Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 26 - Evidence - November 7, 2012
OTTAWA, Wednesday, November 7, 2012
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:15 p.m. to examine the subject matter of those elements contained in Divisions 1, 3, 6, and 14 of Part 4 of Bill C-45, A second Act to implement certain provisions of the budget tabled in the House of Commons on March 29, 2012, and other measures.
Senator Irving Gerstein (Chair) in the chair.
[English]
The Chair: Today, the Standing Senate Committee on Banking, Trade and Commerce is holding its second meeting as part of a study on certain provision of Bill C-45, The Budget Implementation Act. At this meeting, our committee will be looking at two of these provisions, and we have set aside an hour for each of them. During the first hour, we shall look at Division 1 of Part 4, which would allow certain public sector investment pools to directly invest in a federally regulated financial institution.
Let me introduce our panelists: From the Office of the Superintendent of Financial Institutions Canada, Philipe-A. Sarrazin, Managing Director, Legislation and Policy Initiatives; and from the Canadian Life and Health Insurance Association, Frank Zinatelli, Vice President and General Counsel. Gentlemen, the floor is yours. Mr. Sarrazin, would you like to go first?
Philipe-A. Sarrazin, Managing Director, Legislation and Policy Initiatives, Office of the Superintendent of Financial Institutions Canada: Yes, please, and I have some introductory remarks.
Mr. Chair and honourable senators, thank you for allowing me to appear before the committee today. My name is Philipe Sarrazin, and I am the managing director of legislation and policy initiatives for the Office of the Superintendent of Financial Institutions Canada.
Part 4, Division 1 of Bill C-45, which you are studying today, complements the provisions that were introduced in Bill C-38 — now in force — to allow public sector investment pools, subject to certain criteria, of course, to make direct investments in a Canadian financial institution.
OSFI's role in an approval process is to collect and analyze information, as set out in legislation, to help to inform the minister's decision. We conduct our work based on our clear, prudentially focused mandate. We then provide our analysis to the minister for his consideration.
As with current ministerial approvals, investments must be in the best interests of the financial system and are subject to national security considerations. These are elements that are often beyond the prudential scope of OSFI's mandate and are appropriate for the minister to consider, given his position.
I expect that the Minister of State, Mr. Menzies, was able to answer your questions yesterday, but I am happy to answer your questions relating to OSFI's role.
Frank Zinatelli, Vice President and General Counsel, Canadian Life and Health Insurance Association: I am Frank Zinatelli, Vice-President and General Counsel of the Canadian Life and Health Insurance Association. I would like to thank the committee very much for the opportunity to contribute to its review of Division 1, Part 4 of Bill C-45, the Jobs and Growth Act, 2012.
[Translation]
With your permission, Mr. Chair, I would like to make some very short introductory comments. The Canadian Life and Health Insurance Association represents life and health insurance companies accounting for 99 per cent of the life and health insurance in force across Canada.
[English]
The Canadian life and health insurance industry provides products that include individual and group life insurance, disability insurance, supplementary health insurance, individual and group annuities, including RRSPs, RRIFs, TFSAs and pensions. The industry protects almost 27 million Canadians and over 45 million people internationally. The industry makes benefit payments to Canadians of $64 billion a year, has more than $570 billion invested in Canada's economy and provides employment to about 139,000 Canadians.
Life and health insurers are regulated at the federal level under the Insurance Companies Act, and are also subject to the rules and regulations set out in provincial insurance acts.
Mr. Chair, we welcome this opportunity to appear before the committee as it seeks to develop its report to Parliament. The industry is supportive of the provisions contained in Division 1, Part 4 of the bill. Let me comment briefly on these.
Division 1, Part 4 is a follow-up to amendments made in this spring's Budget Implementation Act, formerly Bill C-38, to federal financial services legislation, including the Insurance Companies Act. Those previous amendments allow public sector investment pools that satisfy certain criteria, such as pursuing commercial objectives, to invest directly in a Canadian financial institution, subject to the approval of the Minister of Finance.
In considering such an approval, the minister may take into consideration a full range of statutory criteria, including the best interests of the Canadian financial system. As indicated by finance officials when they appeared before this committee on May 16, 2012, public sector investment pools are already allowed to invest in other sectors of the Canadian economy; and many other countries allow such pools to invest in financial institutions. The effect of Bill C- 38 amendments is to level the playing field with international competitors for Canadian financial institutions and to provide them with additional potential sources when raising capital.
Bill C-45 amendments would provide further details to those earlier amendments, particularly regarding the approval process for permitted investments by public sector investment pools. For example, the application for approval must be made jointly by the financial institution and the investment pool. The powers of the minister are outlined in the event, for example should the financial institution or the investment pool fail to comply with any undertaking.
The amendments in Division 1, Part 4, of Bill C-45 would create greater internal consistency with other provisions of financial services legislation and would provide that the approval process for permitted investments by public sector investment pools is robust. The amendments, which are of a clarifying technical nature, are important; and the life and health insurance industry is supportive of them.
The industry appreciates this opportunity to participate in the committee's review of Bill C-45. I would be pleased to answer any questions you may have.
The Chair: Thank you, Mr. Zinatelli, for your opening comments.
[Translation]
Senator Hervieux-Payette: Mr. Zinatelli, do you understand French?
Mr. Zinatelli: I can understand a little if you speak very slowly for me.
Senator Hervieux-Payette: I was wondering how many federal and provincial organizations are designated as public sector investment pools. Could you explain this term as well? People understand the public sector as being the government. Explain what it is.
I will clarify my question. How many federal and provincial organizations are designated as public sector investment pools? In other words, could you explain what a public sector investment pool is and give us some examples. Before determining whether we support this measure, we should first know what we are talking about.
[English]
Mr. Zinatelli: Public sector investment pools are organizations or pools of investment owned by a government, federal, provincial or foreign, or by an agency that is controlled by any of those governments. I am afraid I do not know how many there are.
Senator Hervieux-Payette: Give me the name of one or two provincially and federally so that I know what you are talking about.
Mr. Zinatelli: I am afraid I do not have those names but I could provide some of those to you.
[Translation]
Senator Hervieux-Payette: So we do not know what we are talking about. Before going in that direction, it would be important to —
[English]
Mr. Zinatelli: I just thought of one: The Alberta Heritage Savings Trust Fund would be an example of such an investment pool. I am sure there are equivalents outside Canada, but I do not have a list of those names.
[Translation]
Senator Hervieux-Payette: I do not know of many that could qualify as a federal organization pool. I cannot invest in the Caisse de dépôt as an individual, even though it is a good fund. Can the companies you represent take part in buying or do business with an organization like the Caisse de dépôt in Quebec?
[English]
Mr. Zinatelli: I believe that they would be. I see no reason for a restriction and why they would not be. In this instance, we are talking about these institutions purchasing shares in the companies that I represent. This bill will allow greater access to capital for financial institutions by these pools of investments that are out there, including the example of the Alberta Heritage Fund.
[Translation]
Senator Hervieux-Payette: There are some in my province.
Mr. Zinatelli: Yes, there are some in your province.
[English]
Mr. Zinatelli: There are such pools internationally. One of the objectives of the amendment, I believe, is to allow companies access to those pools in the right circumstances with the protections provided by the bill.
[Translation]
Senator Hervieux-Payette: What is the percentage that your companies can go and seek? Because in an insurance company, there is still the issue of risk and the limits in the investment sector, and the investments are limited. In this case, we are talking about what percentage of your $570 billion it is possible to purchase, that people will buy.
I am trying to think of a French pension fund that would invest in one of your insurance companies. I want to know what the organizations are, to understand this amendment is being made. Is it that international funds were not currently allowed?
[English]
Mr. Zinatelli: They were not allowed to purchase the shares of insurance companies, for example. This proposed amendment would allow financial institutions, including insurance companies, to issue shares to these pools and, thereby, raise capital. This is not something that can happen now. That is the purpose of the amendment.
[Translation]
Senator Hervieux-Payette: In other words, if there was a fund that had a bad foreign reputation, the Minister of Finance could refuse to give his authorization?
[English]
Mr. Zinatelli: Yes, very much so. The protections put in place through the process and the ability of the minister to look at all aspects of this are for that very purpose. The investments permitted would be in the best interest of Canada and the company. The government has strong powers to control when any such investments would be permitted.
[Translation]
Senator Hervieux-Payette: Do you have some idea of the percentage of foreign investment that will be authorized, or if the percentage of investment is open in this category of investment?
[English]
Mr. Zinatelli: I do not have that information. I would think that it would be on a case-by-case basis with the minister considering all the factors, which is essentially anything. I do not have an answer for that.
[Translation]
Senator Hervieux-Payette: I think we should get a little more of a complete answer in this regard. We should request consultation. Because in the case of insurance companies, there are very specific rules about the amounts that insurance companies can invest in. Is this an unlimited amount? Could someone buy all of an insurance company's shares? I want to know if there are measures in place. For banks, it is 20 per cent.
[English]
The Chair: Senator Hervieux-Payette, I believe Mr. Sarrazin might have a comment on this.
Mr. Zinatelli: May I comment? Insurance companies are supervised, from a prudential perspective, by the Superintendent of Financial Institutions. They play a part in the process of approval because they would not want any type of investment to be made that would put the insurance company at risk. That would be part of what the superintendent would look at, and that is part of the process of advising the minister in making such a decision. There are controls to prevent an insurance company or a bank from being put at any risk from a prudential perspective. That is why the steps that are being taken here are very controlled and limited steps.
Senator Oliver: Thank you both for being here. My questions are for Mr. Sarrazin.
In your opening statement, you said that you are a prudential regulator and that you do most things keeping in mind your prudential mandate.
In your opening statement, you talked an awful lot about how you collect information and then analyze it for the minister to help the minister out. I am interested in knowing what kind of information you collect and from whom you collect it. After it is all collected and you get it assembled, I am interested in knowing what kind of analysis you do and what tests you use in determining whether or not it is in the best interests of the financial sector. What prudential tests are actually used to make that determination for the information that I presume you would exchange with the minister?
Mr. Sarrazin: Thank you for that question. It is a very good question.
All ministerial approvals are sent the superintendent's way; that is how a file begins. You will note that, in the various financial institutions' statutes, some approvals are superintendent approvals. Some are ministerial. Some are ministerial with the advice of the superintendent; some are not. This particular approval is not a ministerial approval on the advice of the superintendent. However, as is the case for any file that progresses through the Office of the Superintendent of Financial Institutions, we are called to collect the information, as you pointed out and as I pointed out in my opening remarks. We analyze it and submit the entire file to the minister. In this particular case, given that OSFI has a clear prudential mandate in Canada but given that we are not being asked to supply our advice this time around, we would reassure the minister that, from the superintendent's perspective, we do not have a prudential concern. It would be a negative reassurance; we do not have a prudential concern for the application in particular.
Senator Oliver: That is these public sector investment pools?
Mr. Sarrazin: Yes. We do not have a prudential concern about them investing in a Canadian financial institution. That is what we would tell the minister if that is our conclusion.
As for your question on the things that we would look at, it is fairly fact driven, and the statute tells us which elements we need to take into consideration. They are mentioned in section 396 and include the integrity of the applicant. We would determine if the applicant is operating with standards of good character. We would look at their track record on investing and whether they are operated in that fashion. Obviously, we would collect information to satisfy the minister in arriving at his opinion as to whether it is in the best interests of the financial system to allow the investment. It is his decision, but we would collect the information.
You have to also consider that we sort of work in collaboration with the Department of Finance. Yes, we do put the file together, but we are in constant communication with Finance officials. If they have particular concerns or consideration that they want us to document, they would ask, and we would do the analysis for them.
Senator Oliver: When you talk about collecting materials for your decision, though, you are not collecting materials just for the Department of Finance. You do some independent research on your own, do you not? If so, what are some of the sources that you use to gather independent information?
Mr. Sarrazin: One of the considerations that I think is called into question in particular here is the notion of national security. It would be by virtue of section 973.01 that we would document national security issues.
Of course, with important investments in the financial sector, you do not want improper investors who would be looking at money laundering opportunities and so on. We are in contact with CSIS, and we run CSIS checks. With the RCMP as well, we do some background checks on the individuals in the context of the investment pools. That would probably be the one aspect that we would document the most and the one aspect that could cause us to incur delays in an analysis of a fund.
Senator Oliver: Thank you.
[Translation]
Senator Massicotte: I basically have the almost same question as Senator Oliver. Sections 105 and 106 give the minister a great deal of power, even if investments were purchased to reverse the transaction and force the sale of the investment if it should contravene the established criteria. The question is, those who invest must be aware of the criteria because they do not want to be punished in this respect.
You are speaking from the point of view of money laundering. I am assuming another important aspect for these pools since they are government funds from a foreign country, which acts out of a commercial interest, and not with a political agenda with their own interest in mind. Human resources may be involved. Is that right? In other words, if the company invests in a Canadian pension pool or investment, is there a written agreement with that investor stating conditions X, and if the conditions are not met, the minister can impose consequences?
Mr. Sarrazin: You are touching on some points that are documented in the bill being studied. But you are also raising some issues that are already in the legislation under Bill C-38. That bill provided a definition of eligible agent.
Senator Harb: Legitimate agent?
Mr. Sarrazin: My technical terms, I was ready to testify in English. I am trying to do credit to the question in French. The term "eligible agent'' means that a pool that would invest in a financial institution must have a clear, public mandate, not a hidden one. We are talking about Crown agents that are basically governmental, so foreign, provincial or federal pools. We had difficulty listing them. I do not know many of them but, at first glance, these pools are agents of the Crown. And this was not allowed previously. Any government involvement in a financial institution was prohibited at the source. To allow this, the ban on the investment of a government agent had to be lifted, and commercial criteria had to be identified, so a public mandate, not a hidden one. In English, we used the term long-term risk adjusted return, so an investor with economic objectives.
Political objectives cannot be pursued. Furthermore, to add to all of that, we are going to say no, particularly if there is political influence. These are the facts.
Senator Massicotte: Despite all that, despite the transparent understanding, the minister still retains the power to say "we disagree'' and can force someone to sell the investment. Have I understood that correctly?
Mr. Sarrazin: At the front door, if we are not satisfied with the criteria, the superintendent will advise the minister not to allow the investment because it does not meet the basic rules. If things later change, if the pool falls under political influences or ceases to have a long-term risk adjusted return, at that point, the minister can withdraw his approval, suspend it, withdraw it and he can also force the pool.
Senator Massicotte: From time to time, we have different interpretations of the facts. We have to agree to disagree. I think that section 106 gives the minister the right, on his judgment, with full discretion to execute it, to force the sale of those investments.
Mr. Sarrazin: I do not know if you have read the other sections that give the right to representations. Should the minister proceed based on false information, the pool or the bank has an opportunity to make representations.
Senator Massicotte: The minister has the right to decide without further proceedings, unequivocally.
Mr. Sarrazin: Basically, should he order a pool to sell shares and the pool does not do so, the minister has the power to go before the courts to have his order carried out.
Senator Massicotte: For information purposes, some good examples might be the Chinese pool, the Singapore pool, the Norway pool, which has significant funds; there are a number of aspects. I agree, it is important to be open to this because we are becoming uncompetitive.
[English]
Senator Tkachuk: Would it be correct to state, for clarification of some of the information, that this deals with who may invest; does not impact existing restrictions on how much any one investor may hold; and does not impact on any rules regarding the maximum level of ownership by non-residents?
Mr. Sarrazin: You are correct. These provisions will lift the prohibition on Crown agents from investing, but they absolutely do not alter the ownership regime in our financial institutions legislation. Large banks will remain large banks with a public float; and they cannot be controlled. Medium banks will remain medium banks and smaller investments will be subject to the same rules as usual. We are not touching the ownership regime.
Senator Tkachuk: Some of them may be funds of sovereign countries or Canadian pension funds, so the minister needs to be able to deal with some of these restrictions. If a foreign company is taking over a Canadian company, it has to go through all kinds of hoops through the Toronto Stock Exchange to get the okay to do that. In this particular case, because it could be a sovereign country, such as Saudi Arabia, who may wish to invest, the minister would want something to do with who that person is on the fundraising. Yes? No?
Mr. Sarrazin: That is correct.
Senator Tkachuk: Do any of these funds have the right to buy shares on the stock exchange today?
Mr. Sarrazin: By the term "these funds,'' I assume you mean foreign funds?
Senator Tkachuk: Yes, of course.
Mr. Sarrazin: Yes, they are allowed to invest in Canada.
Senator Tkachuk: We are talking about fundraising — a company raising capital. They may issue a tonne of shares, which they have not been allowed to do in the past. They will be able to issue the shares, and these foreign investment funds or local Canadian pools will be able to participate in that program as well; is that right?
Mr. Sarrazin: We are talking about financial institution shares, and the way that financial institutions capitalize themselves — or fund themselves permanently, which is what capital basically is. It used to be that Crown agents were not allowed to invest in financial institutions. In Bill S-5, we saw a move from the Department of Finance to open up opportunities for foreign investment. They lowered the barriers for foreign institutions to invest in Canadian financial institutions. This time, in Bill C-38 and Bill C-45, they will allow Crown agents, foreign investment pools to register their shares in financial institutions, thereby allowing access to capital by our financial institutions.
Mr. Zinatelli: As I understand, we are talking only about the primary issuance of shares. The rules surrounding them are very strict in order to be able to address some of the concerns and to look very closely at even the minutest investment by such pools because you want to know where they come from, who they are, et cetera.
Senator Harb: Mr. Zinatelli, you mentioned in your presentation on page 3, the last paragraph, that the application for approval must be made jointly by the financial institution and the investment pool.
Could you give me a scenario under which a financial institution would say, no, to a public sector investment?
Mr. Zinatelli: I can imagine situations where a pool wants to invest in a company but the company is not interested in a takeover from such a party. This provision, which is very interesting, essentially says that this has to be something that both the financial institution and the pool want. Therefore, they must apply together for the investment to be permitted.
Senator Harb: Mr. Sarrazin, clause 105 specifies that the application for approval in subsection 396(3) must be made jointly by the company and the eligible agent. Is that what Mr. Zinatelli refers to?
Mr. Sarrazin: The provision is the amendment to section 401.2(4) of the Bank Act.
Senator Harb: Could you repeat that?
Mr. Sarrazin: It is clause 116, paragraph 2, of the bill — in the version I am reading.
Senator Harb: How does that reconcile with clause 105?
Mr. Sarrazin: I am sorry; I do not have 105, which is perhaps not in the division.
Mr. Zinatelli: I have the Insurance Companies Act version. This was what I was referring to. Is it the same as in section 138 for insurance companies?
Senator Harb: Yes. We have to have some sort of consistency, I suppose, all along. An amendment to the Trust and Loan Companies Act must be the same as an amendment to the Bank Act and to the Insurance Companies Act; otherwise, we do not have consistency. It does not matter where it is.
I go back to my initial question to Mr. Sarrazin. Could you give me a circumstance under which a bank or financial institution will say no to a public sector investment fund that wants to invest in the bank?
Mr. Sarrazin: I am not privy to how banks approach their investments in terms of seeking investors. These are private dealings among banks and their investors. However, I can imagine an investor approaching a bank and offering to invest. However, if a bank is in a period of its operations where it is seeking to buy back shares instead of issuing shares, it would probably say, no. It would depend on their intentions and use of capital eventually. Buying back shares depends on the circumstances. Basel III will impose stricter capital levels, so you would expect that financial institutions would be seeking capital rather than saying no. As my colleague said, it may happen that they are not ready to receive investments. That is a case-by-case matter.
My apologies for earlier; I may have misled you. Clause 105 is in the trust and loan section. I had printed the Bank Act section only. It is an equivalent provision in the trust and loan section.
Senator Harb: My final question deals with the national security test. You have spoken a bit about some of the things that you do in order to provide the minister with the best possible information. When we talk about tests, obviously we are talking about guidelines. We are saying, "It would have to meet this and this and that,'' right? National security is a very broad thing, so you have to incorporate something into it.
Mr. Sarrazin: I am saying yes, but I was just waiting for you to end your question because, in fact, we do not have set guidelines on national security.
Senator Harb: That is what I want to ask you.
Mr. Sarrazin: We have internal procedures on how to document, but they are for us to do. What we make public is for what the institution must do. We have transaction instructions that tell institutions what they need to supply us. When we turn around and do our security checks, this is internal procedure, so I do not know that this is public.
Senator Harb: Yes, but, in the document that we have, it says that the minister will have to give his or her approval based on the national interest. It says here that investments must be in the best interests of the financial sector and are subject to a national security test. As a Canadian, I want to know what that test entails. When would my minister, based on your recommendation, say yes or no to a subject as to whether or not it is in the national interest? The question was: Do you have guidelines? The answer you gave me was no.
Mr. Sarrazin: We have procedures on how to obtain information, including contacting CSIS, contacting the RCMP, verifying the various international sanctions on funds, individuals and countries and verifying the anti-terrorist regulations and the list of prohibited individuals on those lists.
Senator Harb: It would not be in the sense of whether or not it would impact a sector, whether a sector will become subject to, for example, a foreign influence. You do not look at those issues?
Mr. Sarrazin: On the national security part of the test, no. We look at what I answered earlier.
Senator Harb: Just security?
Mr. Sarrazin: Yes.
Senator Harb: Thank you.
Senator Ringuette: I would like to understand correctly. When Senator Oliver first questioned you, you said that you gather information that you provide to the minister, but you do not advise or make any recommendations to the minister.
Mr. Sarrazin: The statute does not ask that we make a recommendation in this particular case. However, it is normal practice given the OSFI mandate.
Senator Ringuette: In this particular case. Why, then, is it not included in this legislation?
Mr. Sarrazin: You would have to ask the Department of Finance. What I can say, though, is that this is no different from any other ministerial approval on investments; they are all drafted in the same way.
Senator Ringuette: What is the foreign ownership limit on financial institutions in Canada?
Mr. Sarrazin: There is no particular limit on foreign investment. There are limits on investments, period. There are levels of ownership applicable by size of our institutions. It depends on what it is. Banks have various categories, and insurers have fewer categories. As I said, the ownership regime has not been touched. It would be as fully applicable as it used to be to foreign investors, just as it is to Canadian investors.
Senator Hervieux-Payette: We know that the bank is 20 per cent, but do you know the insurance limit?
Mr. Zinatelli: It is 20 per cent as well — the significant interest test, 10 per cent and 20 per cent.
The Chair: Thank you.
Senator Ringuette: I find it interesting that, for instance, a country like China has thousands of Crown corporations that come under the category of government agents as per this regulation. We are opening up quite a potential here.
Mr. Zinatelli, particularly with regard to your comments earlier, you indicated that you protect 25 million Canadians and 45 million people internationally. Then you say that your association has more than $570 billion invested in Canada's economy. I have two questions. What is your total investment portfolio? This is the portion you have invested in Canada.
Mr. Zinatelli: I can undertake to provide you with that information, senator.
Senator Ringuette: Okay. With regard to investment in Canada, I would also like to know the breakdown of your investment, whether it is in the manufacturing sector, the service sector, technology and so forth. Right now, we need investment in those industries that are job creators in Canada. I think that the financial sector is doing quite well, thank you very much. TD has, in the last quarter, increased its profits by 75 per cent. If there is money to be invested, it should be into all these other sectors that require capital to gain efficiency and create more jobs in Canada. I would like to know the portfolio that you invest in.
Mr. Zinatelli: I can say, generally, that we invest in pretty well all areas of the economy. We have that information readily available. Unfortunately, I do not remember it all. I can provide that to you or to the committee.
Senator Ringuette: To the committee.
Mr. Zinatelli: I would be happy to do that in the next couple of days.
The Chair: Provide that to the clerk and the clerk will see that all members of the committee receive it.
Senator Tkachuk: A Chinese citizen can buy stock on the Toronto Stock Exchange.
Mr. Zinatelli: Yes.
Senator Tkachuk: They could buy five per cent of a bank. Ten per cent.
Mr. Zinatelli: Once you hit 10 per cent, you have to —
Senator Tkachuk: Then you have to notify authorities. I am just trying to clarify that there is no particular plot, the way my colleague on the other side suggested, to do with Chinese sovereign investors. Individual investors from all over the world can buy stocks on the Toronto Stock Exchange. There is no secret about that.
The Chair: Thank you for that clarification.
Senator Tkachuk: I do my best, chair.
Senator Ringuette: I would also like to clarify that this particular legislation opens things up not only to national Crown corporations but to foreign Crown corporations. We could argue quite a long time on this, but I certainly have the concern that OSFI will only be providing information to the minister. The decision rests solely on the desk of the minister. I think that is not very cautious.
Senator Hervieux-Payette: I tried to understand the purpose. For banks, I would say that probably they need a good amount of cash to meet the standards of Basel III. Up to now in Canada, we have said that Canadian banks are well financed according to the previous rules but now we have to meet the standards of Basel III.
Could you tell me why our insurance companies would request access in this case? The industry, in my view, is well financed. In fact, they continue to consolidate and we have fewer and fewer insurance companies each year. They are huge conglomerates. Some that were foreign-owned and are Canadian-owned now because they were bought back. I want to understand the rationale for banks and for insurance companies. Perhaps someone can confirm this. It is not as though the Minister of Finance, as bright as he is, woke up one morning and said, "I need funds from outside the country.'' Someone has requested this. Are you aware of where and why this request has given us these amendments?
Mr. Zinatelli: I am not sure that it relates directly to this amendment but certainly the life and health insurance industry is extremely capital intensive. A regulator places requirements on us to have significant capital to back the liabilities, which are very long-term liabilities. Consequently, we require capital for that important purpose.
I understood, simply from reading what has been said by finance, that one of the reasons for these amendments is to put Canadian financial institutions on a level playing field with other institutions outside Canada in terms of raising capital. I understood that to be one of the key rationales for these amendments.
Senator Hervieux-Payette: You are not aware of a special request from your industry.
Mr. Zinatelli: I am not aware of a special request.
Senator Hervieux-Payette: They receive this as a gift. What is the mechanism for raising money? My colleague talked about the stock exchange, but you might not have the permission of a company to buy their shares. There must be a mechanism whereby you request the permission of the minister. You cannot do and undo such a transaction. There must be a mechanism. We are talking about millions of dollars, not simply a few shares. Mr. Sarrazin, I would like to know the process whereby these investors enter into an agreement.
Will the bank select some of the investors and knock on the door of the Minister of Finance and say, "I have an investor that wants to put $200 million in my institution?'' What is the process?
Mr. Sarrazin: I testified to this earlier. I am not necessarily privy to how banks enter into negotiations with their investors before they come to see us. Certainly, there is some contact with investors before they apply to the Office of the Superintendent of Financial Institutions Canada. With a joint application, you would presume that both applicants are on the same side and agreeable to the transaction, so they must have spoken before they met with us.
This approval is about issuing shares. When we talk about a major issuance of shares, many legal documents need to be prepared. The process can be lengthy, including prospectuses, and so on. These have to be done in tandem with the application to OSFI.
As you point out, this is definitely not a case where shares are issued and they come to us afterward. They would need our approval before the shares are issued.
Senator Hervieux-Payette: When there is a major investment, the existing shares are diluted.
Senator Tkachuk: It depends on the price of the share.
Senator Hervieux-Payette: May I ask my question?
Senator Tkachuk: That is not true.
Senator Hervieux-Payette: Is it true that when you put $200 million into new shares and you already have investors, there is an impact on those existing investors and on the dividend they pay?
Senator Tkachuk: It depends on the price. If there is money in the bank, what is the difference?
Senator Hervieux-Payette: May I have an answer from Mr. Sarrazin?
Mr. Sarrazin: I have not been a witness to many share issues because I am not responsible for approvals in our office. However, as was pointed out by other senators, pricing issues have to be debated before the shares are issued in the public domain. Certainly, there are circumstances where there is potential dilution but usually prices are set to follow market conditions and market prices.
Senator Hervieux-Payette: There is a market price, but I am not talking about buying shares at a discount. I am talking about the market price.
How much more will it generate in terms of that? When you buy shares, you expect not only your share to go up, especially in financial institutions, but also you expect dividends. That has been the way. After the crisis in 2008 and 2009, many banks issued shares with quite a generous dividend to ensure that they had the proper capitalization.
In this case, we are talking about adding to the capitalization of our insurance companies and banks. Mr. Zinatelli could not tell me why the insurance companies needed that. The only assumption I had regarding the banks was their need to comply with Basel III. When I talk about the banks of Canada, I am talking about billions of dollars, not millions of dollars.
We are talking about the interests of Canadians, for example. Investors have an interest in a return on their investments; otherwise they would not put their money in. How do we ensure that this is in the best interests of Canadians? What is the report? How will Canadians be able to assess this investment to know whether it is in their best interests?
Mr. Sarrazin: I hope I did not lead you to believe that Canadian banks are in direct need of capital. Our banks are very well capitalized.
This is a welcome additional opportunity to access capital, whether it is for growth purposes and not necessarily to meet Basel III requirements, although they are in the balance of considerations.
On your question around pricing, I am sorry to say that we do not regulate that aspect of the transaction, so we are not the best government institution to answer that question.
I forget your last question.
Senator Hervieux-Payette: How will we know whether it will be in our national interest? Will it be a criterion that we will never hear about and there will be no regulations? If I am a Canadian first and an investor in that bank, how do I know that with this investment my interests are protected?
Mr. Sarrazin: I understand the question. We need to distinguish this whole China concept we alluded to earlier. Let us forget for a moment that it is a Chinese investment. The test proposed in Bill C-38 of creating the definition of "eligible agent'' somewhat takes away from the source of the investment. The definition of "eligible agent'' ensures that the fund in question has a clear public mandate and a long-term risk-adjusted return. Where the fund comes from and the country that it is from is a lot less important because you are dealing with a much more objective investor than you would be if it were an investor that was politicized, for instance. Embedded in the legislation is a safeguard that eliminates the political considerations and the objectives that are non-commercial.
That said, by respecting this test, you are probably further along the road to demonstrating that it is in the best interests of the financial system. The minister will certainly take into consideration that more capital in the financial system is a good thing because capital brings stability. I think that was the objective when creating this access to capital.
The Chair: Thank you, Mr. Sarrazin. I have a final question from Senator Tkachuk.
Senator Tkachuk: On this matter, this is not about raising capital. If the bank needs to raise capital, it will raise capital. As matter of fact, CIBC, after the financial crises, raised capital from a Hong Kong billionaire. They have to go through a whole process and prospectus to raise capital because they need equity for a particular purpose, or they need to raise capital for a particular purpose. All this does is add another customer to the list. That is all it does.
Mr. Sarrazin: That is correct.
Senator Tkachuk: It is no more complicated than that, so it is not some plot to dilute shares. The bank will still raise capital whether or not they have this customer. This just gives them another customer.
Mr. Sarrazin: When you want to sell your house, the more buyers there are, the happier you are.
Senator Tkachuk: Exactly, and the higher the price.
Mr. Sarrazin: The more you issue shares, the more takers there are.
The Chair: Thank you very much. Gentlemen, that concludes the questions from our committee. On behalf of all of the committee members, Mr. Sarrazin and Mr. Zinatelli, we greatly appreciate your appearance before us today.
During the second hour we shall look at Division 3 of Part 4, which would, among other things, provide for a limited automatic stay in respect to certain eligible financial contracts when a bridge institution is established. It will also facilitate central clearing of standardized over-the-counter derivatives.
Our panelists include, from the Canadian Securities Administrators, by video conference from Calgary, William S. Rice, Chair. He is also CEO of the Alberta Securities Commission. From the Canadian Deposit Insurance Corporation, we have Greg Cowper, Director, Policy; Chantal Richer, Director, Legal Services; and, from the Bank of Canada, Robert Turnbull, Special Counsel, Financial Systems.
Perhaps we will start with Mr. Rice. Can you hear us clearly, sir?
William S. Rice, Chair, and Chair, Alberta Securities Commission, Canadian Securities Administrators: Yes. Thank you very much.
The Chair: Do you have an opening statement to make?
Mr. Rice: I will go ahead then.
From the standpoint of the securities regulators, at the 2009 Pittsburgh Summit of the G20 leaders, Canada and other G20 countries agreed that "all standardized OTC derivatives should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end 2012 at the latest. OTC derivatives contracts should be reported to trade repositories.''
After considerable analysis and debate, senior representatives of all of the Bank of Canada, the Office of the Superintendent of Financial Institutions, Finance and the Canadian Securities Administrators agreed that, subject to appropriate exemptions, standardized over-the-counter derivatives should be mandated for clearing through central counterparties, or CCPs, and that Canadian market participants could fulfil this complaint by clearing OTC derivatives using any CCP recognized by Canadian authorities, including global CCPs. Canadian securities regulators are among the authorities empowered to authorize a CCP to carry on business in Canada.
Clearing and settlement systems are subject to a number of provisions in the Payment Clearing and Settlement Act, PCSA. The PCSA protects the application of the rules of a securities clearing house. Those provisions ensure that the rules of a securities clearing house for determining final settlement amounts, the arrangements for netting transactions or the transfer of payments or collateral between parties to the clearing house are paramount or final and cannot be challenged by a court or through other means. This provides necessary certainty to securities market participants.
Amendments are required to provisions of the PCSA to provide that derivatives clearing — and not only securities and payment clearing — is contemplated by these provisions. The amendments are required in order to bring into the envelope of the act derivatives clearing. In addition, amendments are required to ensure that there is a derivatives clearing regime in Canada that conforms to international standards and the internationally recognized practices of the global CCPs.
First, there are amendments to definitions. As the PCSA was drafted with securities and payment clearing and settlement systems, rather than OTC derivatives clearing systems in mind, the definitions used are, in some respects, deficient for application to a derivatives clearing system. A number of amendments address those deficiencies. The amendment proposed by the bill to the definition of "clearing and settlement systems'' removes the uncertainty surrounding the application of clause 4 to derivatives clearing systems.
The bill proposes to change the definition of "settlement rules'' so that, in addition to payment obligations, it includes the clearing and settlement of delivery obligations and the posting and transfers of collateral. In other words, the definition of "settlement rules'' will be extended to cover deliveries or transfers of interests in property in order to ensure that transfers of collateral or physical settlements cannot be reversed, repaid or set aside. Again, this accommodates the inclusion of over-the-counter derivatives.
The bill further proposes to update the definition of "financial collateral'' eligible for protection under the Payment Clearing and Settlement Act to include assets commonly used as collateral in the context of centrally cleared OTC derivatives contracts. To ensure that the definition of "financial collateral'' can keep current with evolving market practice, the bill provides a regulation-making power to expand the list in the future.
Then there are amendments addressing the subject of stays and fraudulent preference laws. It is important that the transfers, assignments and hypothecation of assets between clearing system members and their clients be protected from the risks of stays of proceedings under Canadian law. This ensures certainty for the participants.
Bill C-45 expands the scope of the protection in section 13 of the PCSA to include netting agreements between a participant — a member of a clearing house — and a customer to which the participant provides clearing services. Netting agreements are common features of derivative trading. Bill C-45 amends section 13.1 of the PCSA to ensure that the stay protections apply to collateral posted by a domestic CCP to an offshore CCP. This is of importance given the anticipated role in our regime of global CCPs.
Bill C-45 addresses concerns with the fraudulent preference provisions in insolvency statutes by broadening the protections in the PCSA to apply to all transfers of assets within designated clearing and settlement systems, not just the settlement of payment obligations. Further, the bill introduces a clarifying amendment to remove any doubt that the protections apply not only to realizing financial collateral but also the granting of security in and transfers of financial collateral.
The Canadian Deposit Insurance Corporation Act provides that if an order establishing a bridge institution is made, any netting, close-out rights or rights in collateral that would normally be enforceable under an eligible financial contract safe harbour may not be endorsed against the institution if CDIC unconditionally guarantees all of the institution's payment obligations or ensures that all of the institution's payment obligations arising from the EFC will be assumed by the bridge institution.
There is a lack of clarity as to whether this provision would supersede the protections against stays under sections 8 and 13.1 of the PCSA. Bill C-45 amends the PCSA to provide expressly that the relevant provisions of the CDIC Act apply not withstanding provisions of the PCSA.
There is an amendment to the CDIC Act. Currently, the Canada Deposit Insurance Corporation has the pour to create a bank called a "bridge bank'' that would take over operations of a failing bank — a bank that is no longer viable. Currently, when a bridge bank is created, the legislation provides that a conditional stay can be imposed on the termination clauses of certain eligible financial contracts and the stay is imposed if the Canada Deposit Insurance Corporation undertakes to guarantee the obligations of the failing member institution under the contract, or it transfers these obligations to the new bridge bank that is created. That is the current framework; and that stay makes easier the creation of a viable bank — the new bank that is being created.
Proposed amendments to the Canada Deposit Insurance Corporation Act provide for a new stay. It is for one business day and is based on the same criteria. The stay allows one day for the CDIC to decide which of these financial contracts are to be transferred to the new bank and which ones will stay in what is called "the bad bank'' — the insolvent institution that is failing.
In summary, from our standpoint the amendments provide that current legislation governing clearing in Canada will also apply to the clearing of derivatives as agreed by the G20 and now to be undertaken in respect of supervisory authorities by Canadian financial regulators. In addition, the amendments conform Canadian legislation to international standards to allow Canadian participants to function internationally and for global CCPs to provide their clearing services to Canadian financial institutions. The understanding of us Canadian securities regulators is that the amendments proposed are consistent with international standards and practices. These amendments will assist us in the undertaking of our recognition authorities. Those are my remarks. Thank you.
The Chair: Mr. Cowper, please proceed.
Greg Cowper, Director, Policy, Canada Deposit Insurance Corporation (CDIC): Good afternoon. My colleague, Ms. Richer, who is the director of our legal services team, is also here with me today.
The Canada Deposit Insurance Corporation is a federal Crown corporation that protects Canadians' deposits at any of CDIC's 82 member institutions in case of their failure; and contributes to the stability of the financial system in Canada. Since its creation in 1967, we have dealt with 43 member institution failures. The total deposits held by these institutions came to roughly $24 billion and were held by some 2 million Canadians. As at April 30, 2012, the amount of eligible deposits insured by CDIC was over $640 billion.
Since the start of the global financial turmoil, Parliament has amended the CDIC legislative framework to enhance our resolution tools and ability to promote financial stability, including the power to create a new bridge bank to take over the operations of a failing bank, as was mentioned. International standards for effective resolution of financial institutions were also developed by the Financial Stability Board and endorsed by the G20 in 2011.
The proposed amendments to the CDIC Act we are discussing today arise from and are consistent with these international standards. The proposed amendments would enhance CDIC's ability to take on and preserve the critical functions of a failed CDIC member institution by providing time for CDIC to determine which eligible financial contracts it wishes to transfer from the failed bank to a bridge bank. Further, the proposed amendments would provide for a limited automatic stay on the ability of certain counterparties of a failed CDIC member institution to terminate EFCs for one business day following the incorporation of the bridge bank. An example of an EFC would include a derivatives contract or a repurchase agreement.
The stay would be limited in that it would apply only to termination rights arising from CDIC's resolution actions. Counterparties would therefore retain the ability to terminate the EFC on other grounds; for example, if the failed member was in default of any obligations arising from that contract.
However, the automatic stay would not apply to eligible financial contracts with central counterparties that are designated and named for systemic purposes under the Payment Clearing and Settlement Act.
This concludes our opening remarks. We are happy to take questions.
Robert Turnbull, Special Counsel, Financial System, Bank of Canada: Thank you for the opportunity for the Bank of Canada to assist this committee in discussion of the amendments to the Payment Clearing and Settlement Act.
Mr. Rice of the Alberta Securities Commission has done a good job of summarizing the individual amendments. Perhaps what I can do is give you the perspective of the Bank of Canada as to the purpose behind the proposed amendments to the PCSA.
[Translation]
At the 2009 G-20 summit in Pittsburgh, the leaders agreed that standardized over-the-counter derivatives contracts should be cleared through central counterparty clearing systems by the end of 2012. A CCP is a financial market infrastructure that stands between buyers and sellers in financial transactions, ensuring that obligations will be met on all contracts that are cleared through the CCP.
By managing and mitigating counterparty credit risk, CCPs have the potential to reduce systemic risk, both globally and in Canada. They reduce the potential for financial shocks to be transmitted through the financial system and support the ability of markets to remain continuously open, even in times of stress.
About a month ago, Canadian authorities reconfirmed their G-20 commitment to central clearing and indicated that Canadian participants in the derivatives market can respect this commitment by clearing derivatives contracts through the global, cross-border clearing systems that are currently being developed in the United Kingdom and the United States.
Regardless of whether derivatives are cleared through a central counterparty in Canada or abroad, Canadian laws will be applied to determine the rights and obligations of Canadian participants and their customers. It is therefore important for financial stability in Canada that the transfers of assets among central counterparties, Canadian participants and their customers for the clearing and settlement of derivatives transactions are protected from possible legal challenges in the event that a Canadian participant were to become insolvent.
[English]
The main statute in Canada for protecting clearing and settlement systems from legal challenges in the event of a failure of a participant is the Payment Clearing and Settlement Act, the PCSA. The PCSA gives the Bank of Canada the responsibility for the regulatory oversight and clearing systems that could pose systemic risk. The PCSA also provides a number of important legal protections. In particular, it ensures that the rights of a clearinghouse to be paid, to settle transactions and to deal with collateral deposited by participants will not be stayed — unwound under insolvency statutes — if a participant happens to default. The purpose of these protections is to ensure that a clearinghouse will be able to exercise its legal rights to settle the system within a reasonable time frame following a default and that it will have sufficient rights in the assets deposited by participants to ensure that the clearinghouse itself will not be brought down by the failure of one or more participants.
The PCSA was enacted in 1996, primarily to address systems that settle payment obligations. While it has since been updated to take into account payment systems for securities and for derivatives, many of the legal protections in the act remain worded in such a way as to suggest that they apply to payments clearing but not necessarily to the clearing of derivatives contracts. For example, the protections for the enforceability of settlement rules in clause 8 of the act are limited to clearinghouse rules that provide for the calculation, netting or settlement of payment obligations. It is doubtful whether these necessary protections extend to the clearing of derivatives contracts and the transfers of collateral and other assets that support derivatives clearing systems.
The amendments to the legislation remove this doubt in order to ensure that central counterparties can successfully exercise their legal remedies, in the event of a default by a Canadian participant, without risk of having those rights stayed or frozen. This will, in turn, minimize the likelihood that the central counterparty will have to absorb the loss, which could, in turn, pose a risk to the financial system as a whole.
Another aspect that we think it is important to point out is that these amendments also address the views of some global CCPs and their regulators that Canadian law does not protect the ability of the CCP to exercise its rights against Canadian participants and the assets that they have deposited as collateral. This view is restricting the ability of major Canadian participants to clear derivatives on behalf of their clients through a number of CCPs. Canadian market participants are, therefore, finding themselves at a competitive disadvantage relative to their competitors from countries that have chosen to implement comprehensive legislative protections for CCP clearing of derivatives, notably the U.S. and the EU countries.
These amendments will ensure that CCPs will be able to exercise their legal remedies, in the event of a default of a Canadian participant, without the risk of having those rights stayed or frozen.
That is our statement, Mr. Chair, and we would be pleased to discuss individual amendments.
The Chair: Thank you very much, Mr. Turnbull. I will move directly to our list of questioners, starting with the deputy chair of the committee, Senator Hervieux-Payette.
Senator Hervieux-Payette: I presume our guest from Alberta does not have translation, so I will ask my question in English. It might not be as precise as I would have made it in French.
In the past, were the over-the-counter derivatives difficult for financial institutions? My impression was that, when there was a major breakdown in the United States, it was not through derivatives. Did you call the sub-prime a derivative?
Mr. Turnbull: There has been a lot of focus on what we call over-the-counter derivatives during and since the 2008 financial crisis because it was found that over-the-counter derivatives were one of the major ways by which risk was spread throughout the system. These are highly sophisticated instruments. Some of them are highly complex, and they were exempt market instruments. There was no regulation and no central clearing of these instruments.
Senator Hervieux-Payette: You know how much of a disaster it was for our pension fund in Quebec, which lost several billion dollars through the transactions. When you talk about derivatives, my sense is always that they are very obscure and difficult to understand, to the point that experts in pension funds could not see what kind of risks they were taking. They were taking the word of the Moody evaluation.
In this case, will it mean that we will now correct that and that someone will be able to evaluate and say yes or no? I would like to perceive that we would not put the financial system at risk again.
Mr. Turnbull: The G20 commitment to move toward central clearing of derivatives products is indeed one of the measures that governments and regulators have agreed are important to put in place to control the type of risk that you are talking about. These central counterparties help to control the risk in that these instruments are traded and then settle on a later date. Before the trade is settled, they are entered into the central counterparty, and the risk is transferred to the central counterparty, which, itself, is heavily risk-proofed with collateral and a set of rules that gives it the ability to terminate and close out contracts if there is a default.
In turn, these amendments to the PCSA are designed to ensure the legal enforceability of these central clearing systems.
The Chair: Mr. Rice, would you like to add to that?
Senator Hervieux-Payette: Mr. Rice, do you have anything to add?
Mr. Rice: I would maybe make two quick observations, one on the transparency side. There was a sense that regulators and others were not really aware — and many of the participants were really not fully aware — of the magnitude of derivatives transactions or the complications of derivatives transactions. It is proposed that there be a reporting requirement so that there will be much more knowledge out in the open about these transactions, and they will not be quite so mysterious.
The central counterparty is in the middle of every transaction and is a purchaser to every buyer and a buyer to every purchaser. The theory is that if the central counterparty is strong enough, then the transaction will always be viable, sustainable and strong. Clearly, these requirements, as Mr. Turnbull explained, are an effort to address the very problems you have identified and that were experienced throughout 2008-09 difficulties.
Senator L. Smith: Mr. Rice, perhaps you can help me with this question. I would probably be considered a neophyte when we talk about derivatives. The G20 agreed to sset up new rules to have better control. Have all countries of the G20 implemented similar rules? Who qualifies to be central counterparty? How many players are involved? When you say "central,'' it sort of denotes that there are one or two major groups that control transactions to provide and ensure the legitimacy and proper execution of those contracts. If you could help me with that, I would appreciate it.
Mr. Rice: All countries engaged in major financial transactions and in the regulation of financial institutions and securities transactions are engaged in the same process that we are. Some are more advanced than others. The U.S. is probably out in front, to some degree. The EU countries may be a bit out in front. From all we know, Canada is probably well placed in the rest of the pack in achieving the objectives of these amendments and the direction from the G20. We are all in communication with one another, trying to live up to internationally agreed upon standards and to create consistent standards across international borders. That is the intention, although we are not there yet. The process is not complete, but Canada is keeping up at a good pace. We expect that Canada will be in conformity with the regulations and regimes applied elsewhere, with principle concern about the U.S., the U.K. and the EU countries with whom the majority of our transactions are undertaken.
Not many players would play in the most significant areas of derivatives trading. That is one of the reasons behind the decision of the group of regulators to determine that a global central counterparty would be acceptable for authorized trading in Canada. The facilities, the experience and the financial stability rest with only a few very large and well-established clearing agencies in the world. Where matters would become systemically important, only a few clearing agencies would qualify, and that we would consider appropriate, to act as clearing agencies for these kinds of systemically important transactions.
Senator L. Smith: Who would qualify in Canada?
Mr. Rice: The one that comes to mind is LCH.Clearnet of London, England.
Senator L. Smith: It is a big international company.
Mr. Rice: Exactly. That is one of the reasons we have to ensure that our legislative and regulatory framework comply with international standards. The organizations that would deal with systemically important trading to Canada are international global bodies.
Senator L. Smith: Is there a need for any other amendments or additions to the proposed legislation that would be helpful to make it even more effective, in your view?
Mr. Rice: I hesitate to get out of my depth here. We would not have participated in the drafting of this legislation but we have had people involved in discussions with the staffs of various organizations. I am not aware of any deficiencies. I do not want to give you a warranty but, certainly, I am not aware that anything else is required.
Senator Harb: I am interested in the length of time it will take for the clearance of a transaction in the past versus under what is proposed in Bill C-45. For example, is there a proposal to speed up the clearance of a transaction?
Mr. Rice: These amendments are not intended to address speed. In fact, there would be a concern in the market that possibly they will slow it down because, historically, these over-the-counter transactions took place between two parties individually and privately; so there would have been no timing issue. With the proposed amendments, the transactions must go through a process and be subsequently reported. They go through electronic systems that are extremely sophisticated. I am not aware there is a concern about timing, but it would not be one of the objectives of these regulatory and legislative proposals to speed up transactions.
Senator Harb: As a product, we are talking about derivatives. Every second day there is a new product on the market. In your view, does this bill anticipate other types of products or does it specifically deal with existing products? If it only deals with existing products, should it also anticipate future products that Bill C-45 should take into consideration?
Mr. Rice: Eventually, the entire regime will require that all over-the-counter derivative transactions that formerly took place — and there will be exceptions to the requirements — between two parties and without any publication will take place through a central counterparty and through a reporting system. The requirements will not be exclusive to any category of derivative. Future derivatives, if they qualify under that definition of "derivatives,'' would also be caught by the same requirements.
Senator Massicotte: Mr. Cowper and Mr. Turnbull, we all learned from 2008-2009 about the need for greater transparency. There is no debate. The amendments proposed are highly technical, but could you confirm to us that what we are doing here has been done in the United States and in the U.K. and is quite consistent with the same approach?
Mr. Turnbull: Obviously, the legislation in every country is different, but we are trying to provide the same level of protection that is consistent with the protection in those jurisdictions.
Senator Massicotte: Mr. Cowper, as I understand, it has been done in the U.K. and in the United States. Are we doing the same thing? Is it consistent?
Chantal Richer, Director, Legal Services, Canada Deposit Insurance Corporation (CDIC): With respect to the proposal within the confines of our act, those are international standards recently established by the Financial Stability Board and are core elements of effective resolution regimes.
Those are international standards, and the stay is something that has existed in the U.S. for some time under the FDIC act. Other countries around the world are looking towards these standards to try to implement them as well.
Senator Massicotte: I notice that what is being proposed is a one business day freeze. Is that adequate to liquidate and allow the rest of the recourse to occur? I am not sure who can best answer the question.
Mr. Cowper: We feel it represents a good balance between allowing us to do our job, in a very quick fashion, to resolve a financial institution and preserving the rights of contract holders to exercise their rights under those contracts in a timely fashion. We do feel that it strikes the appropriate balance.
As my colleague mentioned, it is consistent with international practices in this area. We are following the international standard.
Senator Massicotte: Thank you.
Senator Moore: I thank all the witnesses for being here. I want to follow up on Senator Massicotte's question. It mentions terminating eligible financial contracts for one business day following the incorporation of a bridge bank. It could be a few days before they set up a bridge bank, which would give you a bit more time, right? It is one day after the bridge bank is put in place?
Mr. Cowper: That is right. Theoretically, if the bridge bank order is issued on, say, a Friday evening, then the stay would run until the end of the following business day, which would be the Monday.
Senator Moore: When you start the process to incorporate a bridge bank, you would have to do some due diligence to decide that you have to put a bridge bank in place.
Mr. Cowper: That is right.
Senator Moore: What is a normal time? I do not know if you have had to set up bridge banks in the other 43 failures, but how much time is there between deciding that it has to be done and putting it in place?
Ms. Richer: The stay commences from the time that the order to create the bridge bank is issued and made public. In my colleague's example, let us say that would be the Friday night. That is when the stay period would commence, and, in his example, it would expire at five o'clock on Monday.
Senator Moore: I understand that, but, to establish that a bridge bank must be put in place, you do not deal with it that quickly, do you? Is that days, weeks?
Mr. Cowper: The bridge bank can be established based on an order issued by the Minister of Finance.
Senator Moore: Yes, but you would have to take some time to assess the circumstances and the assets or whatever of the failed institution, which could be what, a week? You would not do that overnight.
Mr. Cowper: No. We work very closely with our other financial safety net partners in that regard. The Superintendent of Financial Institutions and her staff are on site assessing the financial viability of a CDIC member institution on an ongoing basis, and we would be working in close contact with them prior to any determination that a bank needs to be put into resolution.
During that process, the assessment of resolution options would take place, and a bridge bank would be one of the options considered.
Senator Moore: That could take a number of days. Would it take as long as a week?
Mr. Cowper: I think it would largely be circumstantial. If you have a bank that is in trouble and there is the requirement to act very quickly, then the process could be undertaken appropriately.
Ms. Richer: The process would also be facilitated by the ongoing work with our members to work towards resolution plans and to understand their structure, assets and so on. There is ongoing work in that respect.
Senator Moore: Senator Massicotte had a thought, but I want to come back.
Senator Massicotte: On that same issue, what is a bridge bank? Is that a bank providing bridge financing?
Mr. Cowper: It is essentially a temporary bank that would be owned by CDIC to take over the critical services and functions of a failed member.
Senator Massicotte: It is an entity owned by you, not by somebody external. You take prior charge of all the assets. You advance funds, but you get repaid, I presume?
Mr. Cowper: Essentially, we can transfer the assets and the liabilities from the failed bank into our newly created bridge bank.
Senator Massicotte: Thank you.
Senator Moore: When you have gone through these processes and have cleaned up as much as you can, what happens to that bank then? What happens to that corporation? Do they wind it up?
Mr. Cowper: No, the bridge bank would ideally be sold back into the private sector.
Senator Moore: Someone would buy the shares?
Mr. Cowper: That is right.
Ms. Richer: It is to address a situation where there is no buyer readily available to buy the bank at the time. It is to maintain financial stability until a viable bank can be sold back into the private sector. It is meant to be temporary.
Senator Moore: Mr. Turnbull, you talk about the importance of this bill because it will establish certainty and remove any doubt as to whether these necessary protections stand up to the clearing of derivatives, not simply payment obligations.
In the next paragraph you say "the amendments to the legislation remove this doubt in order to ensure that central counterparties can successfully exercise their legal remedies, in the event of a default by the Canadian participant, without risk of having those rights stayed or frozen.'' You repeat the exact same thing down below.
It must be important to you as you are repeating that. I do not understand what it means. "In order to ensure that central counterparties can successfully exercise their legal remedies, in the event of a default by a Canadian participant, without risk of having those rights stayed or frozen.'' Could you explain to me what "without risk of having those rights stayed or frozen'' means?
Mr. Turnbull: Ordinarily, under Canadian insolvency statutes, there is provision for when an institution becomes insolvent. It is either automatic or the courts have the discretion to stay all remedies by creditors of that institution. It is basically frozen.
Senator Moore: Stood in place. No one makes a claim. No one takes any action; it just remains as it is found.
Mr. Turnbull: No creditors can exercise their legal remedies against that institution.
In certain instances, the legislation recognizes that there are some types of rights, under some types of contracts, that are sufficiently important, for purposes of financial stability, to allow the other parties to those contracts to proceed and exercise those rights and that those particular contracts should be exempted from the usual stays. That is what these protections in the Payment Clearing and Settlement Act do with respect to transactions that take place in the clearinghouse and some transactions that take place outside of the clearinghouse but that can affect the stability of the clearinghouse.
Senator Moore: Are a stay and a freeze the same thing? You mention them both here and repeat it. When something is frozen, is there a difference between that and a stay?
Mr. Turnbull: There is no difference in that. There are various techniques used in insolvency. One is a stay, which is a freezing of the assets and the ability to take action against those assets. Another is the actual unwinding of transactions that have already been settled. Sometimes those can actually be unwound.
Another provision in insolvency statutes — a common provision — is that it is assumed that, for a certain period prior to the insolvency, any transfers of assets by the subsequently insolvent institution are deemed to be done with the intent to defraud creditors or prefer certain creditors.
Senator Moore: What is the time period?
Mr. Turnbull: In some statutes, it is 90 days and in other statutes, it is 60 days.
Senator Hervieux-Payette: I have one question for Mr. Rice and one for Mr. Turnbull.
Can we say that the answer to prevent future problems with this is part of the mandate of the Financial Stability Board chaired by Bank of Canada Governor Carney and that its role emanates from the G20 discussion?
Mr. Turnbull: That is right. You have hit on the main purpose of the Financial Stability Board, namely, to identify where there are regulatory gaps and to make recommendations that could be adopted by countries around the globe for strengthening their regulatory framework as well as their rules for capital to create a more stable financial system so that, for example, the financial crisis of 2008 does not happen again.
Senator Hervieux-Payette: I suppose the Governor of the Bank of Canada and the Minister of Finance are involved in that process.
Mr. Turnbull: Very much so.
Senator Hervieux-Payette: Mr. Rice, I understood you to say that the central counterparty clearing system is not fully in place. This is something that we will reach soon. Am I correct in saying that every derivative transaction will be reviewed or approved by this organization when it is fully in place? Who will oversee these derivatives?
Mr. Rice: There will be some shared responsibility. The Bank of Canada will oversee transactions and clearing agencies that are viewed to be systemically important to Canada. Securities regulators will oversee derivatives transactions and clearing agencies, central counterparties that participate in the clearing of derivatives transactions.
We do not approve the transactions. We require each transaction to take place through a central counterparty and to be reported to a trade repository.
Senator Hervieux-Payette: Do you disapprove if it does not meet some criteria?
Mr. Rice: Well, that remains to be seen. We will have to trust the central counterparty to establish the rules. The central counterparty is being asked to take the risk. It is felt that the central counterparty is a more reliable risk-taker than the parties themselves. That is why we are proposing that the central counterparty be interposed between the two players. They will take the risk, and there will be oversight by a number of organizations to ensure that the central counterparty has the financial strength to withstand that risk.
Senator Hervieux-Payette: Once we pass this bill and it is in place, can I say that besides having a lot of loan defaults, the banks will be secure and we will not have to use the bridge bank? We will be on safe ground because this is one of the big risks. The second big risk is undertaking too many loans. Under Basel III, we will be in a more secure position. However, will we have a much more secure financial sector for the years to come?
Mr. Rice: The view is that it will be more secure, but it is untested. There will always be risk, but it is felt that the system in its entirety will be more secure and more able to withstand the risk because of the introduction of the central counterparties and because of the transparency introduced by a requirement that trades be reported and viewed by other participants. Certainly, it improves the level of security but there will always be a level of risk.
Senator Moore: Further to the question of Senator Hervieux-Payette, either Mr. Rice or Mr. Turnbull may answer my question that refers to the 2009 summit in Pittsburgh. Leaders there agreed that standardized over-the-counter derivatives should be cleared through central counterparty clearing systems by the end of 2012. Mr. Rice, I believe that you said we are at the end of the pack in terms of establishing that. It is now November 7, 2012. Will this be in place in the next 38 days? Are we talking about establishing a kind of counterparty clearing system in Canada or will we be using the LCH.Clearnet of London. Is that what our plan is?
Mr. Rice: I do not believe our regime will be in place by the end of 2012, but we are not alone in that circumstance around the world. Matters have taken longer than was hoped. There is a clearing system in place but there is no mandate in place that all over-the-counter derivatives trading take place on these systems. These large clearing agencies exist and currently engage in the majority of clearing activity. However, the process is taking longer than was hoped in 2009 by the G20 leaders and will be implemented next year in most jurisdictions.
Senator Moore: When do you anticipate Canada's portion being done? Are we looking at the first quarter or later? What do you think?
Mr. Rice: I think it would be in late 2013.
Senator Moore: You said that we are about the middle of the pack. It sounds like many countries will not have their systems in place until about the same time as we have ours. Is that right?
Mr. Rice: That is right. Most countries agonized over whether to require the establishment of domestic clearing agencies and went through a long number of months to determine whether it was in the best interests of various countries to mandate that these clearing activities in respect of systemically important derivatives trading take place on domestic organizations. That analysis took a long period of time. It was our conclusion in Canada that it was not necessary and, in fact, might slow the process down even further. All other jurisdictions were going through the same kind of analysis and discussion.
Senator Moore: I guess it is a jurisdictional thing. We are not anticipating establishing a central counterparty clearing system in Canada, but this bill will mandate the participation in such a recognized acceptable entity in one of our G20 countries, such as LCH.Clearnet in London? Is that where we are heading or can we participate in other ones, perhaps one in the United States? Can we participate in one or are we looking at being able to facilitate others, whether in Europe or in the United States?
Mr. Rice: We will not mandate that a particular organization be used. The recognized clearing agency could be Canadian, American or from the U.K. We will set standards, and if an organization meets those standards, it will be recognized as an appropriate, recognized clearing agency. Then, it is up to the participants to determine where they wish to do their business.
Senator Moore: Mr. Turnbull, do you have a comment?
Mr. Turnbull: Government authorities have indicated in respect of the over-the-counter derivatives market that Canada can comply with this G20 commitment by joining these large, global CCPs that are being developed. The main system that is farthest ahead in development, at least for the types of derivatives in which Canadian banks are predominantly involved is the one operated by LCH.Clearnet in London.
The Chair: Thank you very much, Ms. Richer, Mr. Cowper, Mr. Turnbull, and Mr. Rice. On behalf of all members of the committee, we appreciate your appearance before us today. Your comments were most helpful.
(The committee adjourned.)