls rather than smaller malls, but I would say for the North American shopping mall industry that this is going to be a really tough time if there is going to be a requirement for social distancing rather than the best strategy, which is to try to get as many people through the malls as possible.
In addition, arguably in North America, shopping malls have been very overbuilt. By some estimates there are four times the number of malls that are needed in the U.S., so it was always an expectation that these were going to decline. This has probably accelerated that decline as more people have gone to e-commerce rather than going to a physical store. That's probably going to accelerate this transition to the use of those shopping malls towards other things, such as performance centres or entertainment centres.
On offices, I'd say that it's interesting. The jury is out among smart people right now. On the one hand, as long as there is a requirement for social distancing, then arguably people are going to need bigger floor plates if you can get the people into the offices. On the other hand, yes, the work from home environment generally has been one that most companies in the knowledge industries have been able to cope with and it has worked, so there is probably going to be some stickiness in not needing people to commute all the time and in their being able to work remotely and work from different centres. I personally hope that does stick, to some extent.
That being said, it's still not clear what human behaviour will revert to. Generally, when we went through what was a much shorter episode of SARS back in the day, which a number of the committee members will remember, there was a lot of talk back then about people working remotely permanently. It didn't happen, so it's possible that people will revert to the behaviour of wanting to work together in teams, seeing each other and being physically close to each other. It's not clear yet. We are watching that behaviour very carefully.
Sorry, I didn't mention infrastructure. We don't own any airports, and that's not necessarily from a strategy point of view. I wouldn't like to say that we were really smart in not owning airports; we couldn't find one that we could buy at what we thought was a reasonable price. We were consistently outbid over the last 10 or 12 years around the world on airports, so we have zero airports in our infrastructure portfolio.
We do have other assets, which I'd be happy to talk about, some of which have been impacted and others of which have been less impacted.
We'll see whether once-in-a-lifetime opportunities come back again. I mean, there may have been some in the depths of that crisis, and certainly we took advantage quickly of some opportunities, particularly in the credit markets.
On the long-term trends, in a short answer, I think what's happened here is an acceleration of a number of trends that were going to happen, particularly accelerations online, so that's anything fintech related, referring to my previous answer. The stickiness of people moving to home banking and doing their finances online, seeing as they've been forced to, particularly in older age groups, is something that is likely to stay. It's the same with telemedicine. People who've used telemedicine have really enjoyed the experience and are likely to keep going in that direction.
On home education, I'd say there are mixed views. What we've found is that in the east, people in India and Asia who have used home education have had a really good experience. People in the west, in Europe and North America, have had a really unsatisfactory experience and really haven't enjoyed it. We're trying to dig into why. There's some speculation that in the east there are much more specialized apps and that companies have been very creative in designing a particular online experience that really engages and is tailored to students, whereas in the west, people have just generally had the traditional teacher get online and try to teach a class, which has not worked so well.
There are a lot of trends like this that we're trying to analyze and be ahead of. One other one that I'll mention, which is going to be a longer-term trend, is I think the move to autonomous vehicles. I think a lot of us, if there had been an autonomous vehicle to jump into to get us between one place and another, would have done that, rather than being next to another pair of lungs. That's something where we would continue to invest, and we've made a number of investments around that area.
First of all, I would like to inform you that I will be taking the first speaking turn, and my colleague Mr. Barsalou-Duval will be taking the second one. We will do the same for the next round of questions.
Hello, Mr. Machin and Mr. Leduc. Thank you for being here.
Mr. Machin, thank you for your presentation. The answers to our questions are welcome and very enlightening.
We can see that the financial markets have been very volatile since the beginning of the pandemic. This is very worrying. I would like to have your analysis of the situation with regard to the links between the pandemic and what is happening on the financial markets right now. I would also like to know your forecasts for the next few months.
I'd also like to raise something more specific. The governments of rich countries, in response to the effects of COVID-19, have brought in significant income support measures. The same is true for central banks, which has led to a significant injection of liquidity. But it seems to me that much of this liquidity, that is, new money, has not been used to support demand, either for consumer spending or for investment. Eventually, this liquidity could end up in the financial markets, which could lead to a rise in asset prices, which I would describe as artificial. On a global scale, this could even present the risk of a financial bubble.
What is your analysis of the situation, and what are you doing about it?
Thank you for the excellent question. This is one that we will consistently wrestle with.
Briefly to your first point, I won't give a market forecast. I'll give you an economic forecast—at least based on our economics team—and certainly it's a depressing environment.
These forecasts we hope are negative and will be revised upward over time. For the moment, we see that Canada is in a very sharp recession and likely will grow negative seven-plus per cent this year, but hopefully will bounce back 8% next year. Similarly, the U.S. is over 6% negative for this year, and globally, we see 3.8% negative growth for this year.
It's a very sharp recovery. We predict at the moment that the economy won't recover to its full pre-COVID level of output around the world until the second half of 2022. That is our current prediction. We're looking at it very carefully, based on the employment forecast, based on hopefully a little more optimism around vaccine research, but that's our current prediction.
To your point on asset prices and how they may have moved given the stimulus, that's certainly something that I think, in the short term, a lot of people are taking quite a lot of relief from. There has been a huge stimulus around the world, both on the fiscal front and on the monetary front, and it has had its impacts, certainly for most of the time. Although we've had a difficult day today in markets, most of the time it's put liquidity back into markets and put confidence back into markets.
You are right that it is possible this will result in very high asset prices. Certainly we've seen a very surprising and very rapid rise in equity markets, until this morning. We've certainly seen very little fall-off in real asset prices in many markets. While that is comforting as an owner of assets, it is something we are looking at very carefully, making sure we have a portfolio that will perform no matter what happens, no matter what risks emerge and no matter what events might happen.
We consistently stress test for what would happen if there were another scenario like the global financial crisis tomorrow. What happens if there is something even worse than that tomorrow? It's certainly something we don't wish for, but it is our responsibility to make sure we understand what the consequences of that would be and to make sure the portfolio would be safe even through those types of events.
I would say two things on that front, one on the structure of our mandate and then secondly on our investments in the energy transition.
First of all, I think the country has been really well served by the simplicity of the mandate we were given back in the CPPIB Act in 1997, which is to maximize returns without undue risk of loss. Then it was left to a professional board of directors and management teams over the years to figure out how to do that.
What is the best portfolio we can find, whether in Canada or around the world, to achieve that objective? It's a very difficult objective. Managing money is not simple. It's very competitive. Having that clarity of purpose has made it at least slightly simpler for us to execute, and it has served really well, so we always have the interest of building value in the fund. That is the number one thing that drives what we do every day.
If you load in other complexities and objectives, then it becomes much more difficult, and there are obviously compromises and trade-offs. I think it's something that the country was very smart about—and people were very smart about—back in 1997 in setting up the fund this way. I think it has really proved itself over the years and is the envy of the world, frankly, as a simple, straightforward way to set up the objectives of the fund.
Having said all that, we do believe that climate change is happening, and we do believe it is a major risk, so for the last 12 years we've been focused on understanding the risk, and it's challenging. It's a very difficult risk to understand. We publish a sustainable investing report, “Investing Responsibly for CPP Contributors and Beneficiaries”, every October. It goes into some depth about how we are thinking about climate change and what we're doing with respect to it. I will give you just a couple of highlights around it, because it's a long topic.
The first is that every single major investment we make must take into account climate change risks and make sure that we understand those risks and what might happen to the company, what might happen to the asset, before we make the investment, and that we've been sufficiently compensated for it. For example, in the last year, we invested in a toll road in Indonesia. One of the major issues was, what will happen with climate change? What will happen with flooding? What will happen to the geography around that toll road as climate changes? If it changes [Technical difficulty—Editor]. Understanding the risks is really important.
The second thing is understanding overall, from a top-down perspective, what the risks are that we have in our portfolio and stress-testing the portfolio depending on whether we have faster shifts in climate or slower shifts in climate.
It's a complex area. It's one where we are determined to be at the forefront of understanding those risks and understanding where the opportunities lie around it, so that we can invest in those opportunities.
On the carbon footprint, in our sustainable investing report, on page 61, we disclose—using both scope 1 and scope 2 definitions—the amount of greenhouse gas emissions from the portfolio. We also disclose it on an equity ownership basis, so the per cent of equity ownership and also the per cent of the long-term capital structure that we own. This is across all assets across the portfolio.
To give you a number—and this is challenging work; there are a lot of estimates that go into this—we use, as much as we can, specific information that is disclosed by the companies we invest in. However, it's about 25.7 million tonnes of carbon dioxide equivalent, based on long-term capital ownership. That is the amount of our total carbon emissions across the fund.
As I say, it's challenging. We have used S&P Trucost, a division of S&P, to try to get to as accurate a number for the companies, where we are using proxies and estimates, but that is.... At the moment, the based-on proxy data is about 53% of that number, 18% is coming from company-reported data and14% from Trucost models. That gives you a sense of the amount of carbon emissions from the total portfolio.
With respect to your second question, I'm not sure I have the numbers completely at hand on how many people sit on oil and gas company boards. Generally, across all of our invested companies, we have about 190 board positions for all of the boards we sit on across all the portfolio companies. Some of these are direct. Some are our employees sitting on company boards, and some of are where we will find a particular expert we think is appropriate for that position to act on our behalf. A handful of those will be on traditional energy boards.
Again, another cut would be that if you look at the overall portfolio and how much we have invested in traditional energy, it's about 2.8% of the portfolio at year-end. Our renewables portfolio right now is over 2.2% at last count, and climbing rapidly. I would imagine that in the short term our renewables portfolio percentage will exceed the amount we have in traditional energy, and that makes sense given the move along the energy transition.
Thank you for the question.
As you can imagine, executive compensation is set by the board of directors, as is the case for most organizations. As it turns out, there was actually a comment piece that had been published in the National Post about CPPIB's compensation, which gave the opportunity for our chair of the board to respond. We'd be more than happy to provide the chair's response to the clerk for this committee, but if I have a bit of time, maybe I could summarize the contents.
First, just to be clear, the board did establish a salary freeze on the CEO's salary for the current year, as well as freezing salaries for all senior executives at CPPIB, in recognition of the economic circumstances caused by COVID-19.
In regard to incentive compensation, that's a look back. That's looking at past performance, at the past performance of 20 quarters, not only the 20th quarter that rolls out in the fifth year on which the incentive is based. That's essentially to recognize the importance of aligning investment behaviour—especially a long-term investor—with long-term decisions and not making short-term decisions that may not be in the best interests of the fund. As we have seen, significant economic problems have been caused by short-term thinking, in the financial sector specifically.
In the first 19 quarters of those 20, tremendous value was created, in the order of about $140 billion net income. In the 20th quarter, when the pandemic hit, the fund was impacted, so total fund returns were affected. Having said that, due to all of the decisions that had been made because of active management, because of the strategy put in place by the management team and because of a lot of the diversification well beyond what would be available on public markets, the fund was actually placed, because of its resiliency, in a safe harbour. Had it been invested in the passive strategy, a low-cost simple strategy of indices, the fund would have dropped by about $23.5 billion more.
I think it's a recognition in terms of both the incentive framework for the performance of total fund returns—those 19 quarters—as well as the relative return. As I've said, those details are laid out in the letter from our chair. We would absolutely share that with the committee through the clerk if that's appropriate.
Thank you very much, Mr. Chair.
Thank you, Mr. Leduc and Mr. Machin, not just for your appearance but also for the openness with which you've shared information with members of Parliament and have remained transparent while you do a very difficult job in a tremendously unusual time.
I'd like to discuss the times we're in. I think all of us expected catastrophic drops in the market as soon as the governments of the world started locking down their workforces, and that did happen, albeit only briefly. In late March, markets crashed, by about a third here in Canada and roughly the same in the United States, but then they came roaring back.
That bounceback seemed to coincide with the enormous amount of money that our central banks have been printing here in Canada. It's now about $400 billion of what is effectively quantitative easing through a bond-buying program. In the United States, there's been a similarly large program of purchasing assets and an extraordinary purchase of bonds, not just government bonds but now also private bonds. In Canada, the bank is buying 10 billion dollars' worth of private sector corporate bonds.
The result is that markets are surprisingly valued. According to the CAPE or Shiller price earnings ratio, the S&P 500 this week was 28, which is extremely high. It's only been that high in the lead-up to the tech bubble bursting and in the late 1920s, in 1929, right before the great crash that led to the Great Depression.
I want to get your impressions on how our markets are valued right now and whether you think there is a bubble. If there is, how are you protecting the $409 billion over which you and your fund are the custodians?
Those are really important questions. Before I give an answer, let me go through the skills we have as an investor.
That is, we think we have very good skill at building a diversified portfolio around the world, figuring out what the best long-term portfolio is and diversifying that. Second, we think we have developed skill at picking the right fund over the wrong fund, the right stock over the wrong stock or the right building over the wrong building in securities selection. We have great skill at diversification and securities selection. The third skill is market timing. It is one of those skills that are very elusive for investors and very hard to do. I couldn't put my hand on my heart and say that we have developed skill in telling you what the market is going to do tomorrow or even in the next quarter. We think it's a very elusive skill. We do have a macro investing team that does try to figure out shorter-term issues in markets and take advantage of those anomalies, but it's a tough skill to demonstrate.
With all of those caveats, yes, I would say that most people have been quite surprised about the rally in markets until this morning. Clearly, there's been a significant correction today in adjusting for that. Part of it has been clearly driven by the amount of stimulus that has been provided by the fiscal and monetary stimulus, including, anecdotally, in the U.S. the record number of smaller investors opening accounts and putting money into the market. We've seen extraordinary rallies in the stocks of bankrupt companies. We've seen extraordinary rallies in the stocks of well-known companies. There's some evidence that people are taking their cheques in the U.S. and putting them into brokerage accounts. I hope that doesn't end badly for a lot of people. I do hope they have been prudent in how they've invested their stimulus cheques, but it is an issue and something that we have looked at.
What can we do? We can make sure that we are really focused on our first two skills and are really focused on stress-testing the portfolio. We're really focused on making sure we have a properly diversified portfolio so that all our eggs are not in one market, one basket, one geography, one asset class or one strategy. It is properly diversified across multiple different markets, multiple different time zones and multiple different assets. If something pops in one area, then hopefully other markets are less immune to that. That's the benefit of diversification. Secondly, if we pick the right stocks over the wrong stocks, it doesn't matter if the whole market goes down; we've still made money.
Finally, as I said earlier, we run stress tests. What would happen if tomorrow the global financial crisis happened? What would happen if worse than that happened? We disclose those on page 163 or 164, I think, of the annual report. We go through those stress tests and how we shock the portfolio.
It's an excellent question.
The risk of inflation is real. It's quite possible. There have been massive deflationary pressures for years, whether they're from demographics, technology or globalization. Those things have resulted in deflationary pressures generally around the world. I think the first two forces are likely to stay in place. There is a question mark as to whether the third one is going in reverse. It could exacerbate a potential inflationary pressure over time.
As a fundamental forecast, we're not predicting, as a base case, inflation. If we look at world inflation, we expect inflation in our central economic forecast to be about 2.4% for 2022-23 and 2.5% for 2023-24. Inflation in Canada is similar, so in the 2.5% to 2.6% range, and in the U.S. it's 2.9% to 3.0%, in that time frame.
That's the central forecast. There are clearly risks. We publish interest rate sensitivity in the annual report, on page 165, and we show that if you hold all the other variables constant, a move of 25 basis points in nominal risk-free interest rates would result in an increase or decrease in value in the portfolio of about $2.5 billion. That's as of March 31. That's the sensitivity, basically. It's about $2.5 billion of sensitivity to the debt instruments in the portfolio. Putting it through the rest of the portfolio is a complicated exercise, but again, part of it would be making sure we have a diversified portfolio, sufficient investments in inflation-protected assets, a substantial real assets portfolio and substantial investments in equities, quite of few of which will perform reasonably well even in an inflationary environment.
Yes. That's a terrific question.
One of the things I did when I sat in my seat as CEO four years ago was to focus on our private market valuations. We had pretty good private market valuations, private asset evaluations, but we wanted to make sure that they were world-class. When my chief financial and risk officer, Neil Beaumont, arrived, we sat down shortly after he was hired and said, “Okay, we're going to make this approach really world-class.”
We said that we were going to make sure that we have independent teams of valuers who are incredibly rigorous, and they have the call, they have the pen—the investment teams don't have the call—and also that we have an incredibly rigorous and much more regular approach to private asset valuations. I didn't know that something dramatic would happen on my watch, but both of us looked at each other and thought, “The chances are, with this expanding recovery, it probably will happen on our watch.” We wanted to be prepared for it.
In fact, again, it's super lucky. If you go to our website, you'll see that on January 24, Neil Beaumont put up an interactive video showing how we do our private asset valuations and how had we improved and that this was the approach. We didn't know that we were about to hit a massive market event and would be able to test that process, but we're super glad that we did and super glad that we put it out for the public to understand how we were doing that approach.
As we came in through this and looked at it year-round, we took a really hard look and took some really tough marks on the valuation of our private assets, so they really do represent the value of those assets at that point in the market. They're a true representation of the value of those assets, whether it's private equity assets, real estate assets or infrastructure assets. There were some tough conversations, obviously, with investment teams that believed in the long-term value of these assets, but we wanted to make sure that they were truly right.
Also, then, we have an independent audit approach that comes in, makes sure and goes through a very large number of those assets again. They do their work to make sure that those really are robust valuations. We were quite satisfied with the fact that we had been.... My chief financial risk officer won't like me saying that we were “conservative” on it, but I think he would say we got the right valuations—
Yes. It's a really important question. It's one that we have teams working on across the fund, trying to identify those trends, not just the shorter-term trends but the longer-term trends.
Before I give a few more examples, we think that some of these trends will come back over time. I don't think travel and hospitality are over. I don't think sporting events are over. Even things like movie theatres, which are in some ways somewhat irrational.... We're social beings. We've seen time and again that while people can comfortably watch movies at home, comfortably eat at home, we want to go out. We all want to go out to the noisy restaurant because it has buzz. We want to go and sit in a movie theatre and share an experience with a bunch of people we're never going to talk to, but because there's more buzz in doing that—or maybe there's a slightly better screen—I think a number of these things that rationally maybe shouldn't come back are going to come back, in my personal view.
There may be some terrific opportunities in those sectors, and there have been. We will see. The markets have anticipated a number of these. We've seen, for example, the cruise line companies come back incredibly strongly since March 31. However, it's going to take time for the traffic there to pick up.
There are a number of things that we think will pick up over time, other than data centres, telemedicine and fintech online. I think online grocery ordering is something that is really only limited by capacity. I think quite a few of us have tried to get capacity for online ordering of groceries and have been frustrated by the fact that you just can't get it. Where it has been available, it has increased up to capacity. I think it's likely going to continue. People will continue to try to order online.
I do think, to your point, that the flexibility on location of staff will continue to stick. There will be more flexibility for people who have particular skills and particular expertise. They don't need to keep flying in and out of places or participating via long commutes.
I do think there will be more flexibility, and I hope that's the case. It will bring a lot more people, smart people, who've moved away from the typical centre into the knowledge workforce. I hope that will happen as well.
I'll lay out the next questioners: Mr. Barsalou-Duval will have two minutes, Mr. Julian the same, and then we'll go on to Mr. Morantz and Ms. Dzerowicz.
Before I do that, I do have a question on the oil and gas industry that partly spins off Sean's question. I do see our oil and gas industry constantly under attack. I believe that what we're seeing happen in Canada is that we're driving capital investment out of the country. We're driving human resources out of the country. We're driving innovation and knowledge out of the country. At the same time, the oil and gas industry is expanding elsewhere. We're not using the benefits of our natural resource to transition to a green economy.
We had a meeting this morning with the oil and gas industry in Newfoundland. What they told us is that there are 17 new finds in Norway. The investment isn't coming in to the offshore industry in Newfoundland, and, as a result, the working vessels, etc., are leaving Newfoundland and going to Norway.
There is a lot of politics around this, I know, but my question for you is really this: What are you seeing in terms of the global investment in the oil and gas industry? Is it increasing in other parts of the world? Are we the only ones driving it away?
Thank you very much, Mr. Chair.
Mr. Machin, if we look at the geographic distribution of investments made by the Canada Pension Plan Investment Board, we see that 64% of those investments were made in Canada in 2006, but that percentage falls to 15.6% in 2020. That is a very significant decrease. I understand that there is a desire to diversify assets. On the other hand, when you invest a lot of money abroad, you need to have a very good grasp of those markets.
First, I am concerned about the speed of this knowledge acquisition, given both the speed of this investment diversification, and the desire to limit risks.
Second, I'm concerned that there are almost no investments in Canada anymore. Of course, I am more concerned about Quebec, since I am a Quebecker and I want Quebec's economy to do well. How can you explain this decline in investment: is it because the Canadian economy is considered too risky or not diversified enough, or because you don't have confidence in it?
Could you explain how your investment strategy in Quebec differs from the one you apply in Canada, and give us an idea of the percentage of investments made in Quebec as compared to Canada?
As of the fiscal year end, we have around 15.6% of the fund invested in Canada, or about $63.9 billion. One of the purposes of the fund, as originally set up, was to diversify the portfolio into a global portfolio. When we started, what we inherited from our predecessor was 100% domestic investment in Canada, and so we've been diversifying that gradually around the world where we have found good opportunities.
That being said, we have substantial investment in Canada, and we will continue to have substantial investment in Canada. It's our home market, and we understand the risks here, but we are massively overweight versus any measure of Canada's weight from a global GDP perspective, which is around 2%, and from a global equity market perspective, which I think is around 2.6% of global equity markets, etc. Having 15.6% versus two and something per cent in Canada is massively overweight. We are quite comfortable with that. We probably will remain overweight for quite a while.
In Quebec, we have over $4 billion invested across equities and real assets and bonds. We continue to look for great opportunities in Quebec and in other provinces. We continue to look at some of the really vibrant companies in Quebec.
On our exposures to a wide variety of different types of companies, you mentioned, for example, tobacco. As well, in the U.S. some detention centres are privately run. As part of our efforts to widely diversify the fund, not only geographically but by asset, some segments of our businesses, some of our investment strategies, efficiently apply indices, which means that, to gain added exposures, we might put part of the fund in something that would mirror, say, the SNP500. In doing so, we would then capture some of these types of assets you referred to.
What's come to the fore for us is that.... Individually, these are very tiny exposures for the CPP fund in the context of $400 billion-plus; some of them may be one or two million dollars, because they're spread out across about 4,000 holdings. Even though we've had a very robust due diligence process on the wide variety of risks that would come our way when we make a direct investment in a specific company—a much larger position—we found there could be some exaggerated risks even if it's a small holding.
So we've applied the learning from the processes we've had in looking at large positions. We found tools that are able to identify where there could be exaggerated sources of risk, whether they're controversy risks, social or governance risks, or environmental risks. When those are flagged to us, even though there could be thousands, we're able to narrow them down to a few, and then we're able to apply a more rigorous, detailed assessment. In some of those cases, it's turned out we were not comfortable with the wide range of risk, and the example you provided around detention centres would be one of those cases.
In a situation where we've looked at tobacco companies.... By virtue of our mandate, we don't have broad, sectoral, broad-brush exclusions, so it is not consistent with the CPPIB Act to say we will not invest in tobacco, full stop. Having said that, it does allow us to take an idiosyncratic view if a particular tobacco company is behaving in a certain way that increases, for example, its legal risks. Then we are given the opportunity to do a deeper dive, and there have been instances where we were not comfortable.
At the end of all this process, the one thing that stands consistent is being true to the legislative mandate of making sure that when we are taking a position for the long-term returns we are also equally looking at the long-term risks associated with them.
Before I begin, I'd like to once again thank the members of the committee for their continued work during this particularly challenging period for all of us.
The pandemic continues, obviously, to have serious economic impacts across Canada. For many Canadians, the pandemic has brought about unprecedented uncertainty: uncertainty about their jobs and their financial security and uncertainty about making ends meet.
Today marks three months since the announced the first elements of Canada's COVID-19 response plan. From the very beginning, we've maintained an unwavering commitment to supporting Canadian households and businesses. We've rolled out measures for workers and businesses across all sectors and for employers of all sizes. We've worked and are continuing to work closely with local, provincial, territorial and indigenous partners to minimize the health, economic and social impacts of COVID-19.
Now, three months into the crisis, there are some encouraging signs in Canada that the spread of the virus is slowing down. Many provinces and territories in Canada are beginning to cautiously reopen their economies, something that the finance ministers are telling me in my weekly calls is really beginning across the country, but we're not out of the woods yet. COVID-19 continues to pose significant risks to Canadians and, of course, to our economy.
That is why our government continues to take action to reduce the impact of COVID-19. Our goals remain the same: to protect Canadians, support Canadian workers and businesses, and support our communities to ensure that Canada is ready to bounce back when we emerge from this crisis.
I'd like to highlight some of the measures we've recently announced.
Earlier this month, the announced that funding for the federal gas tax fund has been brought forward this year. The gas tax fund is a permanent source of funding that is provided to the provinces and territories. The provinces and territories then disburse the money to municipalities to support various local priorities.
Usually, the federal government transfers the money in two instalments, one during the summer and the other a few months later. We know that this year the municipalities need the money now so that they can deal with the crisis caused by COVID-19.
In the next few weeks, $2.2 billion from the federal gas tax fund will go to Canadian municipalities: money that will help municipalities move forward with infrastructure projects that will improve quality of life, help restart local economies and create good jobs. We understand that more will be needed to help municipalities, as many are facing significant COVID-19-related financial pressures, but we know that this is an important first step. We'll keep working with provinces and territories in order to help support municipalities.
As the provinces and territories gradually get their economies back on track, our top priority remains protecting the health of Canadians. That is why we have begun negotiations with our provincial and territorial counterparts to ensure that any reopening takes place while protecting the health of Canadians and minimizing the risk of transmission of the virus.
In particular, we are working with the provinces and territories to ensure that all Canadians can have paid sick days. People need to be able to stay home if they have symptoms of COVID-19 without worrying about how they're going to pay their bills.
We also continue to ship equipment across the country, such as surgical masks and gloves, and provide support to the provinces and territories in testing for COVID-19.
As we continue our discussions with our provincial counterparts to make sure Canadians can get back to work safely, we'll also be focused on the following areas: testing and contact tracing; making sure there is personal protective equipment, so Canadians are safe on the job; support for child care; support for vulnerable people, like those in long-term care facilities; and support for cities and municipalities. We know we all need to work together.
Throughout the pandemic, one thing has been clear: we've all been touched by this crisis.
Last week, the announced that seniors eligible for old-age security in the guaranteed income supplement will receive their special one-time tax-free payment during the week of July 6. Seniors eligible for the OAS pension will receive a payment of $300. Those eligible for the GIS, who are the most vulnerable, will receive an additional $200.
The pandemic has also heightened and highlighted the additional challenges already facing indigenous peoples in our country. We're working with first nations, Inuit and Métis communities to address their specific needs. Since we last met, our government has announced additional funding to support indigenous peoples. This includes an additional $75 million in supports for organizations that provide services to indigenous people in urban centres and off reserve, and an additional $650 million to support communities on health care, income support and new shelters for women.
This builds on measures already announced to support the public health response in indigenous communities, as well as the support to indigenous businesses and aboriginal financial institutions.
The measures to help Canadians that were recently announced, and which I just mentioned, are in addition to the measures that were previously put in place. These are measures that we continue to improve. For example, we continue to improve the Canada emergency wage subsidy. Last month, we proposed that the program be extended to August 29.
In recent weeks, the government has also held consultations with representatives of business, labour, non-profit organizations and charities. We want to see what improvements can be made to the program. The Canada emergency wage subsidy has already helped more than 2.6 million Canadians keep or return to their jobs.
The key objectives of any potential changes to the Canada emergency wage subsidy would be to maximize employment to ensure that the program reflects the immediate needs of employers and to support the post-crisis economic recovery.
Overall, our government's swift and comprehensive actions through the COVID-19 economic response plan are providing more than $150 billion in direct support to Canadians. This, coupled with liquidity support of $85 billion through tax and duty deferrals, represents support equivalent to more than 10% of our GDP. This has put Canada at the forefront of our international peers in the robustness of our response. We've done this because we believe that, by investing in Canadians now, we stand well prepared for success in the economic recovery to come.
While there is reason to be optimistic, we must all continue to take precautions to control the spread of the virus. As provinces, territories, municipalities and businesses begin to gradually reopen, we'll stand ready to support them to make sure Canadians remain safe and supported. Our government will be there with Canadians every step of the way.
I would now be pleased to take questions from the members.
Thank you, Minister, and thank you for being here.
I would also like to greet all the teams from the different departments who are with us at the end of this afternoon.
Minister, this morning, I met with some representatives of the creative sector such as stage workers, musicians and technicians. This sector has ceased its activities and it will be a very long time before it starts up again. Almost all of these workers are self-employed workers who are not eligible for the Canada emergency wage subsidy.
They are asking you to do three things: first, to recognize the importance of the creative sector; second, to extend the Canada emergency response benefit, at least for sectors like theirs, because those who are living this reality have nothing else; and third, to insert a mechanism to allow them to qualify for the Canada emergency response benefit so that they don't lose everything if their income exceeds $1,000 a month.
What would you have to say to them?
Thanks to our witnesses for being here today. We hope your families are safe and healthy.
Thank you, Mr. Morneau, for coming back yet again to the finance committee. Through this crisis, you've been very available not only for meetings with the finance critics, but also with the finance committee. The meetings are not always easy, but we appreciate your availability, and certainly your ear.
My first question is very simple. We've been told by OSFI that, in terms of liquidity support, Canadian banks have received access to about $750 billion in liquidity support. That's three-quarters of a trillion dollars. As you know, they have made $5 billion in profits thus far during the pandemic, but we are hearing from small businesses that can't access credit. We are hearing from people who are seeing their lines of credit and their credit card numbers going up. There are penalties and fees being imposed by the banks, and folks are paying interest charges that are, frankly, unreasonable in a pandemic.
My question is very simple. With all this largesse, this $750 billion in liquidity support, why have you not imposed any requirements on the banks to actually provide support to people who are trying to survive this pandemic?
Thank you for your continued focus on how we can support Canadians.
I would say that in fact we have pushed hard for the banking sector to support its customers, and of course that means supporting Canadians. We worked hard to encourage the banks to get to an ability for those in challenge with their credit cards to defer their credit card payments and to take down the interest charges. In most cases, they're now half of what they were before the pandemic. I think that was certainly a positive step for us working together.
I think in terms of the liquidity that we put in the market for banks to use, I'd just like to give you some statistics.
According to the Bank of Canada, total business financing growth increased to 10.7% in April from 7.4% in March. Loan growth was very strong at 30%, driven by non-mortgage loans. These figures don't include the now over 665,000 businesses that got the CEBA loan. I'll also tell you that this week the big six banks reported payments deferred on $67 billion worth of loans.
Mr. Julian, I will always be working hard to push the banks to make sure that they're supporting their customers. We are absolutely expecting everyone to play a part in this challenge.
The money we've put into people's hands directly, supplemented by those loan deferrals, means we've very much filled an important gap in the economy, but there is more to do. We will be expecting all participants to do more to help us get through this.
I just have a couple of points, Minister. On the economist that Ms. Dzerowicz mentioned, her key line was—I think it has a nice ring to it— that “child care is the secret sauce to recovery”. She explained in her evidence that “the secret sauce to recovery” means that if women got child care, they could get back into the workforce, etc. That has a nice ring to it.
There was a witness on June 4, and if there's one thing I can really congratulate you, the and the cabinet on, it's a willingness to basically change the programs to make them work as new information comes in. I know you're trying to do that with the wage subsidy, but one company that was before us on June 4 was Brandt Tractor—I know that Finance has this information—which employs 3,200 people. Their problem is that they actually bought out another company last year. If both companies were operating on their own, they would both qualify for the wage subsidy, but because they purchased this other company, that affects their revenue, so they don't have required drop in revenues to access the subsidy. They are an example that I know you're trying to fix. They're not the only company in that situation, but I just draw that example to your attention because they were a witness before the committee. They're a strong Canadian company, and they were very worried about their 3,200 jobs. This is in the evidence. I know that it's gone to Finance, but it's in the evidence for June 4.
With that, I again sincerely want to thank you for today, and also for the reports you give us. There is a lot of information. As Julie said, it is really unbelievable the amount of programs that have been rolled out and the changes that have been made to them as we roll along. There are still people falling through the cracks—I know that—but we thank you for your efforts. We know that you're working long hours and working hard.
With that, thank you for appearing before us again.
I have two questions for the Department of Finance and three questions for Mr. Carter.
As a comment to CRA, I'm glad you put that out. These are all elements covered under the Criminal Code already. The police can already do a follow-up when it comes to systemic fraud or people misusing social insurance numbers. I'm glad you have publicly said that. That's very important.
My comment would be that we have publicly available information around the Bahamas papers, the paradise papers, the Panama papers, the Isle of Man scam. No corporation has ever been charged, let alone convicted. I think it's a bit rich to focus on widows and students who may have inappropriately gotten the amount.
My questions are first for Mr. Carter.
You mentioned Trans Mountain. The construction costs obviously have to be revised. I'm a few blocks from Trans Mountain and there's not a single person in the Lower Mainland who believes that the costs will not be anything less than 50% higher than what you're projecting. I think it's about time that Trans Mountain did a revised construction schedule. My question is this: How much did we lose on Trans Mountain, including interest payments last year?
In terms of the LEEFF program, I have two questions. First off, how does CDEV intend to monitor executive bonuses and all of the things that are supposed to be conditions around the LEEFF, such as not to issue executive bonuses? What is the process in terms of LEEFF loan forgiveness? We've seen a lot of loans that have turned into grants and gifts in the past, even in January of this year. What would be the process if a company just wanted their loan forgiven? Is it the finance minister going to the board? Is it the board making a recommendation?
I have two questions for the Department of Finance.
Could I have some clarity around the supplementary unemployment benefits? There is still inconsistency about whether or not somebody on the CERB can receive a SUBP. We're hearing from other ministries that they can't. We heard from Finance that they can.
Last, I have a question on ferries as designated organizations. I'm thinking of BC Ferries. Where are we in designating ferry companies as organizations that are able to obtain the wage subsidy?
Thank you very much.
The issue with the personal account has to do with essentially what is referred to as knowing your client. When a business sets up an account as a business bank account, the financial institution they deal with will go through a vetting process. They'll be looking at various websites from an anti-fraud, anti-money laundering perspective, looking at the specific name of that business, looking at the articles of incorporation, looking at the beneficial owners and any connections that business might have to malfeasance. It is the responsibility of the financial institution to have a very good fix on what that entity is.
It also knows that whatever transactions are happening in that account are happening specifically in connection to the business activities. Again, from a money-laundering perspective, you have a clear understanding of the cash flows and the relationship they have to what are specifically business activities.
As you move to a personal account and individuals who are conducting business from a personal account, a couple of things happen. One is you simply do not have the same association with the business name as does the financial institution that has gone through the vetting process. The process they go through in order to get themselves comfortable with an individual involves a considerably more limited degree of scrutiny.
The other thing is that if you're looking at the account from a transactions perspective, what you're likely to find is that there are commingled transactions, where somebody may have been paying for a family dinner and then perhaps on other occasions they're using the account for activities that are very focused on their business purposes. It becomes, for practical purposes, impossible to disentangle those, which just goes to not understanding that entity quite as well.
When it comes to the Canada emergency business account program, because the program was designed to move very, very quickly to make funding available to its recipients, it had to rely on certain points that were very, very easy to validate. That was one of the critical elements of its success in moving as quickly as it did. It was really for that reason that, among other things, it needed to rely on the fact of that existing business banking account.
Thank you. I appreciate the technical reasoning.
I asked about that, because I have heard from a number of constituents who use their personal account that they've obviously had difficulties obtaining the support of CEBA, and they need it right now. I know this matter is being looked at. The minister has been very good on this and is seized with the issue, but I raise it on behalf of constituents, because they have worked hard. It has made very good business sense for them to have a personal account rather than a business account. They could not have predicted COVID-19. They could not have predicted the requirement that our government put in place with respect to CEBA privileging the business account over the personal account. I just raise it because I have heard it a number of times in the constituency. However, as I said, the minister has been quite strong on this.
We as a government continue to adapt to fill in the gaps. We are flying the plane and building it at the same time.
There is something else I want to ask, and this is for any official who wishes to take it.
You would, of course, have seen the recent changes that were introduced by the CMHC when it comes to mortgage rules, and specifically the lending requirements that are in place when it comes to securing CMHC support for insuring mortgages. To what extent is the Department of Finance concerned about household debt and its potential negative impact on the economy?
I know this has always been a concern. It's been a concern in finance. It was a concern on the part of the former governor of the Bank of Canada, and that was pre-COVID-19. With COVID-19 and its impact on the economy, I wonder if anyone from the Department of Finance could speak to what this all means for household debt levels that have seen Canadians already in a very difficult position when it comes to making mortgage payments.
Obviously, this has been highlighted as a key risk to the Canadian economy going into COVID-19. I think the fundamentals are pretty clear to everybody. Canadians were bearing a pretty heavy debt load in relation to their income. Probably the best flagship measure is the debt-to-income ratio that Canadian households carried into the crisis.
For fundamental reasons, we wanted to have a lower debt load so that when we endured the crisis, Canadians would be able to smooth their consumption effectively by taking on more debt. In that position, we've endured the crisis. Notwithstanding some of the very generous government support programs, Canadians are going to have to take on more debt to fund not just their essential needs, but some non-essential needs, such as paying insurance or putting gas in their car. That debt level is going to creep higher.
Just on a nominal basis, there isn't some optimal level of debt for any household to carry. I think we're probably overly fixated on the number. In the same context, Canadians' ability to service that debt will be relaxed with lower interest rates and longer amortization periods or mortgage deferrals.
It's definitely something we need to keep our eye on. As we recover through this crisis there will be another crisis around the corner, and the same expectation will be that Canadians will have the opportunity to deleverage. Then, when they need to make ends meet during the next crisis, they might have to take on more debt at that point in time. It's something we always keep our eye on, but we do it, I think, in balance with other vulnerability metrics.