REGULATION
1. Corporate Governance
2.
The Criteria and Processes for the Incorporation and Regulation of Financial Institutions
3.
Regulation of Financial Service Providers Operating Outside Canada
4. Revisions to Mandate of OSFI
5. Revision to Governance of OSFI
6. CompCorp and CDIC
7. Eliminate
Regulatory Overlap Between OSFI and CDIC
8. Eliminate
Overlap Among Federal and Provincial Governments
9. Streamlining of Federal
Regulatory Procedures
10.
Publication of Information About Financial Service Providers by OSFI
SECTION E
REGULATION
Background
The Committee has had a long-standing interest in issues of corporate governance. In August 1996, the Committee tabled its report, Corporate Governance; in November 1998, its report, The Governance Practices of Institutional Investors. The former focussed on corporate governance issues in the Canada Business Corporations Act; the latter, on the corporate governance practices of pension funds and mutual funds. Both reports contained recommendations designed to improve the corporate governance practices of Canadian business. Further, in its October 1998 report, Comparative Study of Financial Regulatory Regimes, the Committee put forth specific recommendations related to the establishment of sound corporate governance structures by financial institutions.
It is the view of the Committee that corporate governance in the financial services sector – the system by which financial institutions are directed and controlled – is a matter of key importance to the stakeholders of those institutions in particular, and to the smooth operation of the economy in general. The directors of financial institutions should be held responsible for the performance of their organisations.
More specifically, recommendation 15 of the Committee’s 1996 report, Corporate Governance, called for the separation of the positions of chairman of the board and chief executive officer in publicly traded CBCA corporations.
The Task Force was obviously in agreement with the views of the Committee. It argued that it is important for financial institutions to have sound corporate governance practices. These, it stated, are the foundation of a sound, competitive financial services sector. It also adopted the specific recommendation with respect to chairman of the board and the chief executive officer.
Task Force Recommendations
2) Sound corporate governance practices in individual institutions lie at the heart of ensuring a Canadian financial services sector that is both competitive and prudentially safe and sound. In light of this:
(a)The Task Force urges OSFI and other Canadian regulators to emphasise the constant improvement of corporate governance in their regulatory work.
(b)The Task Force encourages further active public discussion of ways to improve the governance of publicly traded Canadian financial institutions, including the requirement that there be a non-executive board Chair with adequate resources and time to fulfil the important responsibilities of such a position.
Views of Witnesses
Little was heard from witnesses about corporate governance issues. The Canadian Institute of Chartered Accountants did say:
… we would like to note the role played by depositors and non-participating policyholders in financial institutions gives rise to some unique governance issues. We question how the particular roles of depositors and policyholders will be addressed in the broader study of corporate governance taking place as part of the CBCA reforms. A more focussed study might be needed to address the unique governance issues presented by depositors and policyholders. (Graeme K. Rutledge, October 6, 1998)
Conclusions
The Committee welcomes the support the Task Force has given to efforts to improve the corporate governance of financial institutions in Canada. Further, it is in agreement with the witness from the CICA about the need for a more focussed study to address the unique governance issues presented by depositors and policyholders. The Committee will address these issues in a separate study.
2. The Criteria and Processes for the Incorporation and Regulation of Financial Institutions
Background
One key feature of a competitive market is ease of entry to those who are interested in offering competition to existing providers of goods and services. While the American financial services market is characterised by numerous local start-ups of small banks fostered by flexible start-up requirements – there were 207 commercial banks started in the United States in 1997 – the Canadian banking sector has been classified as relatively difficult to enter. In fact, the MacKay Report cites a Global Competitiveness study in which Canada was ranked 41st out of 53 countries with respect to foreign bank competition and 39th out of 53 terms of ease of entry into banking. (Task Force Report, Background Paper #1, p. 69)
It is important to create an environment in which new entrants, and even the threat of new entrants, force incumbent firms to be vigorous competitors. However, for prudential reasons, the current regulatory system places impediments in the way of new start-ups.
There is a trade-off that exists between encouraging new entrants and creating institutions that have a higher probability of running into serious problems than those who enter under a more stringent regulatory regime.
Task Force Recommendations
4) The criteria and processes for the incorporation and regulation of financial institutions should be revised to facilitate the establishment and growth of new financial institutions. Specifically:
(a) The Minister of Finance should have discretion to allow a new financial institution, including a bank, to incorporate with less than the $10 million in capital currently required, subject to approval by OSFI of the institution’s business plan.
(b) OSFI should streamline its processes to ensure that applications for approval of the establishment of new financial institutions are processed as efficiently as possible and within a period of time not to exceed 120 days as the norm.
(c) Ongoing regulatory requirements should be revised from a "one size fits all" policy. The administrative burden of regulation for smaller or niche institutions should be commensurate with their size and the nature of their business activities, and not determined by requirements designed for large multi-product financial conglomerates.
124) Canada should continue to play an active role in international initiatives to improve standards and processes for the regulation of financial institutions and, where required, should make timely changes to Canadian financial sector legislation and regulatory practices to implement international best practices.
Views of Witnesses
With respect to what activities should be regulated, there was general agreement that, if an institution does not accept deposits, is not covered by deposit insurance, does not expose the government to risk, and does not expose the financial system to risk, that institution should not be regulated like a bank. Keeping the regulatory burden on such businesses to a minimum will make it easier for new participants in the financial services sector to enter and provide financial services to Canadian consumers and businesses.
The witness from GE Capital stated:
… consumers and businesses will be best served and the services will be provided in the most efficient way by a financial services sector which is maximally competitive and minimally regulated. Use regulation only for prudential purposes to ensure safety and soundness of the financial system, and only to the extent necessary to protect unsophisticated depositors and policyholders and to limit government exposure to risk. Otherwise, allow competitive market forces to operate freely, subject only to the laws of general application governing market behaviour by business.
Let banks, if they wish, extend the services they can offer to their customers, but be sure to remove all impediments to other providers of financial services, domestic and foreign, that can offer alternatives to Canadian consumers and businesses. (Robert D. Weese, October 7, 1998)
Specifically, with respect to entry into the regulated financial services sector, one witness from a recent entrant addressed the obstacles his institution faced gaining entry.
If you look specifically at ING Direct`s problems, the most poignant of which is not so much the normal obstacles of what you would need to enter as a regulated financial institution into the marketplace, but rather the lack of transparency in the rules and the guidelines. It would seem to me that if we are asking people to invest hundreds of millions of dollars, there should be clear guidelines about what you need to do to accomplish certain tasks and tests that would ascertain the security, safety and integrity of the institution.
As we go forward and develop new kinds of models for the regulatory environment, the payment environment and certainly CDIC, we should keep those factors in mind so that more institutions like ING can come into the market and enhance competition to Canadian consumers` benefit. (Arkadi Kuhlmann, November 5, 1998)
The head of one of the big chartered banks supported initiatives to encourage new entrants.
I believe that the MacKay task force report raises the legitimate point of encouraging the formation of second-tier financial institutions in the country. We have quite a bit now with caisses populaires, credit unions, et cetera. Anything that is helpful to promoting those types of boutique or local community banking type players is a plus. I would applaud that. I would ease up the rules surrounding the creation of domestic institutions. I would allow some of these smaller players into the payments system. (Matthew Barrett, October 8, 1998)
Some were quite optimistic about the potential for entry if the rules are changed.
There have been more start-up banks in the U.S. in the last five years. And these are all state banks. They are very small banks; they are community-minded banks, recognising they also have some of the mergers — Bank America, Nations Bank.
They have got a CRA, Community Reinvestment Act, of course, in place; it is not working. But they are opening state banks every day. The OCC, the thrifts, the Federal Reserve are competing for financial institutions, trying to encourage people to start banks, licensing them.
And they are community banks. In Canada, you do not see that because of some of the restrictions. You can start a bank in the U.S. for a couple million dollars, depending on what you want to do with regards to the capitalisation, what you want to do in the community.
In Canada you are talking $10 million probably from a minimum standpoint to start an institution. And again, from a regulatory standpoint, very, very difficult. So getting back to your point is that I do not know whether there is 300 or 400 small community banks that have started up in the last few years in the United States.
In Canada, it is not happening. It could happen. It could happen very quickly, from that aspect, but it is going to require some changes in regulation. And in the United States, FDIC insurance down there is $100,000 U.S. which equates to maybe 150 — I have not checked the foreign exchange this morning.
We are still looking at a $60,000 CDIC limit outside of our credit unions that will, through their own insurance corporation, guarantee 100 per cent or, indeed, of the opportunity of provincial guarantees. So it could happen very quickly. It is a matter of regulation.
There is capital in Canada and entrepreneurialism which start community banks, I believe, if the regulatory environment was more conducive to that, as it is in the U.S. (Warren Hannay, November 3, 1998)
With respect to lower capital requirements for new entrants, one witness from a small Canadian bank argued that:
… I do not think the system of determining how much reserve each institution actually needs is a system we should be lax in. I think you need it because in the long-run, if you allow some institutions to start up that do not need reserves and do not need much capital and they fail, it will hurt the other ones going forward because no one will want to lend them capital any more, the regulators will get nervous, the CDIC insurance premiums will go up so it hurts you in the long run …
… If you are setting guidelines for banks to start up in Canada, there should be minimum limits set on the capital and a leverage test of some kind … If you just say, like they do in the U.S., you can start up a bank with $4 million in capital you see a lot of risk there in the initial start-up phase. (Larry Pollock, October 28, 1998)
The Canadian Bankers’ Association urged caution with respect to raising the level of risk in the system.
We agree with the task force's emphasis on more competitors in the market-place, but we also caution that policy makers must take care as they pursue this goal. Fostering the creation of more deposit-taking institutions can result in additional risk in the system since there is the greater potential for institutional failures. Indeed, the task force fully expects and accepts that there would be failures. However, failure does have its costs, particularly when institutions are deposit-insured. Although the new risk-related premiums being introduced by CDIC may help to better allocate risk among CDIC members, there remains a concern that sounder institutions will bear a significant part of the costs of any failures in the future. (Raymond Protti, September 29, 1998)
The Superintendent of Financial Institutions spoke directly to the trade-off between competition and risk.
The Task Force is recommending that a number of changes be made to increase the number of entrants, the number of players in the financial system, reduce capital requirements, streamlined applications, the streamline processing of applications by OSFI. It talks about lighter regulation for small institutions.
There is nothing wrong with any of those recommendations, but taken together, they increase the prospect that there will be risky institutions within the system. … Institutions with relatively low capital levels sometimes have had, we think have had a higher failure rate simply because they are smaller and cannot diversify their activities.
So if you have a number of risky institutions, a number of more failure-prone institutions in the system, then what do we do? One option is to simply do nothing, is to take the position that we have got a very safe and sound system now. Indeed, the MacKay report points out that on the spectrum of countries, Canada has one of the safest institutions and I think safest systems, and the implication is that maybe we can afford to give a little in terms of safety and soundness to have the benefits of greater ease of entry and more players, and that is a perfectly legitimate position to take as long as Canadians understand that is the position, and more parochially, as long as they understand that OSFI will not be able to prevent some of these new entrants, some of these new players from failing.
Another response is to say, is to go beyond the "do nothing" stance and to say, okay, because we are going to allow more riskier, slightly riskier, more risky institutions into the system, we are going to add to the powers of the regulator in order to reduce the chances of failure that might otherwise occur, and these could be in the form of the ability to assess additional capital. There could be a number of steps. It could be even tougher early intervention powers to move these new institutions out of the system when they get into difficulty.
So there is a number of responses, but all we want to point out is that Mr. MacKay, the MacKay Task Force is shifting the balance slightly between competitiveness and safety and soundness and to ensure that Canadians understand the implications of that. (John Palmer, November 3, 1998)
Finally, one witness was sceptical about introducing real competition to core banking services (which he defined as cashing cheques, making deposits, Interac transactions, and retail loans and loans to small business) while another argued that changing technology has changed the whole nature of entry.
The report talks about removing regulatory barriers to entry in order to further competition. It needs to be stressed that most of the barriers against entry into core banking services are not regulatory barriers. They are technological and marketing barriers. It costs a zillion dollars to go from being a non-player to being a player in core banking services. The consequence of that is that no matter what you do from a regulatory standpoint, you are not going to see many significant, new domestic players in core banking.
…
For most of those core banking services you have some non-regulatory obstacles, which means you are not going to get significant new players, no matter what you do from a regulatory standpoint. That is a good reason to facilitate entry of foreign players, but it is a mistake to assume that whatever is done to facilitate that will mean substantive new competition in those services. (William Black, October 21, 1998)
Conclusions
Committee objective 1 focuses on the safety soundness and integrity of the Canadian financial system; objective 2, on fostering competition within that system. There is a clear trade-off between the two. Most observers of the sector argue that competition needs to be encouraged. Easing entry is a direct way of addressing this issue, but with the implication that additional risk will introduced into the financial system.
It is the view of the Committee that measures recommended to encourage competition will entail some modest added risk to the system, but that the expected benefits to consumers and businesses from the added competition justify the added risk. Further, while the Committee recognises that regulation cannot prevent all failures, if OSFI is provided with adequate resources to monitor the new entrants, the added risk to the system should not be a problem.
The Committee supports the recommendations of the Task Force with respect to the criteria and processes for the incorporation and regulation of financial institutions. The Committee recommends, in addition, that OSFI be provided with adequate resources to permit it to monitor those institutions that enter the regulated sector under less stringent conditions than existing institutions face.
3. Regulation of Financial Service Providers Operating Outside Canada
Background
Technology has broadened the options available to firms around the world to offer products and services in places where those firms do not have a physical presence. Most governments, however, continue to rely on existing laws and regulations to protect consumers physically resident in their respective countries and to regulate businesses with a physical presence in their countries. The implication of this situation is that providers of goods and services who have no physical presence in Canada are able to engage in transactions with Canadians, while at the same time, avoid compliance with Canadian legislation and regulation. As a specific example, Wells Fargo, a U.S. bank with no physical presence in Canada, now provides loans to small business in Canada based entirely on the use of the mail service. Wells Fargo is not considered to be undertaking any banking business in Canada. This makes no sense.
To effectively deal with this situation, the Task Force calls for international co-operation and warns that premature domestic regulation may stifle innovation and experimentation.
The Task Force based its recommendations on dealing with foreign providers without a physical presence on three objectives:
(i) provide Canadians with the broadest range of financial service providers and products possible.
(ii) ensure that as much information about providers as possible should be made available so that Canadians can make informed choices. and
(iii)set up a regulatory regime that is workable and will not discourage entry into Canada. >
The Task Force distinguished financial sector firms seeking to attract funds from Canadians in the form of deposits or premiums from those that wish to lend money to Canadians. The former would require a much stricter regulatory regime than the latter.
Task Force Recommendations
7)There should be a clearer regulatory framework within which providers of financial services from outside Canada can do business with Canadians. See Recommendation 119.
119)The Bank Act should be amended to make it clear that all providers of financial services that undertake mass solicitations or target marketing of financial services to Canadians without establishing a physical presence in Canada are required to comply with federal financial institutions legislation. For a lender, such compliance would entail the need to obtain certification from OSFI, which would be available upon the lender’s filing a binding undertaking to comply with consumer protection rules applicable to banks in Canada, to disclose that it is not regulated in Canada, and to provide a mechanism for dispute resolution in Canada.
120) The certification process would not be available to financial services companies wishing to take deposits from, or sell insurance products to, Canadians from outside Canada. Such providers would continue to be required to conduct these activities through a regulated Canadian subsidiary or branch.
Views of Witnesses
This was not an issue directly addressed by witnesses.
Conclusions
It is the view of the Committee that the current situation is unacceptable. In particular, there is no assurance that objective 4, consumer protection, will be adequately addressed if the government does not act. Since most "offshore" financial service providers can be expected to be American firms, it is incumbent upon the government to work with American policymakers to develop a joint policy to deal with such providers.
The Task Force recommendations require an offshore institution to voluntarily submit to Canadian oversight of its activities in Canada. What can Canadian regulators do if an offshore provider chooses not to follow Canadian directives?
The Committee recommends that the government develop a concrete proposal for discussion with American policymakers to deal with "offshore" financial service providers. The policy should enable Canada (or the United States) to ensure that the rules and regulations governing financial service providers in Canada (or the United States) are respected by those institutions providing financial services in Canada (or the United States) when they have no physical presence in Canada (or the United States).
Once such a policy is developed on a North American basis, it should be extended on a bilateral, or multilateral, basis to other countries wishing to deal with this issue.
4. Revisions to Mandate of OSFI
Background
Until 1996, OSFI did not have a legislated mandate. In its November 1994 report, Regulation and Consumer Protection in the Federally Regulated Financial Services Industry: Striking A Balance, the Committee recommended that the mandate of OSFI be clearly spelled out. The Department of Finance, in a White Paper published in 1995, agreed that OSFI should have such a mandate. In the absence of a clear set of legislated objectives, there is no defined standard against which to hold OSFI accountable to Parliament and to the Canadian public, or to measure its performance. As a result, the OSFI Act was amended and now sets out the mandate of OSFI which is to:
(i) supervise financial institutions to determine whether they are in sound financial condition and in compliance with the law;
(ii) advise management if this is not the case and require remedial action to be taken;
(iii) promote the adoption by management and boards of directors of risk control policies and procedures; and
(iiii) monitor events at the industry level that may negatively affect the financial condition of institutions.
In carrying out this mandate, OSFI is instructed to strive to protect the interests of depositors, creditors and policy holders while at the same time "having due regard" to the fact that financial institutions must be allowed to compete effectively. The Act also recognises that it is not OSFI’s role to prevent failure at all costs; that management and the board of directors of the financial institutions are ultimately responsible for financial institutions; and that the competitive environment in which they operate necessitates the management of risks and may lead to failure, notwithstanding regulation by OSFI. The purpose of the OSFI Act itself, as opposed to the mandate of OSFI, is stated as ensuring that financial institutions are regulated in order to contribute to public confidence in the Canadian financial system.
Along with its new mandate, OSFI adopted a mission statement, which reads in part: We are the primary regulator of federal financial institutions and pension plans. Our mission is to safeguard policyholders, depositors and pension plan members from undue loss. We advance and administer a regulatory framework that contributes to public confidence in a competitive financial system.
OSFI’s attitude toward competition is probably best summed up by comments on the subject contained in the 1995-96 Annual Report:
OSFI’s competition objective does not call for the active promotion of competition but rather an awareness that excessive regulation and supervision can stifle competition. OSFI must find ways of accomplishing its other objectives in a way that does not unduly impair the level of competition among financial institutions in the Canadian marketplace and the competitiveness of services available to the Canadian public.
OSFI views its competition objectives as consisting primarily of monitoring the regulatory burden imposed on financial institutions, reducing regulatory overlap and duplication where possible, and developing performance measures for competition of regulated institutions and OSFI’s impact in that area.
The Task Force believes that OSFI has interpreted its mandate correctly but that the mandate needs to be strengthened and improved.
The Task Force believes that the current mandate of OSFI is deficient in three respects. First, … the current mandate does not reflect OSFI’s role with regard to consumer protection. In view of the recommendations that the Task Force is making to strengthen this role, it becomes even more important to recognise it in a statutory mandate. Second, the mandate does not adequately reflect the need to balance safety and soundness considerations with the desirability of facilitating effective competition in domestic financial markets by recognising the importance of competition in carrying out the regulatory mandate. This is particularly so with respect to reviewing applications for entry and proposals by existing institutions to introduce new and innovative ways of serving customers. Third, the Task Force is of the view that the OSFI Act’s reference to protecting "creditors" in addition to depositors and policy holders is confusing and unnecessary. (This section based on Report of the Task Force pp. 177-178)
Task Force Recommendations
112) There should be revisions to the OSFI statutory mandate to better describe its ongoing responsibilities with regard to the federally regulated financial services sector.
(a) OSFI should have a clearly defined statutory responsibility to administer the consumer protection provisions of federal financial institutions legislation, including legislation in respect of disclosure and transparency, privacy and coercive tied selling.
(b) Given the importance of effective competition in the Canadian financial services sector and the rapidly changing competitive environment, the OSFI mandate should be revised to make it clear that OSFI has the responsibility to balance competition and innovation considerations with its present statutory obligations in respect of safety and soundness.
(c) It should be made clear in the OSFI mandate that OSFI is required to protect the rights and interests of depositors and policy holders, but that it has no special responsibility to other creditors of financial institutions.
Views of Witnesses
The Committee did not receive testimony supportive of these recommendations.
On the consumer protection mandate for OSFI, the Consumers Association of Canada argued that:
Care will have to be taken to ensure that OSFI is not put in a conflict of interest situation. The OSFI has the task of ensuring the long-term viability of the financial services sector. CAC would be concerned if this duty were allowed to override the consumer protection function of the office. For this reason, it may be useful to consider setting up a special arms-length office of OSFI to deal with the consumer protection aspects of the recommendations. (Jennifer Hilliard, September 30, 1998)
M. Martel of the Quebec Securities Commission was more definitive; he did not see a role for OSFI in consumer protection.
As regards the new consumer protection role that we would like the Office of the Superintendent of Financial Institutions to play, we wonder whether the tasks force's proposals are realistic.
OSFI is a prudential organisation — I believe the MacKay report acknowledges this fact — whose culture and expertise have developed accordingly. Its priorities, reflexes and instincts are naturally directed toward safety, compliance with the undertakings of regulated organisations and their solvency. This is an organisation whose structure is highly centralised and will be even more so if its governance structure is altered in accordance with the report's recommendations. As for its geographical presence, its proximity to consumers and its knowledge of the particular characteristics of each regional market in the country, these will have to be vastly improved to enable it to meet all the challenges the task force has thrown at it. (Jean Martel, October 23, 1998)
With respect to adding to OSFI’s mandate the role of promoting competition, while efforts "to streamline regulatory effectiveness, making it flexible and responsive to market forces without compromising prudential concerns" (John Cleghorn, September 29, 1998) are desirable, adding to OSFI`s mandate the role of promoting competition was viewed as a difficult task.
That is going to be a difficult issue for OSFI to handle. Certainly since we are on the — if it is solvency that we are worried about, I think that the other — the competitive side is long-term solvency with a good competitive environment, why you are going to have long-term solvency. Our concern is that if it is just prudential criteria with financial services around the world, unless competition is taken into consideration, we may be fine in short term, but long term there would be a problem. Therefore, I, myself, have no difficulty with that recommendation, but I think it will be difficult for OSFI to take on properly. I am sure they will be struggling with that. (Alan Morson, October 27, 1998)
Others argued, however, that this change in mandate is:
… a bad idea for two reasons. Regulatory bodies do not do a good job with conflicting mandates. But at a very much more pragmatic level, OSFI is not equipped to do the one mandate that it has today, let alone having a new mandate. (William Black, October 21, 1998)
He also said:
I worry about challenging OSFI with conflicting mandates. That is not a good idea. Competition and more of it is good, and we should always be looking for ways of getting it. But, I do not think OSFI is the place. I can see how it might be good to have a separate entity whose role is to advocate and promote competition. That entity could try to get OSFI to bend their rules, arguing that there is no risk to the system and demonstrating how it will be better. However, let OSFI think only about safety.
The former Superintendent of Financial Institutions expressed strong opposition to the proposed change in OSFI’s mandate.
… in considering giving rulings, interpretations, licences and whatever to do this or that, that the mandate make it clear that the regulator is to take into account factors of competition and innovation along with safety and soundness, I think that is dynamite. The woods are full of people who like to push very hard at the edge and push the envelope, as some people say, and it may make almost impossible for the superintendent to turn down some things because he is faced with "Yes, but you are inhibiting competition. You are inhibiting innovation," and frankly, I think that is a very bad recommendation.
The second thing that I do not like is the expansion of the role of OSFI to include consumer protection issues. I think that muddies the water. The job is difficult enough to deal with the safety and soundness issues …(Michael MacKenzie, November 3, 1998)
The Superintendent of Financial Institutions also expressed reservations about this set of recommendations.
With respect to OSFI’s role in the area of competition, regulation and supervision necessarily involve some degree of intrusiveness into the affairs of institutions which may have direct and indirect costs and, therefore, some impact on competitiveness. As part of its statutory mandate, OSFI is required to fulfil its role with due regard to its effect on competition. This is a passive requirement, but in our view, a useful one because it helps us resist the temptations of excessive regulation.
As we interpret this requirement, OSFI’s duty is to interfere as little as possible with competition, but we do not see this giving us the responsibility to actively facilitate competition. Instead, OSFI’s overriding objectives, currently, are to safeguard depositors and policyholders from undue loss and to contribute to confidence in the financial system.
Recommendation 112(b) suggests that OSFI’s mandate be revised to make it clear that OSFI has the responsibility to balance considerations of competition and innovation with its current statutory obligations with respect to safety and soundness, suggesting perhaps an equal footing. However, the Task Force also states that it does not believe that OSFI’s role should be to actively promote or foster competition. We are not opposed to competition and innovation, both of which are indispensable to the proper functioning of the financial services sector as well as its vitality and growth, but because they are not matters within OSFI’s control, they may sometimes conflict with safety and soundness.
For example, our current mandate emphasises the importance of early intervention into the affairs of troubled institutions. The need for early intervention was one of the lessons learned from the financial sector problems of the 1980s. It has been considered and promoted by the government, by both the House Finance Committee and the Senate Banking Committee and was codified in our 1996 mandate.
The addition of a specific responsibility for competition and innovation might put increased pressure on OSFI to increase regulatory forbearance to the detriment of early intervention and the early resolution of problems. In addition, combining matters of competition and innovation with OSFI’s current mandate could make OSFI less independent and more vulnerable to pressure based on non-regulatory concerns.
In approving new entrants to the financial system, regulators traditionally apply a fit and proper test to the people behind any application. If competition were a more important part of OSFI’s mandate, OSFI might be placed under pressure to accept less than desirable owners of financial institutions.
We would ask you to consider whether issues of competition and innovation belong more appropriately to the market and to other government players. Although we have reservations as to whether the encouragement of competition should be within our mandate, we do believe that more can be done to develop an open, regulatory approach that will encourage competition, and there were some useful suggestions in this regard in your report, including greater reliance on disclosure, and a careful cost benefit analysis before new regulations are introduced.
In our view, any approach to lighten the regulatory regime should still include the principle of firm, early intervention, but could involve fewer regulatory and supervisory procedures, particularly for institutions in sound financial condition.
Recommendation 112 proposes that OSFI’s mandate also be broadened to include more responsibility for consumer protection issues. OSFI understands the need for additional consumer protection and fully supports these initiatives. We are inclined to add that our safety and soundness focus may be one of the most important aspects of consumer protection within the financial services industry. We like to think that we protect consumers now by helping to preserve and enhance the ability of institutions to meet their financial obligations to those consumers, but the reservations which I have expressed with respect to increased responsibility for matters of competition apply equally to the proposals for increased responsibility in the area of consumer protection.
First, an expanded consumer protection role may conflict with OSFI’s responsibility to promote safety and soundness. For instance, the recent vanishing premium issue pitted policyholders against insurance companies over the issue of duration of premium payment based on estimated rates of inflation and investment return.
Certainly, OSFI has a responsibility to protect policyholders' interests, but how should OSFI best do so? By maintaining an adequate level of safety and soundness in the institutions or by advancing particular consumer interests? It is unclear which role would take precedence in the event of such a conflict if consumer protection ranked equally with depositor, policyholder protection in a new mandate given to OSFI.
Further, OSFI does not have the resources, skills or even the management mindset now that would be required to fulfil an expanded consumer protection function. We would have to hire new people with relevant experience. In short, although we support consumer protection initiatives, we would ask you to consider whether OSFI is the right body, the best-suited body to take on a consumer protection mandate. (John Palmer, November 3, 1998)
Conclusions
The Committee does not support the recommendations of the McKay Task Force with respect to expanding the mandate of OSFI. The Committee favours a strong financial institutions regulator with as clear and unambiguous a mandate as possible. OSFI is working, under its existing mandate, on the development of measures of performance that will enable it to measure its effectiveness and cost to the economy. The Committee strongly supports this endeavour.
5. Revision to Governance of OSFI
Background
The Committee recently completed a study of the regulatory regimes in a number of market economies, including, Great Britain and the United States. The Committee was persuaded by what it heard from regulators in those two countries about the value of a board of directors for the regulator. These boards act as oversight bodies, not enforcement bodies, and provide the regulator with individuals knowledgeable about the regulated sector, individuals who can bring a private sector perspective to the processes implemented by the regulator to fulfil its mandate, and individuals able to communicate the views of the regulator to the public.
Consequently, in its report, Comparative Study of Financial Regulatory Regimes (October 1998) the Committee recommended that OSFI have a board of directors to oversee the exercise of its statutory powers. The board would operate with the powers of a corporate board except that it not have the power to hire and fire the Superintendent. The Task Force adopted a similar approach.
Task Force Recommendations
113) The governance structure of OSFI should be strengthened to make it more appropriate to the increasingly complex needs of regulation and its revised mandate. To that end:
(a) The OSFI Act should be amended to provide for a board of directors for OSFI, made up of a majority of independent directors, including experienced independent business people and persons familiar with consumer issues, together with the Superintendent of OSFI, the Chair of CDIC, the Governor of the Bank of Canada and the Deputy Minister of Finance. An independent director should serve as board chair.
(b) The board of directors would be responsible for:
(i) overseeing how OSFI conducts its business and administrative affairs;
(ii) approving major OSFI policies and strategies;
(iii) monitoring the achievement by OSFI of progress against its strategic plans and statutory mandate; and
(iv) ensuring that there is effective senior management, particularly in the position of the Superintendent, who should be appointed by the Minister of Finance on the recommendation of the OSFI board.
Views of Witnesses
One witness expressed support for such an oversight board but expressed concern that
Sometimes government appointed boards are not filled with people whose principle reason for being there is their skill and the task at hand. If that is the case then it would be a lousy idea. There are other government appointed bodies where that is not the case. Then it might be okay. I have a board of directors and I find it very valuable to have them to bounce ideas off of.
All the roles that MacKay described for the OSFI board could be valuable to John Palmer or whoever is in that role. I see potential for good there as a governing structure for OSFI itself. I see potential for nonsense. (William Black, October 21, 1998)
The importance of the quality of the members of the board was emphasised by others.
OSFI could bring in people with expertise and market intelligence, with knowledge about institutions. That would certainly give the superintendent some background information as well as counsel that he probably needs. It would be easier for him to make his case in front of his peers. (Léon Courville, September 29, 1998)
The Superintendent of Financial Institutions supported in principle these recommendations but added that
In defining the board’s responsibilities, care would have to be taken to ensure that the powers of the superintendent and the Minister were not undermined and the existing accountabilities in the system, from the superintendent to the Minister, from the Minister to Parliament were not undermined. (John Palmer, November 3, 1998)
Conclusions
The Committee is on record as recommending the establishment of an oversight board for OSFI. It supports the Task Force recommendations on this subject.
Background
Depending on the product in question, Canadian consumers are protected under a number of different insurance plans when they purchase financial products. These plans generally provide insurance for the consumer against the possibility of failure of the financial institution and its inability to meet its obligations. (This section based on Report of the Task Force, pp. 184-187)
CDIC insures deposits at banks and other federally incorporated deposit-taking institutions, and at some provincially chartered trust companies. Members of credit unions and caisses populaires are not insured by CDIC but are protected by deposit insurance or guarantee plans that vary from province to province. The Quebec Deposit Insurance Corporation (QDIC) also insures Quebec chartered trust companies. Life insurance products are insured through CompCorp, of which all life insurance companies are members.
CDIC is a crown corporation, with its obligations guaranteed by the Government and with the additional ability to borrow from the CRF when necessary. There is an accurate perception among Canadians that CDIC, with the strength of the Government of Canada behind it, will meet all of its commitments.
In contrast, CompCorp is not a crown corporation and has no entitlement to borrow from the CRF. The quality of its compensation commitment to customers is therefore not as strong as that of CDIC.
The Task Force argued that there is public recognition that the quality of the compensation commitment given by CDIC is stronger than that of CompCorp, and that this market reality creates a competitive disadvantage for life insurance companies, compared with deposit-taking institutions. It went on to argue that, if financial conglomerates, led by life insurance companies, are to become robust competitors to the large banks, the competitive disadvantage inherent in the compensation arrangements should be removed.
The Task Force also viewed the primary rationale for deposit insurance today as the protection of the small depositor. Competition in the form of encouraging new entrants by not putting them at a disadvantage in relation to established players comes second. In searching for a solution to redress the competitive imbalance between deposit-takers and life insurers created by the two different product insurance plans, the Task Force put forward three principles to guide restructuring of such plans by the Government:
- The minimum that is required to provide a more level playing field between banks and life insurers is to put CDIC and CompCorp on an identical basis with respect to the Crown guarantee. The Crown guarantee should apply to the obligations of both CDIC and CompCorp or to neither, and the ability to borrow from the CRF should be available to both or to neither;
- Convergence at both the institutional level and the product level requires a parallel convergence of insurance plans. There should be one plan for both deposit-taking institutions and life insurance companies, with a common administration and parallel coverage, but with separate funds and separate premiums to take account of the different risk profiles of deposit-takers and life insurers; and
- Product insurance plans should not have supervisory responsibilities.
The Task Force argued that the continuation of two plans, even if with similar characteristics, is inefficient. Its position is based on a number of factors: the increasing integration and overlap of financial services, existing examples of involvement of both insurance plans in the same failure, and the recommendation that life insurers become members of the payments system. The argument for one plan is bolstered by the fact that both deposit-taking institutions and life insurers are under the supervision of the same regulator, OSFI.
Levelling the playing field in a truly meaningful fashion, according to the Task Force, requires structural changes to put CDIC and CompCorp on an even footing. In addition to levelling the playing field, the Task Force believes that one integrated plan would provide other benefits:
(i) A unified plan would assist in reducing current consumer confusion about coverage.
(ii)A unified plan would provide an administrative framework within which to pursue comparability in coverage, priorities in the event of liquidation, and payout practices for products that are essentially identical although sold by different institutions.
Task Force Recommendations
12) In order to promote more effective competition between banks and life insurance companies, there should be the same level of support from the federal government for the insurance plans protecting customers of deposit-taking institutions and customers of life insurance companies. See Recommendation 117.
117) In order to promote effective competition between banks and insurers, to eliminate public confusion and to provide equivalent protection to Canadians, regardless of their choice of financial services provider, the insurance plans for federally insured deposit-taking institutions and life insurers should be amalgamated. The Task Force proposes that one of two possible models be adopted:
(a) The continuation of the Canada Deposit Insurance Corporation (CDIC) as a Crown corporation, with access to the Consolidated Revenue Fund, but with an expanded scope to cover the activities now conducted by the Canadian Life and Health Insurance Compensation Corporation (CompCorp).
(b)A new independent organisation, established by statute and with provision for a liquidity backup borrowing authority from the Consolidated Revenue Fund, but without Crown corporation status. Details of each of these structures as proposed by the Task Force are contained in Background Paper #5.
118) The amalgamated insurance plan would, in the first instance, maintain separate pre-funded insurance pools for deposit-taking institutions and for life insurers. It would also have the mandate to review and, where possible, to develop a common framework for priorities in insolvency, product coverage and other matters where there are now different legal rules or differing CDIC and CompCorp policies.
Views of Witnesses
The Executive Vice-President of CompCorp addressed directly the life insurance industry argument that a level playing field does not exist between the life insurance and deposit-taking sectors.
Currently, consumers who purchase their products from deposit-taking institutions receive both a government guarantee of protection and almost immediate access to their funds on the insolvency. This access to funds is achievable because of the liquidity support the government provides to CDIC. Life insurance policyholders receive neither the government guarantee, nor the benefits of the liquidity support.
This inequity has not resulted in reduced protection to policyholders up to this point. CompCorp has met all its obligations in the three insolvencies it has faced. It is true that in Confederation Life, some consumers did have restrictions placed on their funds, but the impact of this was alleviated by the adoption of a Hardship Committee. Such Hardship Committees have been put in place in all three insolvencies. In a different interest rate environment, i.e., if interest rates were rising, it would obviously be more difficult to satisfy policyholders in the future. The availability of liquidity support from the Consolidated Revenue Fund would facilitate greater consumer access to their funds on insolvency and provide them with more choice at that point. Despite the past successes, the general public still perceive CompCorp's insolvency protection to be second-class coverage. It is, therefore, a very important competitive issue for both consumers and the industry. CompCorp believes that the same level of government support should be available to both deposit-taking institutions and life insurance companies. While we do not advocate any particular level of government support at this time, we do consider that models with reduced government support would be entirely consistent with the general direction of public and government attitudes. (Gordon Dunning, October 27, 1998)
The basis for the industry argument about public perception was made by the President of CompCorp.
The competitive issue is that the industry in its polling for a number of years, before Confederation Life and after Confederation Life, have found that a high percentage of consumers of the general public when asked the question which they prefer, prefer the government backing. Now in good times, like now, it is not a particularly big issue because consumers do not ask the question of their intermediary because the outlook is fine, but when things become financially unstable, like just after the failure of Confederation Life, everybody in buying a product was asking about the nature of the consumer protection. So the issue has always been there from a polling point of view, but it is only important when there is an unstable economic environment. (Alan Morson, October 27, 1998)
While the Chairman of the CDIC indicated that the Task Force recommendation with respect to a CDIC-CompCorp merger could certainly be implemented, he raised some questions about the logic behind the recommendation.
… This recommendation rests on the assumption that the government guarantee now offered deposits via CDIC significantly affects the competitive playing field between deposits and short-term deferred annuities and that this effect is important enough to warrant a major change. However, one also has to pay attention to other differences in the playing field and where a change such as this may lead.
Another factor is trying to assess the extent to which the proposal carries with it potential for a huge increase in the government's financial commitments. It should also be recognised that life insurance companies at present can gain access to CDIC’s guarantee by setting up subsidiaries. In addition, the proposed change could well seriously erode the effectiveness of CDIC’s role in the safety net supporting the safety and soundness of the system.
…
I think the main problems with that scheme is that if you are really interested in levelling the playing field, then you have to consider a lot of other players outside the insurance companies, such as investment dealers and the mutual funds. Now, that all is contingent on them getting into the payment system one way or another, but I am assuming that has not been done but certainly is being discussed.
So what I think is a little surprising is that because of this small residual overlap between deferred annuities five years and smaller and shorter, the life insurance companies have argued that the protection should be accorded to all their products. That includes death benefits, disability benefits, health benefits, and so on. In principle, you know, the government can guarantee anything it wishes, but it takes on a fairly substantial package of obligations when it does that. There are, for example, additional areas you might want to consider if you were in that mood, such as the private pension benefits, private pension funds, and similarly, property and casualty insurance. (Grant Reuber, November 2, 1998)
Witnesses from the Canadian Bankers Association, while not indicating a view on the recommended CDIC-CompCorp merger, stated:
We believe that it should be clearly recognised that the nature of deposit-taking and insurance and their concomitant risks are different. If it is decided that the two plans should be integrated, it is essential that the funds supporting the two insurance schemes be completely separate and that there be no cross-subsidisation. Deposit-taking institutions should not have to bear the costs of a failed insurance company, and vice versa. (Raymond Protti, September 29, 1998)
Conclusions
In November 1994, the Committee released its report, Regulation and Consumer Protection in the Federally-Regulated Financial Services Industry: Striking A Balance, which dealt with the CDIC-CompCorp issue addressed in this section. The following comments are from the executive summary of that report.
In reviewing how products of the life and health insurance industry should be insured, the Committee seriously considered the submission of the industry that a new Crown corporation … be established to provide insurance protection to purchasers of their products. Three main arguments for a Crown corporation were presented:
The first argument is the "level playing field" or fairness argument. It is based on the position that it is increasingly difficult to separate products of life and health insurance companies from the products of deposit-taking institutions. Since deposit-taking institutions are insured by a Crown corporation (CDIC), fairness requires that the government offer a similar mechanism to the life and health insurance industry.
The second argument calls for the creation of an insurance organisation which would meet two objectives: (i) such an organisation must be independent of operating life and health insurance companies so that it can have full access to information regarding companies which are in financial trouble, without the provision of this information creating conflict-of-interest problems; and (ii) such organisation must have the legal authority and the financial capacity to help effect a "going concern. solution to a life and health insurance company in financial trouble.
Because CDIC can use its funds to help effect a Going concern. solution for a deposit-taking institution that is in financial trouble, the life and health insurance industry also argued that since CDIC's financial capacity extends to borrowing from the Consolidated Revenue Fund, the insurance organisation for their industry should also be entitled to access this same source of funds.
The Committee decided not to accept the first argument, the "level playing field" or fairness argument, for two reasons:
- Life insurance company products that are virtually identical to products offered by deposit-taking institutions, such as guaranteed investment certificates, could be fully insured by CDIC under current rules if the insurance company marketed these products through a trust company subsidiary. Trust company subsidiaries of insurance companies are eligible to be members of CDIC and insured by CDIC. Using this approach, there is no reason to create a new Crown corporation to insure virtually identical products.
- In the case of life insurance products which are unlike any product offered by a deposit-taking institution – for example, products that contain both a savings element and a protection element – the Committee was persuaded by evidence presented at the hearings, including evidence presented by the industry itself, that it would be impossible to split these products so that the savings element would be insured by CDIC and the protection element in some other way. The Committee, therefore, was given the choice of recommending that these products be protected by a Crown corporation, maintaining the status quo or developing a third option. In the former case, an element of unfairness would be introduced into the system since a Crown corporation would be insuring a set of products which are not offered by deposit-taking institutions. The Committee also rejected the status quo and opted instead for the private sector alternative described below
The Committee rejected the Crown corporation alternative by reference to the primary reason for deposit insurance – the protection of the Canadian payments system. Insurance company failures do not have a direct effect on the Canadian payments system. Hence, there is no public policy reason for giving life insurance company products the same type of protection, using the same mechanism, as is given to products of deposit-taking institutions.
Moreover, this conclusion has also been reached in other jurisdictions. The United States and the United Kingdom, for example, have deposit insurance systems that have access to borrowing from government. Protection plans for purchasers of products of life and health insurance companies in those same jurisdictions, however, do not have such access.
The industry's final argument for a Crown corporation, that the organisation responsible for protecting purchasers of products of the life and health insurance industry should be able to borrow from the Consolidated Revenue Fund (because CDIC can), was also rejected by the Committee. The Committee believes that an appropriately designed protection plan for products of life and health insurance companies, such as the one described in the following paragraphs, could borrow the money it requires from private capital markets.
Further, the Committee believes that government should become involved in protecting the purchasers of products of the life and health insurance industry only after all other private sector solutions have been attempted and failed. The Committee believes that the industry has the capacity to resolve its own insurance problems. In doing so, the industry should not assume that it has access to the Consolidated Revenue Fund or to government guarantees of loans from private capital markets.
The Committee agrees with the industry, however, that an organisation is needed which would have appropriate access to information regarding financially troubled companies and which has the legal authority and the financial resources to be able to help effect a "going concern" solution for a company in financial difficult.
CompCorp has successfully fulfilled this role.
The Committee stands by its position outlined above and does not support the recommendations of the Task Force. It is the view of the Committee, however, that, once the life insurance companies are granted access to the payments system (as discussed in section C.1 and begin to offer what are essentially demand deposits, all products which satisfy the clear definition of a CDIC-insured deposit should be insured by CDIC.
7. Eliminate Regulatory Overlap Between OSFI and CDIC
Background
OSFI was, and continues to be, the regulator for federally chartered financial institutions: banks, trust and loan companies, life and health insurance companies and property and casualty insurance companies. In fact, the Office of the Superintendent of Financial Institutions is itself the result of a merger, in 1987, of the Department of Insurance and the Office of the Inspector General of Banks.
CDIC was set up in 1967 to insure specified deposits of member financial institutions, banks and other federal and provincial deposit-taking institutions.
Existing legislation provides that OSFI is the primary regulator and is mandated, among other things, to do examinations on behalf of CDIC. Under regulation, OSFI prepares reports for CDIC on a number of issues: viability, premiums, and whether or not an institution is following standards of sound, fit, financial practices. Two of the directors of CDIC are from OSFI. Further, CDIC has the capacity to set standards, to monitor the activities of financial institutions insured and to conduct special reviews.
Among the recommendations in the 1990 Annual Report of the Auditor General is one related to the OSFI-CDIC relationship: OSFI should enter into a memorandum of understanding on co-ordination of activities with CDIC as quickly as possible. (paragraph 25.95, p. 599)
In December of 1992, a Strategic Alliance Agreement was executed by CDIC and OSFI to provide "a framework for CDIC and OSFI to co-ordinate their related activities by promoting consultation and exchange of information".
In 1993, CDIC published eight Standards of Sound Business and Financial Practices with which all member institutions must comply. These standards deal with subjects such as liquidity management, foreign exchange risk management, and capital management. In many instances, the subjects covered by the Standards are also dealt with in regulations or in guidelines and bulletins published by OSFI.
CDIC has developed the Standards Assessment and Reporting Program (SARP). Under this program, the CDIC requires banks and other members of CDIC to annually report that the institution is complying with the Standards. Boards of directors are required to pass a resolution to this effect. SARP is an exercise in corporate governance, asking boards to assure CDIC that they understand their responsibilities and that their institutions have risk management processes in place.
In 1996 CDIC was given the power to introduce risk-based premiums, and CDIC has published a draft by-law in that connection. Member institutions are to be classified into one of four categories on the basis of various measures of the soundness of their financial management.
In the Committee’s 1994 report, Regulation and Consumer Protection in the Federally-Regulated Financial Services Industry: Striking A Balance, the overlap between CDIC and OSFI was dealt with. The Committee recommended that
Department of Finance officials work with OSFI and CDIC, to ensure that there is minimal confusion and ambiguity in the monitoring and protection system behind Canadian financial institutions. The mandates of OSFI and CDIC should be clearly spelled out and there should be minimal overlap of these two mandates: regulatory responsibilities should be clearly assigned to OSFI; insurance responsibilities, to CDIC. (Recommendation 42)
The Task Force pursued this approach.
Finally, the Task Force examined the possible amalgamation of CDIC and OSFI. This was recommended by the Estey Report and by the House Finance Committee. The Committee, in its 1994 report, also addressed this question and concluded:
… given that some tension between the regulatory function and the insurance function is inevitable, the following question arises. Is it better to have the discussion settled in a relatively more open forum, which will be the case if there are two institutions, or within the confines of a single bureaucracy with little outside input, which will be the case if the two institutions are merged? The Committee favours the more open process, that is, having two separate institutions. (In the United States, they have tended to move away from the one regulator–insurer model. There is some evidence that the savings and loan problems would have been dealt with earlier had the two functions been separated.) (p.88)
The Task Force also favoured two separate institutions.
Task Force Recommendations
114) To eliminate regulatory overlap at the federal level, OSFI should have the sole responsibility for promoting standards of sound business and financial practices in financial institutions and for establishing policies and procedures to manage and control risk. To that end, the present overlapping statutory mandate of CDIC on these subjects should be repealed. OSFI should collaborate closely with CDIC in establishing business standards, financial practices and risk management policies, and should act on behalf of CDIC in monitoring compliance.
Views of Witnesses
Witnesses from the Canadian Bankers Association supported the Task Force recommendations on the CDIC-OSFI overlap.
… we support the report's recommendations to eliminate the overlap between the roles of the regulator and the deposit insurer. While CDIC does not directly supervise banks, it has developed standards of sound business and financial practice that in many cases overlap with regulations or guidelines published by OSFI. Moreover, while OSFI assesses the risks an institution carries in conducting its business, CDIC is also developing risk-based premiums, and this will require deposit-taking institutions to provide duplicative information at considerable cost.
We agree with the task force that OSFI should be the single-window collector of information and act on behalf of CDIC in monitoring compliance, while working closely with CDIC in developing risk-management policies. (Raymond Protti, September 29, 1998)
With respect to transferring the standards from CDIC to OSFI, the chairman of the CDIC stated:
At present, these are within the jurisdiction of CDIC. We proposed them. They were in our mandate, they are part of our mandate and under the Act, we developed them in close co-operation with OSFI and provincial regulators. They are widely accepted as being of a very high standard and they have been emulated by others. We have established a process whereby members self-assess themselves relative to the standards. Their self-assessments are acknowledged by the directors in senior management. The whole process is monitored by OSFI and examiners of provincial regulators.
I think it is fair to say that both OSFI and CDIC believe the benefits arising from implementing CDIC standards have been substantial, a system run smoothly and the criticism of wasteful duplication in costs is unwarranted. SARP was developed to fill a gap in the information that we obtained, and assuming the substance of SARP remains the same, it is not at all clear how changing a reporting line would change anything else.
There are, however, two reasons for keeping SARP and standards where they are. First, because the requirement to comply with standards and SARP emanates from CDIC, the requirement applies to provincial as well as to federal institutions. If all references to standard were removed from the CDIC Act and transferred to OSFI, provincial institutions would no longer have to comply unless required to do so by new legislation in each province.
Secondly, because the standards emanate from CDIC, CDIC’s ability to deal with the problem institutions is greatly strengthened. The same is true of its ability to take legal action in cases where CDIC suffers from the losses because of neglect or wrong-doing.
In my view, the present arrangements regarding standards are working well and there are clear advantages in leaving them under CDIC’s jurisdiction. (Grant Reuber, November 2, 1998)
Mr. Reuber went on to say:
The final point made in the report specifically related to CDIC is the matter of getting data. This reflects a complaint by the Canadian Bankers Association. We generally have a policy of not requesting information from members unless it is necessary to meet our obligations and it is unavailable through OSFI or provincial regulators.
Levying differential premiums is the responsibility of CDIC, not of OSFI, and CDIC has to do its best to ensure that the differential premiums levied are fair and equitable. The differential premium system was designed so that virtually all the information that it uses is that which is currently collected by OSFI, although some information has been adapted for insurance premium purposes. The remainder of the information is currently readily available at member institutions for their own sake. Also, this proposal does not take into account the fact that some of the information is from provincial institutions and is not at all collected by OSFI. (Grant Reuber, November 2, 1998)
He was not in favour of turning the CDIC into essentially a paying agent.
… if you really make CDIC into essentially a paying agent, then OSFI would be the primary source of decision-making and indeed, that was the case prior to 1987, and the reason that was changed was precisely because of the Estey findings that that was not satisfactory, that the incentive structure within the organisations was such that action was too late in coming and so on, and you needed to increase the role of people who end up paying the cheque who took interest in taking action more promptly and so on. (Grant Reuber, November 2, 1998)
The Superintendent of Financial Institutions was not an advocate of changing the status quo.
If you were designing the system from scratch, we would certainly favour the placement of the standard setting responsibility with OSFI. We think that is where it belongs. Not everyone shares this view.
But the fact is we now have a system of standards in the case of the CDIC member institutions and a system of compliance that goes hand in hand with this, the system that is popularly known as SARP. It has gone through its teething pains, it works, and we do not think there is a particular need to change it. (John Palmer, November 3, 1998)
Conclusions
The Committee continues to support a clarification of the functions of CDIC and OSFI as it recommended in its 1994 report. It therefore supports the recommendations of the Task Force.
8. Eliminate Overlap Among Federal and Provincial Governments
Background
The issue was described succinctly by David Brown of the Ontario Securities Commission.
One of the challenges, of course, arises from the constitutional division of powers in Canada. As we all know, regulatory and legislative jurisdiction over banks and banking is the exclusive purview of the federal Parliament. Courts have awarded securities regulation to the provinces under the Property and Civil Rights power. Trust companies and insurers are regulated in accordance with the jurisdiction of incorporation.
The result has been that the regulatory field has been divided along institutional lines rather than by category of activity or business. We have seen in recent years that the role of market participants has changed dramatically since the present regulatory structure was put in place. In large measure, these changes were facilitated by the demolition of the four pillars concept approximately ten years ago.
We now have a financial marketplace where domestic and foreign banks, securities dealers, trust and insurance companies, credit unions and other intermediaries offer many similar services, but under quite different regulatory regimes. In fact, the left-hand sides of the balance sheets of most of these players are virtually identical. The business of banks and their investment dealer and trust subsidiaries are becoming increasingly integrated. (David Brown, November 2, 1998)
Task Force Recommendations
115) Governments should work aggressively to eliminate overlap in prudential regulation, both between the federal and provincial governments and among provincial governments. To that end:
(a) In consultation with provincial regulators, OSFI should establish a central, electronic data base which would permit common reporting formats and single-window electronic filings.
(b) The provinces should be encouraged to delegate solvency regulation of trust, loan and life insurance companies to OSFI so that, over time, prudential regulatory responsibilities for financial institutions could be consolidated in a single, well-resourced, and experienced regulator, applying common practices and international standards.
(c) To the extent that delegation cannot be achieved, the federal government and the provinces should harmonise the laws and regulations relating to trust, loan and insurance companies, including in particular the development of common capital adequacy tests and the recognition of home-jurisdiction regulation.
Views of Witnesses
The Canadian Bankers Association did not feel that the Task Force recommendations went far enough.
In our view, the task force's recommendations, such as provincial delegation of prudential regulation to OSFI and the harmonisation of rules, constitute useful first steps but do not go far enough in streamlining the system. In our view, the key to addressing the issue of overlap and duplication in the Canadian regulatory system is to achieve national regulation of all financial services for those provinces that choose to participate.
It is interesting to note that, internationally, through our trade obligations in NAFTA, the WTO and the upcoming Free Trade Area of the Americas discussions, Canada is moving toward a common market in financial services with our trading partners. Internally, however, we still face a welter of overlapping and conflicting provincial rules. (Raymond Protti, September 29, 1998)
The CEO of the Mouvement Desjardins explained the effects of the lack of harmonisation.
Currently, the lack of harmonisation deprives certain institutions of the means that would allow them to increase their competitiveness. For example — and this point was not raised in the MacKay report — provincially chartered insurance companies cannot acquire the portfolios of federally chartered companies but foreign companies can do so.
That is one example of inequality that penalises provincially chartered institutions when one knows that acquiring portfolios is one of the most efficient ways of reducing unit costs and maintaining the growth of companies.
Over time, all participants in the offer of financial goods and services should be treated equally and fairly, whether they are Canadian or foreign companies, federally or provincially chartered companies, or companies that are regulated or not. At the end of the process, what is important is that the same rules apply to all participants working in a given area and that these rules be clearly defined and understood by all. (Claude Béland, October 23, 1998)
Witnesses from the securities commissions in Quebec, Ontario, Alberta and British Columbia argued that provincial co-operation in the area of securities regulation has come a long way and can serve as a model for co-operation across the financial services sector.
The MacKay report proposes a reorganisation of the regulatory framework, eliminating as far as possible all overlap, inconsistencies and non-compliance with standards resulting from multilateral regulatory activity that is not centralised or co-ordinated.
In the Canadian securities industry, we have made remarkable progress in the past two years, which I would call the post-national commission years, and we are in the process of establishing a unique collaborative model which kills three birds with one stone: by systematising harmonisation without forcing standardisation, structuring collaborative efforts and integrating the process as though we were dealing with a single vast pan-Canadian organisation.
The Canadian Securities Administrators have done this without having to turn their backs on their markets, stock exchanges, respective financial communities, investor populations or specific needs and, in particular, by retaining an independence of action that inspires creative discipline in every part of the whole.
This is an achievement that the task force would have done well to consider. This could be a good model to follow to reduce the disparities and successive layers of regulation criticised by the MacKay task force. Incidentally, Mr. Chairman, in the sustained international talks we conducted with my colleagues around the world, the Canadian model of co-operation and collaboration is setting a new standard. In the financial industry in the 1980s and 1990s, I remember we talked about Europe in 1992 and thought that it was marvellous and would work well. But now the Europeans are looking at what we do because very soon, particularly once the single currency is introduced, they will find themselves in a situation very similar to the one we were in a few years ago. Even at this level, I believe the models we have put in place in Canada can definitely inspire many other initiatives in the European community or in other regions of the world, which would be well advised to draw on the initiatives, efforts and resources of a number of countries.
We believe our recommendations on eliminating disparities and overlap conflict with other measures recommended in the MacKay report, and that the MacKay recommendations cannot be implemented without increasing those disparities or adding other monitoring authorities with jurisdiction over the same stakeholders. (Jean Martel, October 23, 1998)
David Brown of the Ontario Securities Commission stated:
We, as the Canadian securities administrators, are currently examining whether it is time that we should be rethinking the regulatory split, that regulatory responsibility should be divided according to business activity and not by institutional type. We think, for example, that it is unlikely that the regulation of banks exclusively by federal authorities and the exclusive regulation of their wholly-owned investment dealer subsidiaries by the provinces will produce the best regulatory result, and clearly, we believe that the state of affairs has contributed to the concern about consumer protection set out in the MacKay report.
Much of our thinking has been influenced by the new regulatory system which has just been implemented in Australia. … on July 1 of this year, the regulatory system in Australia was reorganised into two separate regulators, a prudential regulator, which concentrates only on the safety and soundness of market participants, and a market regulator, which regulates the market activity of all financial service providers.
In the Canadian context, OSFI would be the natural choice for the prudential regulator. That is currently OSFI's principal thrust, and indeed, OSFI currently has very little involvement in market regulation. We believe that the prudential regulation of provincial trust companies and insurers by provincial bodies should also be slowly transferred or migrated over to the federal authorities by provincial agreement.
Clearly, we also believe that the security commissions through the Canadian securities administrators would be the natural choice to regulate market activity of all financial players. It is essentially what the securities administrators do. We have the regulatory systems and infrastructure in place. Our mutual reliance system has created a national system of harmonised regulation across the country with the regional presences necessary to accommodate differences in local practices.
Under this model, the securities commissions would assume responsibility for the market practices of all financial institutions, including banks, trust companies, insurance companies and credit unions, and would set the standards for portfolio management for all pools of capital, not just mutual funds, but including pension funds and segregated insurance funds.
Over the next few months, the Canadian securities administrators will continue to develop these concepts and to discuss them with our provincial governments. Our objective will be to be in a position to submit proposals to the federal authorities, so that they can be factored into the continuing consideration of the MacKay report. (David Brown, November 2, 1998)
Mr. Hess of the Alberta Securities Commission explained in more detail the consumer protection approach of the securities commissions.
What we would need would probably involve the federal level as well. To make it clear, what we would be talking about is consumer protection regulation of all financial products. Let me use an example. We have a fairly sophisticated regulatory regime with respect to disclosure, conflicts of interest, qualifications of sales people, know-your-client rules in the mutual fund area. There is a pooled investment product which is regulated and regulation is increasing. We have seg funds which are sold by insurance companies, less regulated. We have GICs that are not traditional GICs, but the rate of return is linked to a stock index. That also is a pooled investment, and I would submit totally unregulated. Maybe there is some disclosure about how the rate of return will be calculated, but that is it. There are little or no proficiency standards, no know-your-client standards, so that is a similar function that needs to be regulated in a similar way. That, I believe, is a given. You can do it by having three different regulators performing the same function and having them get together and have this massive group of regulators, or you can streamline it, reduce duplication, eliminate duplication, eliminate the gaps that may appear between them by having it done by one regulator. But you see, it covers banks, which are federally regulated; it covers insurance companies which are provincially and federally regulated; it covers securities dealers which are provincially regulated. It needs co-operation. Senator, I would ask you how long it would take?
We are dealing with a practical issue here. We have the most sophisticated, the best-funded, at least in four provinces, financial consumer protection regulators which are the securities commissions. We are suggesting that why not have both levels of government hire the best people and hire one entity to do the financial consumer regulation. On the prudential side, we think prudential regulation has less in the way of gaps there. A good job is being done by both the provinces and the federal government on prudential regulation. If they want to combine entities, if the provinces want to follow the lead of some and move the prudential regulation from the provinces of trust companies into the federal, that is fine. It perhaps would reduce duplication. But what we are saying is the area within which there is the biggest gaps, there is only one body, and that is currently the securities commission that regulates financial consumer products adequately. Hire them to do it, get rid of them, hire someone else to do it, or alternatively, develop numerous agencies at both the federal and provincial level, but let us hear no more criticism of duplication of securities regulation if you are going to pile on more duplication. (William Hess, October 29, 1998)
Mr. Hyndman of the B.C. Securities Commission pointed to gaps in the current system.
A lot of the activity that we are concerned about that gets carried on in financial institutions outside the scope of securities regulation is the sale of products which are very similar to securities, but that are excluded from our general regulatory requirements, either because they are defined out of the term security, and that would include things like deposits and some types of insurance contracts, or they are technically securities but they are given specific exemption with our legislation. There are a lot of exemptions for financial institutions that are founded on the premise that securities regulators do not need to regulate that, because it comes under another regulator, when in fact the other regulator does not regulate it from the same perspective of securities commissions. They do not look at disclosure, they do not look at the proficiency of the people selling it.
With the elimination of those exemptions and exclusions from the definition of security, that could give the securities commissions authority to bring in a lot of the activity that we are concerned about that is really on the boundaries of securities regulation of the securities industry that constitute effectively substitutes for products that are sold through the securities industry but come under a different regulatory regime. This becomes particularly evident when looking at the bank groups where a bank has a trust company subsidiary and now insurance company subsidiaries, and a dealer and the bank is making decisions as to which one of its subsidiaries should we shove this activity in. One of the factors no doubt considered is where do we get the least regulation, where are we going to have those busybodies sticking their noses into our affairs less than in another.
In our view, that does not make a whole lot of sense if they decide we are going to put this particular investment advisory service in our trust company because then we do not have to worry about securities commissions, but if we put it in our dealer, we would. Getting rid of the exemptions or limiting them could go a long way to addressing that issue. It would not be a complete answer to the system that we talked about, but it would get us well down the road and could be done fairly quickly.
There is the caveat that … from time to time we hear arguments from banks that they are under exclusive federal jurisdiction and do not have to pay any attention to provincial law. I do not profess to be a constitutional expert as to whether that would stand up or not, but that is a potential impediment if that objection is made. If the banks say if we do it inside the bank, then we do not have to listen to you. I think as a general principle that they are subject to laws of general application in the province, but I would just as soon avoid that fight. The simple way to avoid it would be a federal law saying the bank had to comply with provincial securities legislation and provincial investor protection legislation. (Douglas Hyndman, October 29, 1998)
The Superintendent of Financial Institutions also spoke favourably of the Australian approach.
I think broadly, if you were redesigning the financial sector and could control all of the pieces, including the federal and provincial pieces, you would move in the direction of the recommendations of the Australian Wallace commission, which really established two regulatory bodies, a prudential regulatory authority, and a regulatory authority responsible for consumer protection, including investor protection along the lines of what securities commissions are responsible for now. That seems to me to be a very sensible model, and if Canada could ever move in that direction, we think that OSFI would be the natural body to evolve into the Canadian equivalent of the Australian prudential regulatory authority.
But can we get there from here? Mr. Brown has some interesting ideas of how the securities administrators might move toward a virtual securities, national securities commission, even if it cannot be achieved on a legal basis. We are very supportive of Mr. Brown's initiative, and if it becomes possible then for that affiliation of organisations to take greater responsibility for consumer protection functions outside the pure securities area, I think the system would be much better off, and as you will have observed, we are not terribly enthusiastic or we have reservations about expanding OSFI's role in the consumer protection area, so this would fit rather nicely with that model. (John Palmer, November 3, 1998)
Mr. LePan then made a more specific comment on the challenges facing regulators in dealing with the securities subsidiaries of the banks that OSFI regulates because it is an important issue.
… the line of division between a securities dealer and a bank for a particular operation is really a pretty blurry line. They share trading floors, very often.
… as a practical matter, we are actually looking at aspects of the consolidated entity that involve the investment dealer subsidiary or affiliate, and it is why, for example, we want oversight responsibilities for holding companies.
A couple of examples: We set capital rules on a consolidated basis. International bank regulators have developed capital formulas for market risk quite recently, involving the use of fairly sophisticated models for measuring the value at risk. Those models used by major banks do not differ between the bank part of the operation and the dealer part of the operation.
Our office is required by those international regulatory agreements to validate those models so that they can be used to determine the total capital of the enterprise. We go in and spend a fair amount of time on that. It is a challenge because the level of sophistication required is quite high. We are always trying to play a bit of catch-up. We have done a pretty good job compared to a number of other players in the industrialised countries, I am quite pleased about that, so I will never say that this is absolutely a snap, but on the other hand, in doing that, we are looking at the models, the control systems that are being used in the consolidated operation including in the dealer operation.
We have seen, of course, with announcements in recent weeks that the personnel move back and forth. You know, wealth management now at one of our major banks is going to be, I think announced last week, run by somebody who was going to move from the dealer subsidiary to be the vice-chairman and in the vice-chairman's office in the bank.
Ultimately, when it comes to a bank, we will go wherever we have to in order to find out if there is an issue that we have to deal with from a safety and soundness point of view. Now, we consult, co-operate, share information with provincial regulatory authorities. We continue to enhance that. It probably can be enhanced more. The models we have talked about, if you were starting from scratch might help more, but this is a very evolving kind of area and sort of a clear conclusion that somehow we are just outside of this and there is a big black hole there that we do not really know anything about is really not an accurate representation of the situation. (Nick Le Pan, November 3, 1998)
The CEO of the Investment Dealers Association confirmed that OSFI does have access to data from the securities subsidiaries of banks and further emphasised the need to minimise regulatory duplication.
There has, in fact, been greater co-operation between OSFI and the securities regulators over the last few years in particular, in respect to banks' securities subs. It is important to minimise regulatory overlap, since the IDA has regulatory responsibility for financial and for sales compliance of these bank-owned affiliates.
OSFI basically obtains information from two sources, from the banks' own internal audits and from the IDA's financial compliance reviews. We believe that there are ways to enhance the process by which the IDA can meet OSFI's need for comprehensive and timely financial information, something we have been in discussions with them about.
So the use of a single self-regulator, the Investment Dealers Association, by both the securities commission and by OSFI can avoid duplication and confines compliance reviews of investment firms to one external auditor. (Joseph Oliver, November 2, 1998)
Conclusions
The Committee supports the Task Force recommendations. It is encouraged by the progress made by the provincial securities commissions, and supports the efforts of the latter to set up a regulatory system in Canada that assigns prudential issues to OSFI and consumer protection issues to provincial regulators.
9. Streamlining of Federal Regulatory Procedures
Background
The Canadian regulatory system requires banks and federally incorporated trust, loan and insurance companies to obtain consent from the Superintendent of the Financial Institutions or the Minister of Finance for numerous transactions: such as incorporations, acquisitions of a significant interest in a class of shares, corporate reorganisations, acquisitions of certain substantial investments, exercising certain powers in-house rather than through a subsidiary, the issuing of orders to commence and carry on business, exemptions from the requirement to carry on data processing outside Canada, redemptions of shares, and granting a security interest in property.
Many have questioned the need for the degree of regulation imposed. OSFI is currently working on proposals to streamline the regulatory approval process under the federal legislation.
The Task Force encourages OSFI to proceed with these efforts.
Task Force Recommendations
116) Regulatory procedures at the federal level should, wherever practicable, be streamlined. Among other things:
(a) Approvals of regulatory action should be taken at appropriate levels within government. Wherever practicable, the Superintendent of OSFI should be mandated to provide approvals without the need for referral to the Minister of Finance, except where matters of policy are involved.
(b) Decisions on the entry into Canada of foreign banks should, in routine cases, be made by the Superintendent of OSFI rather than the Governor-in-Council. Only in cases involving significant policy issues should the approval of the Minister of Finance be required.
(c) Wherever possible, approvals should be replaced with notice filings or eliminated entirely for non-material matters and in other circumstances in which there is little or no prudential risk.
(d)Mechanisms such as blanket or consolidated approvals and fast-track approvals or advance rulings should be developed to streamline the regulatory process. To implement this proposal, a committee should be struck with representation from OSFI, the Department of Finance and the affected financial services industries to review streamlining options, with priority to be given to easing requirements which entail the greatest regulatory burden.
Views of Witnesses
There was widespread support for efforts to streamline the regulatory process.
Witnesses from the Canadian Bankers Association said:
… we fully agree with the task force that structural options can create the scope for lighter regulation of some activities, which would provide benefits to Canadian consumers and to competition. (Raymond Protti, September 29, 1998)
A number of witnesses made a strong case for a regulatory environment that was flexible.
The Office of the Superintendent of Financial Institutions oversees us every year. They learn about our new practices. They train themselves. Sometimes they hire from us. They keep up with our new business venues, and thus they understand better what we do and the constraints under which we operate.
This is a good system. It is not regulation in terms of directives and restrictions; it is regulation that is more managed, in a way. I prefer that kind of regulation, because it both promotes a quicker assessment, by regulatory regime, of how institutions perform and also enables us to present our case in a much more interesting way. (Léon Courville, September 29, 1998)
The CEO of the Bank of Montreal expressed similar views.
I would like to see the regulatory regime become flexible and adaptable. I do not think I will get very far with this one, but the Bank of Montreal's submission to the task force said that one of our problems is the fact that we have historically looked at regulation through the prism of four pillars, and those pillars are blurring completely. If you could disaggregate legislation and regulation down into functions like deposit-taking, lending, and risk insurance, and then let the market form whatever combinations and permutations it likes within the regulatory framework, it would make it easier for regulators. Rather than trying to turn this battleship of institutional regulation every 10 years, you would be able to adopt smaller chunks of legislation that govern each element of it like a flotilla of small ships. Each is more manoeuvrable.
The counter-argument to that is that functions do not fail; people do. There is a regulatory oversight issue that must be grappled with. I should like to see some way that we would not need to go through 10 years of Socratic debate every time we wish to change a specific piece of legislation. I should like to see legislation see through institutions, which are, after all, only commercial organisations, and regulate across the function. (Matthew Barrett, October 8, 1998)
One member of the Committee asked the Superintendent to respond to the following statement by Mr. Greenspan, Chairman of the Federal Reserve Board on the future of regulation. "As we move into a new century, the market stabilising private regulatory forces should gradually displace many cumbersome increasingly ineffective government structures."
With respect to Mr. Greenspan's remarks, I guess the short answer is that I agree with him but that nirvana that he describes will not occur tomorrow.
I think we have got two phases to go through. Phase one is that we have to deal with globalisation and the increasing interlinkages of financial institutions and global economies, and that means strengthening of traditional regulation and supervision in many of the developing countries, many other countries, not developed countries, where it is comparatively weak.
So phase one is strengthening the type of regulatory model that we have in Canada and in a number of other countries.
Phase two is making much better use of market discipline so that some of the regulatory apparatus can wither away. As the other factors, the other elements necessary for market discipline are developed in many of these other economies, like very good accounting rules, a good, well-disciplined, honest auditing profession which exists in fewer countries than I might have liked you to believe a few years ago, like good, well-informed financial analysts, like honest governments.
A number of these factors have to be in place before you can have the sort of model that Mr. Greenspan is talking about but there is no question that that is the direction we are headed. I think that is one phase away from the first phase that we have got to go through. (John Palmer, November 3, 1998)
Conclusions
The Committee has consistently recommended and supported efforts to streamline the regulatory process. The ultimate beneficiaries are clearly consumers and small business who will benefit from the added competition that a streamlined regulatory process will produce.
10. Publication of Information About Financial Service Providers by OSFI
Background
OSFI lists at its Internet site every federally incorporated or federally registered financial institution that it supervises. It also maintains a "Warning Circular" listing over 200 entities which have come to its attention and that may be operating in Canada illegally. The list is preceded by the following statement:
Published periodically, the Warning Circular lists the names of entities which have been brought to the attention of OSFI through some form of inquiry or complaint. If these entities, or persons purporting to represent these entities, are operating in Canada, they may be violating provisions of the Bank Act. The following entities are NOT licensed chartered banks in Canada and are NOT registered representative offices of foreign banks in Canada. (Task Force Report, Background Paper #5, pp. 82-83)
The lists of federally regulated financial institutions maintained at OSFI’s Internet site are a step in the right direction toward keeping consumers informed. However, the Task Force is of the view that the lists should be expanded to include all regulated financial institutions, both federal and provincial, thus providing the consumer with one stop where all the information can be found. OSFI should collaborate with provincial supervisors in keeping the information up to date. In addition a list of lenders certified by OSFI should be separately posted. Finally, the Task Force is of the view that the Warning Circular should be given a much more prominent position at OSFI’s Internet site. It should be updated regularly and include all foreign financial service providers believed to be operating in Canada either illegally or without a physical presence and without certification. The Canadian public should be actively encouraged to bring the names of any such entities to the attention of OSFI.
The lists of regulated financial institutions and certified lenders, and the Warning Circular, and the fact of their existence, should be given widespread exposure in different media.
Task Force Recommendations
121) The Task Force affirms its belief that an important element of consumer protection in an age of electronic service providers will be the provision of timely and accurate information, designed to inform consumers accurately about the status of providers. To that end, OSFI should regularly publish on its Web site, and periodically make visible to Canadians through other appropriate media and means, accurate information whereby consumers will be able to know:
(a) the companies that are regulated by OSFI or other Canadian regulators;
(b) the companies that do not have a physical operation in Canada but have obtained OSFI certification of their lending activities to Canadians; and
(c) the companies which OSFI believes to be offering financial services to Canadians illegally
Views of Witnesses
There was no direct comment on this recommendation.
There was support for transparency and disclosure, however. For example, the CEO of the Bank of Montreal stated that financial institutions
...must have a strong commitment to transparency and disclosure. The stock market will discipline you on the basis of that.
I absolutely believe in more granularity and more exposure to the public and investors. I do not fear it at all because it will tend to favour the bank with a prudent risk profile. Therefore, we have a good incentive to have good granularity. Micromanagement by regulators would be terrible. (Matthew Barrett, October 8, 1998)
Conclusions
The Committee is on record in favour of transparency and disclosure. It supports the recommendations of the Task Force.