Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 8 - Fourth Report of the Committee
TUESDAY, March 28, 2000
The Standing Senate Committee on Banking, Trade and Commerce has the honour to table its
FOURTH REPORT
Your Committee, which was authorized by the Senate on Tuesday, November 23, 1999, to examine and report upon the present state of the domestic and international financial system, now tables an interim report entitled Export Development Act.
Respectfully submitted,
E. LEO KOLBER
Chair
EXPORT DEVELOPMENT ACT
Report of the Standing Senate Committee on Banking, Trade and Commerce
Chair : The Honourable E. Leo Kolber
Deputy Chair : The Honourable David Tkachuk
March 2000
MEMBERSHIP
The Honourable E. Leo Kolber, Chair
The Honourable David Tkachuk, Deputy Chair
and
The Honourable Senators:
| Angus | Kelleher, P.C. |
| *Boudreau, P.C. (or Hays) | Kenny |
| Fitzpatrick | Kroft |
|
Furey |
*Lynch-Staunton (or Kinsella) |
| Hervieux-Payette, P.C. | Meighen |
| Joyal, P.C. | Oliver |
*Ex Officio Members
(Quorum 4)
Note: The Honourable Senator Grafstein was a member of the Committee at meetings at various stages during the course of this study.
Staff from the Parliamentary Research Branch, Library of Parliament:
Mr. Marion Wrobel, Senior Analyst and
Mr. Blayne Haggart, Researcher, Economics Division.
Staff from the Committees and Private Legislation Directorate:
Ms. Lise Bouchard, Administrative Assistant.
Gary Levy
Clerk of the Committee
ORDER OF REFERENCE
Extract from the Journals of the Senate, Tuesday, November 23, 1999:
"The Honourable Senator Kolber moved, seconded by the Honourable Senator Ferretti Barth:
That the Standing Senate Committee on Banking, Trade and Commerce be authorized to examine and report upon the present state of the domestic and international financial system;
That the papers and evidence received and taken on the subject during the First Session of the Thirty-sixth Parliament and any other relevant Parliamentary papers and evidence on the said subject be referred to the Committee;
That the Committee be empowered to permit coverage by electronic media of its public proceedings with the least possible disruption of its hearings;
That, notwithstanding usual practices, the Committee be permitted to deposit an interim report on the said subject with the Clerk of the Senate, if the Senate is not sitting, and that the said report shall thereupon be deemed to have been tabled in the Chamber; and
That the Committee submit its final report no later than December 31, 2000.
The question being put on the motion, it was adopted."
Paul Bélisle
Clerk of the Senate
RECOMMENDATION 14: THE MAIN EDC-BANK ISSUE
A. Background
B. Explaining the Banks’ Absence1. Structure of the Guarantee Facility
2. Niche Industry
3. Market Power
Organizations that sent briefs or correspondence but did not appear
In 1993, the government passed amendments to the Export Development Act, which substantially expanded the powers of the Export Development Corporation (EDC), Canada’s export credit agency (ECA). Section 25 of the revised Act requires that a review of EDC be undertaken five years after the amendments come into effect, and every 10 years thereafter, and that it be studied by both a House and Senate Committee. On 21 July 1999, then-Minister for International Trade, Sergio Marchi, tabled the Report on the Review of the Export Development Act by the law firm of Gowling, Strathy and Henderson, and referred it to this Committee and the House Standing Committee on Foreign Affairs and International Trade (SCFAIT).
The House Committee’s report, Exporting in the Canadian Interest: Reviewing the Export Development Act, did a thorough job of reviewing and responding to the 39 recommendations of the Gowlings report. In its hearings throughout November 1999, SCFAIT heard from some two dozen groups representing the EDC, exporters, environmental and human rights organizations, and domestic export finance competitors.
Not wishing to duplicate the House Committee’s work, the Banking Committee concentrated on a few specific areas in order to complement the House’s study. Specifically, the Committee focuses upon what it sees as a central issue: the lack of private-sector involvement in the medium-term financing of Canadian exporters. The EDC is required to both promote and build export capacity. While EDC's Annual Reports indicate that it is doing a brisk business in supporting Canadian exporters, it has not done as well enhancing the participation of Canadian financial institutions, such as banks, insurance companies and factors, in the financing of exporters. Indeed, the testimony heard by the Committee suggested rather clearly that the banks particularly could expand Canada's export capacity for small and medium sized enterprises if they were able to participate in this market on the same basis as the EDC.
The Committee’s view on this topic is simple: the more institutions competing to provide financing to Canadian exporters, the better it is for exporters and Canada. As Guy David, the project leader for Gowlings’ review team, remarked to the Committee, "Canada is far too dependent on trade for its economic well-being to place excessive reliance on a single financial institution." (15 December 1999)
The Committee also received written submissions from civil-society groups. Though the House Committee examined their concerns in greater detail, the Committee would like to comment on one important point. As a Crown corporation, EDC has special responsibilities and obligations. Canadians are rightly proud of the importance we all place on values such as human rights and respect for the environment, and we expect our institutions to respect these values. As an agency involved in financing projects around the world, EDC is a highly visible symbol of Canada. As a Crown corporation, Canadians have a right to expect that EDC—like all Crown corporations—respects Canadian values in its work.
To this end, the Committee notes that EDC continues to address these concerns through its Environmental Review Framework (instituted in 1999) and its Code of Business Ethics. EDC has also indicated that it is in the process of formulating disclosure guidelines which will provide greater transparency in EDC’s actions. Further, the Committee expects that EDC will build on these efforts, continuing to reflect Canadians’ concerns in its policies. We also expect that the government will bear in mind EDC’s role as a representative of Canada to the world when it makes changes to EDC’s enabling legislation.
The Committee is not suggesting that EDC is currently failing to meet its civil society obligations. Moreover, the Committee is also mindful of the fact that this is primarily a commercial agency, and we do not wish to suggest measures that would make it more difficult and costly to achieve those commercial objectives. Nevertheless, it is important that these principles be acknowledged, understood, and reflected in the activities of EDC.
RECOMMENDATION 14: THE MAIN EDC-BANK ISSUE
Gowlings Report Recommendation 14: The government should make a program available to the banks on Canada Account which would provide guarantees for Consensus loans. The cost of establishing and operating this program would be charged to the banks in the form of risk-based Consensus-compliant guarantee fees. The program would only be established if a sufficient number of banks were prepared to subscribe to it.
SCFAIT response: The Committee recommends that the Government give careful study to the question of setting up a new medium-term Consensus loan guarantee program that would have the backing of the banks, in order to reach a decision based on the best interests of Canadian exporters and the country as a whole.
The Committee, in considering these recommendations, heard from the five major banks, which supported the recommendations, and EDC, which did not favour a separate guarantee facility, but has since indicated its willingness to participate in a study of the recommendations. The creation of a guarantee facility has been a bone of contention between EDC and the banks for several years. At present, EDC is essentially the only Consensus-term lender in Canada. Of the $6.1 billion in direct financing it undertook in 1999, some 25% was done on Consensus terms.
Export credit agencies are regulated by the World Trade Organization’s Subsidy and Countervail Measures Agreement, which limits the use of export credits as subsidies, and the Arrangement on Guidelines for Officially Supported Export Credits (the Consensus), a "gentleman’s agreement" among OECD members. This agreement, instituted in 1978, requires that exporters using ECAs compete on the basis of price, quality and service, and not on the level of government support received.
Under Consensus rules, ECAs are allowed to guarantee up to 85% of medium-term loans (e.g., trade finance—financing capital goods—or project finance—large-scale projects). These are usually more complex and riskier than short-term finance (less than 1 or 2 years). This guarantee makes it more palatable for banks to make loans that would otherwise be too risky. The importance of these loans has declined over the past decade, both for EDC and ECAs generally.
In order to address this issue, in 1994 an agreement was reached among the government, EDC and the banks. It was based on three principles:
- The interests of Canadian exporters are paramount. The participation of financial institutions should result in more financing being made available to exporters at more competitive terms and conditions. Exporters should always have a choice on any transaction of financing support from EDC or from financial institutions.
- There should be no additional costs to the treasury.
- Risk sharing between financial institutions and EDC is essential to partnership and should reflect market realities.
The guarantee facility set up by EDC as a result of this agreement differs significantly from the terms offered by other ECAs. Most make available the allowable 85% guarantee; EDC offers a maximum guarantee of 65%-75% on the 85% allowed, depending on the transaction’s riskiness. In other words, banks using the EDC facility have access to a maximum guarantee of 64%.
Despite the availability of this guarantee, banks have not undertaken any substantial Consensus lending. This concerns the Committee, which feels that greater involvement by the banks would bring with it the benefits of increased competition: the potential for better service and enhance choice for exporters, who would not have to rely on one institution. Greater participation by the banks could also lead to more exporters being served, thus increasing capacity.
B. Explaining the Banks’ Absence
The Committee’s main concern in understanding the banks’ absence from medium-term financing was to examine whether EDC and the banks are subject to a level playing field. It heard several explanations as to why the banks are not involved in this area.
1. Structure of the Guarantee Facility
The Gowlings Report suggested that the structure of EDC’s medium-term guarantee induces the banks to locate their medium-term business outside the country, where it is of little use to Canadian exporters. In fact, the banks complain that EDC offers a poorer deal than other ECAs in both quantity (a 64% maximum versus 85%) and price (the banks claim that EDC’s exposure fee requirement is more onerous than that of other ECAs, and that other ECAs allow banks a modest return on the guaranteed tranche).
During the consultations for this Review the Canadian banking community, including some subsidiaries of foreign-owned banks, expressed concern about the area of medium-term trade finance, particularly the absence of a program of guarantees that would provide them with support comparable to what banks in other countries receive from their export credit agencies for medium-term trade. (Report on the Review of the Export Development Act, p. 62)
EDC in turn questioned whether the banks would really be interested in a guarantee facility, even if it were made available.
Canadian banks already have access to a 100 per cent guarantee program from U.S. ExImbank. They likely advocated that model, as they have for more than 15 to 20 years. However, the total business of Canadian Schedule I banks with U.S. ExImbank in 1999 was $250 million compared to the $15 billion in core business with EDC, and some of that $250 million they did with U.S. ExImbank was for Boeing Aircraft. Clearly, guarantees are not the panacea to Canadian banks engaging in trade finance, and I think their rhetoric is a little hollow on this score. (A. Ian Gillespie, President and CEO, EDC, 10 February 2000)
Gowlings Research Economist Stan McRoberts also raised concerns on this point.
If we established a level playing field between the way Canada supports commercial lending in the trade finance area and the way other countries do it, it is an open question whether the banks would take it up. That is what the banks have told us. They have said that the reason for their lack of participation is the lack of activity. That is widely accepted by the clients of EDC, and the banks themselves admit that commercial lenders are not sufficiently active in this area. The banks acknowledge it. They say that the way to fix this is to establish a program that would provide the same kind of support for them in Canada as is available to them in other countries. (15 December 1999)
EDC suggested that the banks are not interested in trade finance because it is a niche industry, with very volatile returns. Since EDC’s goal is to maximize exports, not profits, it is better suited to the higher-risk area of medium-term export financing:
Trade finance, because of the volatility of returns and required capital, is not seen to maximize shareholder value. Trade finance has not been a prime focus of Canadian banks. Banks do not have the same degree of risk appetite as export credit agencies, indeed, EDC. (A. Ian Gillespie, 10 February 2000)
Along these same lines,
It is not a criticism of the banks, but the Canadian banks have recognized that maintaining project finance across a variety of sectors is tremendously intensive in terms of personnel and capital … . There are huge overheads and it is necessary to maintain an international presence, and the return on equity is just not there for them. We have seen them either reduce the number of sectors that they are prepared to concentrate on or, alternatively, to just plain shut down their capability. Some of the banks have shut down their London teams or their New York teams because the return on equity in their view is not there. There has been a global concentration of banks. There are bigger players out there who can put out bigger teams. The net effect is that Canada is left vulnerable. We have been able to step up and fill a void. That is why you have seen a lot of our growth on the medium- and long-term side; it is because we are doing something that others cannot do. (Eric Siegel, Executive Vice-President, Medium and Long-term Financial Services, EDC, 2 December 1999)
For their part, the banks note that they are in fact involved in medium-term trade finance, through their overseas affiliates. However, in a submission to the Committee, the Royal Bank’s Bernard Kruyne asserts that a global presence in trade is no longer a major goal of his bank. He attributes this to constraints the bank faces in Canada.
It has become obvious that we lack the base in Canada to build such presence. Contrary to international banks with a home base with a more supportive ECA, RBFG (and other Schedule I banks) can not build this business at home in competition with our ECA. Building it in foreign markets—virtually exclusively in support of non Canadian clients does not appear justified in RBFG's Canadian based strategy. If we cannot grow the Trade Finance business in our home market, why pursue it outside our home market if it uses scarce resources?(Submission, Bernard Kruyne, Managing Director, Global Trade Finance, RBC Dominion Securities, 15 February 2000, p. 1)
Crown corporations exist to fill in gaps in the marketplace by providing services demanded by Canadians which are not already being provided by private-sector actors. If a service being provided by a Crown corporation can be provided by the private sector, then the private sector should be allowed to do so. EDC was created because there were export-financing gaps.
However, EDC’s privileged position as "the only game in town" should not impede competition. The banks claim that EDC's monopoly is in fact impeding competition.
Using its current advantages, EDC may be gradually moving towards a monopoly situation in the field of medium- and long-term export finance. This a dangerous situation for Canadian exporters and other taxpayers. (Peter Wren, Managing Director, Trade Finance, Bank of Montreal, 9 February 2000)
The Gowlings Report remarks several times on Canada’s dependence on a sole institution—EDC—for export promotion. As a Crown corporation, EDC, does not pay dividends or taxes, and can borrow at government interest rates, providing it with an inherent competitive advantage. These two factors place EDC in a position to exert market power in export financing.
In fact, there is a general reluctance among banks to refer a client to EDC for fear that you will get left out of the picture. Most of the deals that we do work on directly with large exporters and large deals are those where, because of the type of transaction or the choice of the exporter, they do not want to involve EDC. It is because they think they can do it using the banks only and they would rather reserve the EDC for the more difficult transactions.
We have examples also of very commercial, viable deals where three banks were competing for the transaction. We won the bid and then EDC came in and underpriced the deal. It was a very bankable deal. (Peter Wren, 9 February 2000)
The Committee is heartened by Gowlings’ findings, confirmed by EDC, that its prices are generally competitive with normal market prices. However, the Committee remains unconvinced that the banks’ absence from medium-term financing is purely the result of market failure.
C. Possible Benefits and Detriments of a Guarantee Program
Any new guarantee facility should increase the financing options available to Canadian exporters, following the principles agreed to in 1994. EDC and the banks have diametrically opposed positions on the effects of a guarantee program: the banks hold that they have something to offer exporters; EDC asserts that a new facility would be expensive and redundant.
The bankers who appeared before the committee asserted that they could, working with EDC, bring added capacity to Canadian exports.
The banks’ vast value-added distribution capabilities, of particular convenience to SMEs, EDC's trades finance expertise, and private sector insurers capacity for risk offer the key ingredients that should make recommendation 14 work. (John Leckie, Managing Director, Financial Institution and Trade Finance, Toronto Dominion Bank, 9 February 2000)
The possibility of increased competition from Canadian and foreign banks was also raised. A guarantee facility, the banks claimed, would encourage them to conduct more export business in Canada.
We have said before that a guarantee, or partial guarantee, will help us move more quickly to more and more offshore markets. If this were extended to all banks operating in Canada, whether they are Canadian or foreign, it would have the effect of increasing the total amount of financing available to Canadian exporters. (Peter Wren, 9 February 2000)
When recommendation 14 is implemented, we expect that it will attract foreign banks to compete for Canadian export finance. It will provide an incentive for major international banks to use their considerable resources to support Canadian exporters with competitive export finance packages. … Market competition will ensure that such attractiveness translates into lower pricing, longer terms, higher amounts, and/or other features valued by the importers of Canadian exports. (Bernard Kruyne, 9 February 2000)
It should be noted that medium-term finance is a "big-deal" area, of greatest interest to larger exporters able to work on large projects. Still, the banks contend that there is a "trickle-down" effect for small- and medium-sized exporters as well.
As you do large transactions, you build your business and tend to move down market. In fact, that is where the SMEs gain because there is a greater emphasis on that business as it moves down market. With that is greater capacity, it does benefit the SMEs. There is more opportunity out there. You have more people doing this business and there will be more support for this. (David Robbie, Vice-President, Trade Finance Division, CIBC, 9 February 2000)
In its testimony, EDC took a strong position against setting up a guarantee facility such as that recommended by Gowlings. EDC asserted to the Committee that the cost of such a facility would outweigh its potential benefits, and would do nothing to increase capacity.
In our view, it would add no additional capacity, it would increase the cost to the taxpayer, and it would increase the cost to the exporter. It does nothing for Canadian competitiveness. That is the short of it. …
The EDC position is simply that our mandate is to support Canadian exporters and investors going around the world. Their interests are paramount. Yes, we would object to any decision that we think would impair the competitiveness of Canadian exporters. We think that would add to the amount of time it would take to conclude transactions. We think it would add to the cost to the exporter, therefore, less business would be done. (A. Ian Gillespie, 10 February 2000)
The Committee remains unconvinced by the assertions of the EDC. We fail to see how a greater number of participants in the Consensus market can impair the competitiveness of Canadian exporters. In fact, we think that just the opposite is true. We think more participants will enhance the overall capacity of Canada's exporters.
Regarding the cost to the taxpayer, it is important to consider the experience of other ECAs, which, unlike the self-sustaining EDC, depend on government appropriations.
…In every single instance in the world with other export credit agencies, the track record is very clear. Their losses are in the billions. (A. Ian Gillespie, 10 February 2000)
The Committee believes that the Government, if it decides to provide consensus loan guarantees for the banks will develop a scheme that does not enhance moral hazard.
Neither EDC nor the banks presented any solid data on the potential impact of an independent guarantee facility. EDC asserted that it wouldn’t work, while, the Bank of Montreal’s Peter Wren, stated that firms are losing out by the non-involvement of the banks, though they cannot "quantify the opportunities lost by mid-market and smaller companies."
EDC also seemed to be concerned that a guarantee facility would be the first step toward EDC’s losing its direct-lending role.
However, sooner or later the banks say that it is not worth it to even pursue potential financing on a guaranteed structure if EDC can respond directly to the exporter with direct financing. There was a suggestion yesterday that EDC makes the decision as to whether a guarantee or financing gives the route that is extended. (Eric Siegel, 10 February 2000)
Indeed, the Canadian Bankers Association, in its submission to the SCFAIT hearings, calls for a greatly restricted lending role for EDC, suggesting "that funded deals by EDC should only be allowed when there is no participation by the private sector. This would put EDC in the same position as ECAs in other OECD countries" (Submission to SCFAIT, 29 November 1999, p. 2).
This goes beyond the Gowlings Report, which explicitly recommends that any guarantee facility provided by the government should not compromise EDC’s ability to act as a direct lender. Along the same lines, EDC’s status as a competitor with the banks and other financial institutions suggests that any bank guarantee facility would be best provided separate from EDC, so that EDC would not be placed in a conflict in which the guarantor would also be a potential direct lender.
This guarantee facility is not about addressing the needs of the banks; it is about increasing Canada’s ability to support its exporters. While the testimony heard by the Committee was often vague and contradictory, several points are clear:
- The main problem is that, while EDC and the banks do cooperate in several areas, EDC is both a competitor of and a guarantor to the banks. This seems to be an almost untenable position for a Crown corporation charged with bringing more players into the export-financing arena.
- Crown corporations exist to deal with market failures; where there is no failure, a Crown corporation should not be active. EDC has not articulated a convincing argument as to why it should remain the de facto sole provider of Consensus-based loans in Canada. At the very least, the banks should be given an opportunity to compete with EDC on a level playing field.
- EDC, while providing a valued and professional service to Canadian exporters, cannot do so alone. To drive this point home, the Committee notes that a significant number of exporters surveyed by the Canadian Federation of Independent Business had "never heard" of EDC (Review of the Export Development Act, p. 95). This suggests that Canadian exporters are underserviced, both by EDC and by the market in general. They could benefit from something that would make export financing options more visible, such as greater use of the banks’ branch system.
- Banks should be able to compete on a level playing field with EDC. At present, the guarantee facility offered by EDC, its status as a Crown corporation and its position as both competitor for and administrator of these guarantees, tilt the playing field in EDC’s favour.
- EDC has warned that the guarantee facility recommended by Gowlings will end up costing taxpayers and will not create extra capacity. Still, it is hard to see how such a guarantee facility, run on a cost-recovery basis and only created after a serious expression of interest by the banks, could change the present situation for the worse. It is also helpful to remember that the Consensus lending being discussed is generally declining in importance. If a Consensus guarantee facility is used, then Canadian exporters will benefit. As the Bank of Nova Scotia’s Senior Vice-President Tim Plumptre (Trade Finance and Correspondent Banking) remarked:
(I)f the bank guarantee scheme has nothing to offer exporters, they will not use it. This is not a replacement for EDC's direct financing, just an alternative. If exporters do not use it, it will go away, but if they do, it will be because they believe it would help them export. Should they not be allowed to have that choice? (9 February 2000)
The Committee supports the inclusion of the banks in medium-term export financing on a level playing field with EDC. It therefore calls on the government to establish a guarantee facility that levels the playing field while not compromising EDC’s ability to serve exporters, and to report back within six months on steps taken to achieve this objective.
WITNESSES
| ISSUE NO. | DATE | WITNESSES |
|
2 |
December 2, 1999 | From the Export Development Corporation:
Mr. A. Ian Gillespie, President and Chief Executive Officer; Mr. Eric Siegel, Executive Vice-President, Medium and Long-Term Financial Services; Mr. Gilles Ross, Senior Vice-President, Legal Services and Secretary; and Ms. Louise Landry, Vice-President, Corporate Performance and Communications.
|
|
4 |
December 15, 1999
|
|
|
5 |
February 9, 2000 | From the Bank of Montreal:
Mr. Peter Wren, Managing Director, Trade Finance. From the Bank of Nova Scotia:
From the CIBC:
From the Royal Bank Group:
From the Toronto Dominion Bank:
|
|
5 |
February 10, 2000 | From the Export Development Corporation:
Mr. A. Ian Gillespie, President and Chief Executive Officer; Mr. Eric Siegel, Executive Vice-President, Medium and Long-Term Financial Services; Mr. Gilles Ross, Senior Vice-President, Legal Services and Secretary; and Ms. Louise Landry, Vice-President, Corporate Performance and Communications. |
ORGANIZATIONS THAT SENT BRIEFS OR CORRESPONDENCE BUT DID NOT APPEAR:
Alliance of Manufacturers & Exporters Canada
North-South Institute
Probe International