Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 14 - Evidence - January 31, 2007
OTTAWA, Wednesday, January 31, 2007
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:04 p.m. to examine and report upon the present state of the domestic and international financial system (the study on hedge funds).
Senator Jerahmiel S. Grafstein (Chairman) in the chair.
[English]
The Chairman: Honourable senators, we have a very ambitious program before the Standing Senate Committee on Banking, Trade and Commerce. I want to welcome our witness, Julie Dickson, from the Office of the Superintendent of Financial Institutions, OSFI. We are being seen by Canadians from coast to coast to coast and by Internet around the world so your words have a global effect.
The Banking Committee of the Senate has been part of the history of the Senate and Canada since Parliament first met back in 1867. Several months after Confederation we were one of the first committees established and we have been in continuous service to the Canadian public. The committee, originally called the banking, commerce and railways committee, has concerned itself with banking, insurance, trusts, loans, caisses populaires and small loan companies, some types of taxations, corporate affairs and bankruptcy. Clearly, the committee's mandate extends to a number of issues that affect the functioning and the foundation of the Canadian economy as a whole. We are the only committee of either House of Parliament that has a mandate to look at large and small issues that affect the national economy as a whole.
This committee recently issued reports on consumer protection in the financial sector and how it affects the economy. In fulfilling our mandate, we travelled to New York City last October to discuss with our American colleagues issues including hedge funds, a sector valued at that time at $1.1 trillion in assets globally. Given the size and scope of our trading relationship with the United States, the integrated nature of aspects of our economy, and the priority that must be given to global financial stability, it is imperative that Canadian policy-makers understand what is happening in Canada and the United States in this important matter. During our discussions with U.S. regulators and representatives of the financial services sector, hedge funds did emerge as a key issue. Members of this committee agree that it requires much further study by us given the high-profile hedge fund failures recently and the increasing number of investors, both sophisticated and retail, using this financial tool. The Canadian hedge fund assets were estimated at $26.6 billion in June 2004 and we are sure they have grown since then.
We also heard from hedge funds during our study of consumer issues in the financial sector and we recommended the appointment of a person to review appropriate regulatory oversight of hedge funds. Nevertheless, the key question remains the extent to which and how these new and intricate types of financial products should be regulated or supervised in order to protect the consumer and the stability and transparency of our domestic and global financial markets. The committee continues to have an open mind on the issue of the type of regulation or the supervision of hedge funds and welcomes additional testimony to clarify these issues for us.
In our continuing study of this important topic I welcome our next witness, Ms. Julie Dickson.
Julie Dickson, Acting Superintendent of Financial Institutions, Office of the Superintendent of Financial Institutions Canada (OSFI): Mr. Chairman and honourable members of the committee, I would like to thank you for the opportunity for OSFI to provide information as part of your consideration of hedge funds. I have some brief opening remarks outlining OSFI's role in financial sector regulation, and then I would be pleased to answer your questions.
[Translation]
OSFI is the prudential regulator of federal financial institutions. ``Prudential'' means we are concerned with the safety and soundness of financial institutions such as the large banks, and appropriate risk management by financial institutions, which contributes to the overall stability of the financial system. Our mandate does not extend to market conduct or investor protection issues, which are the responsibility of other organizations in the provincial and federal sphere.
[English]
With our prudential mandate, OSFI is interested in the market and credit risks that banks might face as the result of business dealings. OSFI is paid to be vigilant and to do something if we think that the entities we regulate and supervise are engaged in unsafe or unsound activity or do not fully understand the potential risks in their businesses or, in the case of the issue at hand, are not adequately assessing the risk of exposure.
OSFI uses a risk-based methodology in its supervision. An institution can, in principle, assume higher risks without attracting supervisory attention provided that the quality of its risk measurement is enhanced. How does OSFI know if the proper risk mitigants are in place? We ask questions, verify the answers and follow up. During our regular assessments of financial institutions we focus on their risk management strategies, changes in their risk appetite and changes in their risk profile.
In this context, a review of the major banks' exposure to hedge funds and their management of that exposure was recently completed. This review indicated that the exposure of banks to hedge funds is relatively small and risk management practices are adequate. Canadian banks are found to be taking a cautious approach to hedge funds.
While OSFI does not currently have any concerns with the participation of Canadian financial institutions in hedge funds, activity in this area will continue to be evaluated as part of OSFI's ongoing supervisory process.
[Translation]
Finally, we meet with our international counterparts on a regular basis to discuss issues, including hedge funds. With respect to hedge funds, we pay particular attention to the work and views of U.S. and U.K. regulators, as the U.S. and U.K. are countries where the bulk of hedge fund activity occurs.
I would now be happy to take any questions the committee might have.
[English]
The Chairman: Senator Angus reminded me of my manners. I neglected to introduce our distinguished deputy chairman from Montreal, Senator Angus. I would be remorseful if I did not mention as well Senator Chaput, who also joins us for this session, and the distinguished Senator Campbell from Vancouver. Senator Campbell was a great protector of the public interest when involved in the public affairs of British Columbia and continues with that work in Ottawa. We welcome them to our committee.
Senator Angus: Thank you, Mr. Chairman. Welcome, Ms. Dickson. I believe it is fair to assume that you have been following the hearings we have been having up to now and that you have a sense of the range of issues that have been troubling us.
Ms. Dickson: Yes.
Senator Angus: I would like to follow up on the chairman's earlier comment regarding the scope of hedge funds. I realize that the mandate of the Office of the Superintendent of Financial Institutions is limited, as its name suggests, to financial institutions, and you are not a consumer protection agency. However, I gather from your opening statement that you are involved and interested enough to be able to give us a sense of the scope of hedge funds. How much of Canadian investment dollars are tied up in hedge funds today? Would it be a trillion dollars?
Ms. Dickson: I have looked at the testimony various people have given to the committee. At OSFI we do not have statistics like that. We are most interested in what individual banks are doing with respect to hedge funds, the amount and kinds of activities they are conducting. We would also be interested in the growth rate of activity that banks have with hedge funds. We have found that the exposure of banks to hedge funds is very small — 2 per cent of the assets of a bank. That is very small in our world, but it is growing quickly; I have seen numbers that suggest 30 per cent a year. Any time we have exposures that grow that quickly, we keep a close eye on them, but it is such a small exposure that we are not losing sleep at night.
Senator Angus: I am happy you are not losing sleep at night. When this new vehicle came into vogue in Canada, it was limited to a sophisticated or exempt investor category, which would include the banks and the so-called institutional investors, but not the retail trade. We have heard that hedge funds have become more popular and many investment counselling and money management firms have been setting up hedge funds and putting their clientele into them, perhaps borderline clientele. In your opening comments you said that OSFI is concerned about making sure the companies or the institutions you regulate understand the nature of the risk and it is sometimes difficult given the degree of leverage that takes place.
I will not pursue the area of the unsophisticated investor with you, unless you feel you can add something, because it is not part of your mandate. We have other people like the Ontario Securities Commission and other agencies in Canada that are interested in that. Let me focus with you on the bank part.
In The Wall Street Journal from yesterday, January 30, the chairman and I noticed the possibility and the actual prevalence, if you will, of conflicts of interest that grow up amongst the banks. We saw it in the recent case of Amaranth. When that blew up we wondered if we were into another long-term capital situation where billions of dollars would have to be ponied up by the bank to save the system and to prevent a big run. In Amaranth it seemed to be managed. Yesterday's The Wall Street Journal headline read, ``Amid Amaranth's Crisis, Other Players Profited.`` The article notes that Goldman Sachs offered a deal; JP Morgan balked and then did one itself. Then the article highlights what I refer to as a conflict of interest. Could you enlighten us in that regard? What did your review turn up?
Ms. Dickson: I can say a number of things. People have identified several issues they would like to look at regarding hedge funds. One is consumer protection, which, as you noted, is not part of our mandate. Two, they want to know whether hedge funds are acting appropriately in the marketplace; that is, is there insider trading or other market integrity issues? Securities commissions are interested in that. Three, people want to know more about anti-money laundering and whether hedge funds pose an issue there. Last, people want to look at whether there is a systemic risk problem of any kind. Could there be a buildup of concentrations of risks in the system such that if a hedge fund collapsed there would be ramifications for the entire system? We are most interested in that last issue, which does touch OSFI. We are very interested in the Amaranth case where a fund collapsed and the market dealt with it. It was a disturbance but not a systemic event. Some people like to point to that as a situation well-handled within the marketplace.
OSFI looked at the exposures of Canadian banks in the Amaranth case and whether they were well managed — how much was on their books, did they know what was on their books, was it collateralized, did they lose any money — because we care about the solvency of the banks. We were satisfied with what we saw.
However, we must continue to stay abreast of what is happening. I meet every six months with my counterparts from around the world, including finance or treasury officials plus central bankers. Hedge funds have been on the agenda for a while. Those meetings are an opportunity to compare notes to see whether people are noticing things that concern them.
Many speeches are made by bank regulators, securities regulators and central bankers. For the most part, the view is that hedge funds are a useful addition to the financial system for reasons you have heard before: price discovery, added liquidity and more efficient allocation of resources. However, people still want to be sure that they understand exactly what is going on. Therefore there continue to be meetings, especially in the U.K. and the U.S. where most of the activity is taking place.
Bank regulators meet with the major players in the system, the major financial institutions, to check what they are doing and whether they understand the hedge funds. Most people think that if the banks that are lending the money understand those to whom they are lending the money, that has a positive outcome for the system because it constrains the leverage of those parties, those hedge funds.
Meetings also take place between major securities regulators like the U.S. Securities and Exchange Commission and the Financial Services Authority in the U.K. Those are not banks but large securities firms that play a big role internationally. They are looking at their risk management practices and whether they understand their counter parties, the hedge funds.
There are also meetings with hedge funds. Even though they are not regulated entities, the Securities and Exchange Commission, SEC, and the Financial Services Authority, FSA, are meeting with major hedge funds. That is good business. We all want to know more about these hedge funds. OSFI tries to stay on top of what the SEC and the FSA are learning. We see those people every six months. We also receive updates and we can talk to them at any time between meetings.
Senator Angus: Those meetings and your interest in hedge funds vis-à-vis the banks' lending practices are interesting points.
I have not heard you say that OSFI has implemented any particular regulation. I know that one of your ways of overseeing and regulating the banks is by setting out guidelines, in effect regulations that are not really regulations. That seems to work in your world.
Do you have specific guidelines for the banks regarding hedge fund exposures? If so, we would be interested in seeing those.
Ms. Dickson: We have no specific guidelines. We make a guideline only if we feel it is necessary because we see something that we do not like. Our review looked in-depth at what the banks are doing with hedge funds, and that was definitely a signal to the industry that we are watching. That has an impact.
Based on that review, we felt that the management of the risk was good so we did not see a need to produce specific guidelines. However, we are also involved in international discussions on capital, and a new Basel Accord will come into effect November 1, 2007. That accord contains a few parts that deal specifically with hedge funds, which we are adopting. It says that if a bank has an open equity investment in a hedge fund, the capital charge would be higher than what it is today. It also talks about collateral management practices, so that if a bank is taking collateral, which it always does when it deals with a hedge fund, it has to think about the liquidation value of that collateral. That is an important development internationally and those rules will come into effect at the end of year.
The Chairman: Are those future guidelines or objectives in writing?
Ms. Dickson: They will appear in a guideline in Canada at the end of the year. I can send you that information.
The Chairman: Thank you. We would like to circulate it to our members.
Senator Goldstein: Thank you, Ms. Dickson, for coming to speak with us about this issue. We understand that OSFI does not have any direct role in the regulation of hedge funds and for a variety of constitutional and mandate reasons you cannot, but you can exercise some indirect control. Some controls are starting to be exercised. For instance, in the United States there is now talk of increasing the threshold for what we call sophisticated investors to $2.5 million plus. Chancellor Merkel has indicated that at the forthcoming G8 meetings she intends to put the hedge funds issue on the agenda. The U.K. has started working on some regulation.
Has your organization been aware of the fact that many Canadians are not worried but wary about the quantity of the market in securities that hedge funds hold? Now almost 50 per cent of the traded stock on Canadian stock exchanges is held directly or indirectly by hedge funds. Is that concentration of concern to OSFI? Bearing in mind that the hedge funds in turn are financed by banks, although you indicated that you are comfortable with that and that in the aggregate the hedge fund loans by banks do not exceed 2 per cent of their assets, does the concentration not start to concern you?
Ms. Dickson: You are speaking about the concentration of trading on the stock exchanges?
Senator Goldstein: Yes.
Ms. Dickson: I am not well placed to comment on that. I think a stock exchange person might be better placed to comment.
Senator Goldstein: As far as we are aware, some 40 per cent of the Canadian hedge funds are held by pension funds, and that does fall within your jurisdiction. Have you done anything about pension funds in terms of guidelines on this issue? For instance in 1997 you did issue guidelines for derivatives.
Ms. Dickson: We have looked at what private pension plans are doing with hedge fund investments. OSFI is in charge of 10 per cent of the private pension plans in Canada. We do not see much investment taking place. I have seen the numbers you are talking about, but they do not represent investments by the plans we regulate. That may reflect the fact that we have only 10 per cent of the plans. We do know that some of the larger plans that we oversee are dipping their toes in the water, so to speak. Again, they are very small exposures.
If a private pension plan wanted to start to invest heavily in hedge funds I think it would have to change its investment policies. We require that pension plans have a statement of investment policies and procedures and every year that has to be reviewed. If a plan decided to make a major change it would have to put that in the policy, which is available for everyone to see. At this point it is pretty small.
Senator Goldstein: Is the review you completed of banks and their exposure to hedge funds in writing?
Ms. Dickson: Yes.
Senator Goldstein: Is that sensitive or could we get copies?
Ms. Dickson: We actually had an access to information request for that report and we shipped it out. I can certainly look at shipping it over here.
Senator Goldstein: That would be good.
Senator Campbell: I am relatively inexperienced in this field but I was wondering whether with hedge funds and unaccredited and unsophisticated investors it is like everything else, buyer beware.
I understand that for the exempt market and sophisticated investors one would expect that they have all the tools at hands to make informed decisions, but if you are not in that category, how do you end up getting into a hedge fund?
Ms. Dickson: I am not well placed to answer that question either.
OSFI plays a minor role to the extent that we look at the lending practices of banks in respect of hedge funds and that helps to ensure that hedge funds are safer than they would be otherwise. However, I would not be able to answer the question as to how much information people should or should not have about hedge funds before making an investment.
Senator Campbell: If an unsophisticated investor wanted to get into hedge funds and went to a bank to borrow the funds, would the bank say anything to that investor or would it simply hand over the money?
Ms. Dickson: Banks care about their business practices. We issued a reputation risk management letter about a year and a half ago in which we stressed the importance for banks to understand the businesses they are in and the reputation risk to which they could be subjecting themselves in some of those lines of business. That applies across the board. It does not matter what business it is.
We are not the only regulator who did that; many others started working on that. Although we are responsible for solvency regulation and oversight, we must also worry about things that can come back and bite a bank and potentially create a solvency issue for them. That is why we issued such a letter. It would be relevant in any situation where they are selling products to customers. However, I do not have the power to oversee how banks go about selling products to customers; that is not the role of OSFI.
The Chairman: Was that letter sent to the banks on your behalf?
Ms. Dickson: Yes. It is on our website.
The Chairman: Could we have a copy of that as well?
Ms. Dickson: Yes.
[Translation]
Senator Chaput: What administrative structure is in place in the case of Canadian hedge funds? Is there a typical structure for managing hedge funds?
For example, could the fund administrator and the investment advisor be one and the same individual? To your knowledge, how are hedge funds typically administered?
[English]
Ms. Dickson: I know a little bit about hedge fund structure, but I am certainly not an expert. The manager could be separate from the advisor and the administrator.
I believe that previous witnesses spoke to that, possibly from the Ontario Securities Commission and one other.
[Translation]
Senator Chaput: So then, you cannot tell me if any resources are allocated to fund management, or anything about the nature or extent of the resources allocated to that purpose?
[English]
Ms. Dickson: When you speak about resources, are you talking about the amount put into management versus administration?
Senator Chaput: Yes.
Ms. Dickson: I would not be able to answer that question.
Senator Harb: In what you and many other witnesses appearing before the committee have said, I have heard no alarm bells raised that would lead me to believe that hedge funds are problematic in Canada. Yet we visited the United States where there seems to be a universal problem. From your position as an organization that oversees financial institutions, perhaps you can shed light on why that is. In Canada it seems to be so mundane and rather smooth going, while across the border, as well as in Europe, alarm bells are sounding everywhere. Is that partially because, as you said, Canadian banks are not as involved as are American and overseas banks? Are you aware of other factors?
Ms. Dickson: The activity is much greater in the U.S. than it is in Europe. Therefore, the bulk of hedge fund managers are located in the United States, creating greater interest there than in Canada. Long-Term Capital Management, LTCM, and Amaranth Advisors were both located in the U.S, which creates interest.
In Europe, in particular, there is some disagreement among the countries as to how to proceed. Some countries are far more vocal than others. As well, some people are beginning to worry about whether hedge fund activity will move out of their country and into another, which would not solve any problems; if you try to regulate such business, it will move elsewhere, thereby resolving nothing. People could get excited about some of these issues.
While OSFI knows full well that the exposure is quite limited here, I also want to be sure that all the discussions and the good points being raised are explored. We have to stay on top of them because an event somewhere else could lead to a major loss of confidence that eventually could affect Canada, thus becoming our problem too.
Senator Harb: My question deals specifically with the sales of principle protected notes. At least one or two groups made a big deal out of them but I do not understand that. If someone goes to a bank and the bank guarantees to come up with the principle, then that is good from the consumer's perspective. If we make more money, then we will give you more money. I do not see the problem.
Has anyone complained to you about that particular aspect? If so, what was your reaction to it?
Ms. Dickson: Because we are a solvency regulator, people would not phone us to complain about that. They might phone other people. A solvency regulator would not get such a complaint. To the extent that banks are offering such products, our role is to ask whether the banks understand the products they are offering and whether they have enough capital to move on such products. We would look at that aspect but we would not receive calls.
Senator Harb: The mandate of the Office of the Superintendent of Financial Institutions is interesting in that it oversees the financial institutions and looks at the Bank Act from time to time, as well as other responsibilities. In Canada, we seem to have a vacuum in terms of oversight to look at the market and to address concerns, whether enforcement, accountability, regulatory or otherwise.
Has it crossed your mind that you should entertain an aggressive discussion to determine whether you might have a role to play in bringing partners together, whether you should expand your mandate to include a more proactive role in the marketplace? Or do you think you have enough on your plate now and it should be up to someone else?
Ms. Dickson: We truly have full-time jobs and we make a point of focusing on our mandate. We do not like to stray too far from our mandate because then we are doing things Parliament did not ask us to do. Anytime anyone tries to move away from the mandate, we have a discussion about it. We are not a huge organization. We must be sure we stick to our knitting and do what is expected of us and not go off in other directions. The government must decide what it wants agencies to do.
Senator Harb: Do you oversee banks and financial institutions within the boundaries of Canada or do you follow the money? If a financial institution is doing work in Asia, for example, is it your mandate to extend beyond the border?
Ms. Dickson: We follow the money.
Senator Harb: Wherever the money goes, you follow it. What about other subsidiaries? Banks may have a vested interest in a third party organization, such as an investment group. When do you determine something is outside your mandate because it has nothing to do with the bank but with the vested interest the bank has in that financial entity, whether it is a trading house, insurance company or other type of financial organization? First, the entity is outside of Canada and, second, it is not real activity with the bank. How do you reconcile those conflicting issues that may come up from time to time in your daily operation?
Ms. Dickson: If the bank owns something, we make it our business. Banks are becoming increasingly international, as are insurance companies, and they could have material operations in other countries. Because of that, we must look at how they are managing the risks when they go into other countries or when they get into other businesses. Therefore, we do follow the money.
From a solvency perspective, it is our business. We will go to those countries and look. Because the bank owns them, it is not an issue. We just do it.
Senator Harb: Even if they own 20 per cent or 30 per cent and someone else owns 80 per cent?
Ms. Dickson: It all depends on materiality. If they own 20 per cent and do not control it, there are rules that limit how much they can own.
We like it when banks control because they have deep pockets, and we like to be sure they can manage the exposure and can therefore ensure the subsidiary is doing what needs to be done.
With that being said, there is flexibility to allow financial institutions to dip their toes into other markets and take minority positions. There are limits on that because when you do not control, you do not call the shots.
Where activity is material, we have to make it our business. Banks and insurance companies appreciate that. They make it their business at the board and senior management levels, so it becomes our business as well.
Senator Goldstein: I am intrigued by the fact that all the witnesses we have heard here, including your good self, have indicated they are quite sanguine about the situation. There is nothing that appears to be alarming or of concern to them.
That seems to be contrary to the attitude of many other people in other countries. It is perhaps inconsistent with the report issued on January 12 by the Canadian Securities Administrators; they considered that the framework was generally sufficient for hedge funds but mentioned six areas of concern. It does not seem to me, and I suppose to my colleagues, that anything particular is being done about those six areas of concern and perhaps no great amount of thought is being given to them. That may be in part because many of those areas of concern fall outside of your mandate and do not appear to fall within anybody else's mandate, ignoring for the moment the serious generic problem we have in Canada with having a plethora of securities regulators instead of a single national one.
Mark Twain talks about the weather and nobody does anything about it. This is the same thing: Everybody is talking about hedge funds, but nobody is doing anything to establish some level of comfort about the areas acknowledged as being areas of concern — hedge fund evaluations and improper referral arrangements, for example. I am taking these points from the report. Nobody is sounding an alarm or saying let us look at this more closely. Therefore, nobody is looking at it more closely. Could you comment on that?
Ms. Dickson: Yes. Regarding hedge fund evaluations, I mentioned earlier that the Basel Accord and our new capital rules would require more capital for open equity investments that banks may have in hedge funds. That is precisely aimed at the fact that hedge funds are difficult to value. If you have an investment in a hedge fund, you cannot mark- to-market it everyday or assume you can sell it within 10 days, which you would assume if you had blue chip stock, for example. The capital rule change reflects that.
The referral issue is not my issue. However, I do know that the securities commission and the Department of Finance are looking at the issue of principal protected notes.
Market integrity issues, which I mentioned earlier, I think are the purview of the securities commission. They recently decided that they would start to oversee the administrator.
I am not sure of the six issues that you mentioned, but some of those issues are definitely being addressed. Hedge funds are an interesting topic: on the one hand, there is a lot of evidence to indicate they have been quite helpful in distributing risk and assisting in price discovery; on the other hand, there are things that people worry about. Balancing the two and trying to determine how concerned you ought to be is a tough assignment.
Senator Goldstein: That is what we are trying to get to. It is not easy. Thank you.
The Chairman: Senator Eyton is here. He may want to ask a question or two.
Perhaps I might raise a couple of issues with you. I think you see that all senators are concerned about this, primarily because the evaluations are so swift in terms of ups and downs. For example, the article that Senator Angus referred to, which we will circulate to the members, was written January 30, 2007. It was a full page in The Wall Street Journal. It is a very informative insight about what happened in just a short period of time.
Let me give you two benchmark figures. Amaranth received a paper profit in 2005 of $1.26 billion. The energy trader received an estimated $75-million bonus after he or his group produced that profit. Less than a year later, the losses in that firm were $3.2 billion.
These are massive numbers that move very quickly, and it goes to the question of security evaluation. Because the nature of a hedge fund, as we understand it, is so given to hedging bets, and the bets shift so dramatically, the valuations never sit still. Given the market forces, particularly in the gas futures business, they have gone up and down. In the oil business, we have seen huge, swift changes in these prices, and they are hedged by pieces of paper.
Having said all that, and subject to what my colleague, Senator Goldstein said, one of the concerns that the deputy chairman and I have are the banks themselves. As best we see it, the situation is pieces of a puzzle put together. The banks are in the hedge fund business. First, they are buyers. Second, they are sellers. Third, they are brokers. Fourth, they are lenders. There does not appear to be, as there was in the United States, divisions or walls between those activities. We are not aspiring conflicts, but it opens the doors to raising questions of conflict when a bank must sit there every day and make up its mind as to where it will make a profit and where it will deal with its loss. It puts banks in a somewhat of an invidious position that sometimes might impair not only their own investment but also that of others. They will obviously put their own investment and their own cash flow ahead of others, including their customers or the funds they manage. The banks are now managing huge dollops of private investment.
You raised the question of control. On the one hand, I think it is important, as you say, for the banks to have control because that allows you much more easily to regulate, in effect. On the other hand, however, the fact of control also opens up the door to these questionable question marks.
Have you or your group given any thought to that? Does it concern you? As the regulator, in effect, of first choice or second choice of the banks, obviously there is not just the question of risk; there is also the question of how risks can shift quickly and the question of conflicts, which both Senator Angus and I have raised.
It is quite complicated. I believe you understand that we are trying to grapple with these questions and come up with recommendations that do not impede capital markets but, at the same time, protect the consumer and protect the bank investor from gigantic ups and downs.
We have all experienced it ourselves. Four or five years ago everyone thought the tech market would go up and all of a sudden there was a huge crash. We have seen when the market is doing great but we have also experienced crashes recently. Can you give us the benefit of your skills and expertise and suggest how we should navigate our path here to come up with recommendations appropriate in the public interest?
Ms. Dickson: Regarding the issue of conflicts, our information is that banks are not really important investors in hedge funds. They actually just lend or they will be a counter party to a hedge fund or to any other party out there in foreign exchange transactions or taking bets on interest rates or whatever. There are many counter parties out there, as well as hedge funds.
On the investing side, however, in the case of Amaranth, the banks were not investors in Amaranth. They had lending exposures but they were not investors. We have not focused on that conflict of interest issue.
Clearly, part of the reason people are interested in hedge funds is because of the valuation issues and the fact they can change strategies pretty quickly. There are also other things happening that are helpful. There are rating agencies now starting to rate hedge funds. Standard & Poor's and Moody's came out last fall.
The Chairman: Is that the group in Chicago?
Ms. Dickson: They have offices in both Canada and the U.S. To have rating agencies starting to rate hedge funds is a major development. Because hedge funds can change their strategies quickly, they would be looking at internal controls. Do you have to talk to someone before deciding to bet on the weather? What kinds of processes do you have in place? That is worth reading. Internationally we have found some solace in that.
The Chairman: I was just talking to the deputy chairman and the clerk. I think it would be important for our committee to get the names of those rating agencies and ask them to give us evidence because it goes to the heart of what we are talking about, the analysis of risk.
Ms. Dickson: Their websites also explain how they go about rating the funds.
The Chairman: I want to thank you, Ms. Dickson. You understand this is a complex subject. We are trying to grapple with it, sort it out and put the pieces together. We are not here to impede the capital markets. We think there is value added to hedge funds in the sense of the capital markets and so on, but there are some issues. We are traditionalists here and we need to modernize ourselves to ensure we assess properly the risks to the economy, to the banks and also to individual investors, whether sophisticated or otherwise.
If you have any other information you would like to send us, please send it to the clerk. We want to wish you well in your interim position. Who knows, greater things may be in store for you as a result of this astounding evidence you presented here today.
The committee continued in camera.