Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 10 - Evidence - Morning Session
OTTAWA, Wednesday, October 2, 1996
The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:00 a.m., to examine the state of the financial system in Canada (review of financial sector legislation).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Welcome, honourable senators.
Senator Meighen: Mr. Chairman, before you introduce the first witnesses, I would like to clarify something from yesterday. I think it would be a good idea, in light of some of the testimony we heard yesterday, to have officials from OSFI and the department back.
The Chairman: I am certainly prepared to support that. I would not do it this week because I think the officials who drafted the paper should have time to reflect on some of the comments that were made yesterday.
Do I hear from you that it would be a good idea to ask officials from the department and OSFI back before we write our final report?
Senator Kolber: When do you hope to complete a final report?
The Chairman: We hope to complete a final report around the end of October. I realize the Senate is not sitting during the next two weeks.
The ideal time to have them back would be Tuesday, October 22, at our normal time from 10 to 12:30.
Is that acceptable? They could appear together, if we agree. We want both OSFI and departmental officials. Is that correct?
Some hon. Senators: Agreed.
The Chairman: We have before us two witnesses from the Insurance Bureau of Canada.
We will begin with a summary of the IBC brief which is before you. Then we will turn to questions.
Mr. George Anderson, President, Insurance Bureau of Canada: Thank you, Mr. Chairman. We have enjoyed a productive working relationship with this committee and we look forward to that continuing as we follow changes in the financial services sector.
Just to remind senators of what we represent, we are the property and casualty insurance industry, as distinct from life and health. We paid about $13 billion in claims last year to restore loss and damage to cars, homes and businesses, and to rehabilitate injured accident victims. There are about 240 companies in this field in Canada. We employ about 100,000 Canadians.
During the course of the testimony, you will hear a lot about competitiveness, I am sure. It is a theme that clearly plays an important part in all the deliberations you will be undertaking regarding reform to our financial services system. Certainly I would expect that most of those appearing before you will make the case that competitive markets are the markets that best serve Canadians, and, not surprisingly, we support that view.
However, we think it is important for policy makers to ensure that competition serves not simply to make some institutions bigger at the expense of others, or to satisfy some vague notion that bigger is always better, but rather they should be able to demonstrate clearly how competition offers tangible benefit to Canadian consumers, and, I would add, how it creates and maintains employment in Canada.
Today, in terms of highlights, we would like to discuss three things. The first is the deadline for this round of the review of legislative reform. The second has to do with the task force on the future of financial services. The third is regarding the regulatory environment in Canada, ending with the issue of privacy, which I know is important to the committee.
The original intent of the current round of legislative review, as we read it, is that there was to be an interim and limited review of the 1992 legislation. This was not intended to be an opportunity for segments of the financial services sector to resurrect old debates about business powers.
Consequently, we support the view expressed by the government in the last budget, and in the white paper, that the 1997 changes will be modest reforms to a system, which appears, from all the testimony we have read, to be working well. What is needed now is not more distracting and adversarial debate. What is needed is some legislative stability so that we can all focus our attention on improving products and services for customers in Canada, and on lowering costs. To do this, we urge the House of Commons Finance Committee and the Senate Banking Committee to ensure that the March deadline is, in fact, met.
In terms of the task force, we are of the opinion that the last round of debate focused too much on incremental powers for our banks and not enough on how to add value for the Canadian consumer, how to keep our institutions competitive, and how to create and maintain employment in the country.
It might be instructive, for example, for the task force to examine how the products, services, prices, and degree of customer satisfaction in each of the financial sectors in this country stack up against the satisfaction in those sectors in the other G-7 countries.
How important is the size of banking or other institutions internationally to the domestic consumer? If size has tangible benefits to the Canadian consumers of banking products, what is the most direct and fair way of achieving them?
There are other questions that we feel are important is. Are there no limits to the economy-of-scale argument that people put forward about financial institutions? Do "dis-economies of scope" eventually overwhelm economies of scale in financial services? Are all the elements of financial services so similar that efficiency techniques of one sector automatically apply to another? Finally, how does the balance of market power of our Canadian institutions stack up against the domestic competitive situation in the other G-7 countries?
Those are just a few of the questions we think the task force should undertake. With the right mandate and the right membership -- and I understand we will learn more about both of those shortly -- this task force can be a prime opportunity to examine how we want to structure the financial services sector in years ahead. It is our view, though, that this opportunity for real guidance will be lost if we allow the task force to be manoeuvred into another round of unproductive debate about business powers.
Moreover, it is our firmly held view that the work of the task force primarily should feed into the next round of legislative review scheduled for 2002, and not become another window for making ad hoc, mid-term policy changes. We do not support the view that the next round of legislative change should come in 1999 or the year 2000, as some have said. We view that, in effect, as repudiating a clear understanding that we have from the government as a result of the last budget announcement.
Perhaps I could just touch on the regulatory environment. Last year, when I appeared before you, I characterized Canada's regulatory landscape as 11 solitudes: 10 provinces and the federal government all claiming sovereign power to govern business activity.
In the new world in which we live, I think an argument could be made that it is past time to ask how we can most effectively manage the regulatory requirements before us and stay competitive. We are pleased to see that the current government, in the Speech from the Throne, has made this a priority, and I know it is a major issue for this committee as well.
However, as one group which recently tried to bring positive change to the regulatory environment in Atlantic Canada, we remain sceptical about the ability of public officials to move with any real political will on this question.
A study released in 1985 showed that, in Atlantic Canada, a region with a population less than Metropolitan Toronto, four regulators -- five if you add the federal regulator -- were administering our separate yet very similar insurance acts and charging insurers and their customers almost $4 million per year in compliance costs. This is in addition to federal compliance costs. The study clearly showed that a harmonized regional system could reduce those costs by at least 25 per cent. Despite initial enthusiasm for this study, and supportive political statements, there has been no action on its recommendations. Indeed, 15 months later, the body that was intended to coordinate the response to this study has not even been appointed.
Let me give you some examples from the federal regulatory system. The federal Office of the Superintendent of Financial Institutions collects $37 million per year from financial institutions to fund its continuing operations. This is in addition to the costs of provincial compliance, which for the P and C sector are considerable, as we are largely regulated at the provincial level.
Some 22 per cent of that $37 million comes from the property and casualty insurance industry. These insurers, however, account for less than 3 per cent -- in fact, I think the number is closer to 2 per cent -- of the assets of the financial institutions monitored by OSFI. At the very least, it would appear that there is a prima facie case to ask if this sector is not overregulated in relation to its systemic risk.
We believe that the frequency of OSFI audits should be on a par with the frequency of audits done in other G-7 countries. Presently, OSFI collects information from insurers every quarter, requires an annual audited statement once a year, and conducts detailed examinations at least once every two years.
In many other countries, of course, annual statements are collected as well, and quarterly statements are asked for in some jurisdictions. However, our preliminary research shows that on-site examinations of well-run companies are rare in other countries when compared with Canada.
In the United Kingdom, France and Germany, detailed examinations take place only when the regular statistical reports indicate that an audit is necessary. In the United States, insurers are examined at least once every three to five years, not every two years.
We have said that we would welcome an opportunity to work with OSFI to determine the appropriate regime for Canada, and I have to say that we have received a good response from them on our proposal. This is just one example of how we could look more carefully at compliance costs and the overhead costs of regulation in our country.
Finally, I should just like to say a few words on privacy. I will ask Mr. Kennedy to tell you what our industry has done in this area, because we think we have taken some serious steps there. The generally announced intention of the white paper is to reduce the regulatory burden; however, in respect of privacy, the white paper proposes to increase it. We realize there is broad concern among Canadians about how private information is handled. For that reason, we understand why governments have an interest in this area. We support measures which provide all Canadians proper privacy safeguards. The challenge will be to do this without making the process excessively cumbersome.
We believe it is important for regulators to understand that protecting individual confidentiality is fundamental to the business operations of property and casual insurers. The greatest sanction that can happen in our business comes not from government regulation of this area, but from the loss of consumer confidence and customers, were it ever to be the case that privacy of information was not respected.
If you examine the real situation in our industry, as opposed to the theoretical one, we submit you will find that while there may be a demonstrated need for privacy regulation in many fields, there is not a strong case for such regulation in our field. By that, however, we are not merely trying to escape being part of a regulatory regime.
We believe we have taken strong steps in this area, and I would ask Mr. Kennedy to tell you an a bit about what we are doing.
Mr. Alex Kennedy, Vice-President, General Counsel and Secretary, Insurance Bureau of Canada: Mr. Chairman, to provide Canadians with the insurance products that they want, property and casualty insurance companies have to ask consumers for personal information. This information is needed so that insurers can assess the risk, charge the appropriate premium, and assist in the fair and reasonable settlement of insurance claims. Insurers have long recognized that this personal information must be kept confidential and used in a respectful manner.
Protecting the confidentiality of their customers' personal information is of prime importance to insurers. With that in mind, the IBC developed its own model privacy code in 1992, which has since been adopted by the majority of our member companies. The IBC code is based closely on the 1981 OECD guidelines and on a draft study prepared by David Flaherty -- now the privacy commissioner in British Columbia -- for the 1992-93 hearings of this committee on the subject of the protection of personal information. A unique feature of our code is that it attempts to provide for dispute resolution.
More recently, the IBC has been an active participant in the development of the CSA model code for the protection of personal information, a voluntary, self-regulatory code which can be adapted and used by all business sectors across the country.
Like our own code, the CSA code is based on the 1981 OECD guidelines. The CSA code has been accepted as a national standard by the Standards Council of Canada.
The CSA Implementation Committee, of which IBC is a member, is currently discussing appropriate options to ensure compliance with the code. To the best of our knowledge, no other country in the world has developed a voluntary privacy code, so there are no precedents to be followed in this area. All of us who are involved in this field acknowledge that the development of implementation options, including oversight mechanisms, is crucial to the acceptability and success of the code.
The CSA code states that it can be tailored to fit the business practices of a specific industry. Guided by a privacy committee made up of chief executive officers of a number of our companies, IBC tailored the CSA code to the requirements of our industry. In doing that, we did not make a single change to any of the 10 principles in the CSA code. The only changes that were made are to the commentary on the principles, as the CSA code allows.
I am pleased to say that in June of this year, our board of directors approved the wording of the new tailored code. We have recently submitted our tailored code to QMI -- the Quality Management Institute, a division of the Canadian Standards Association -- for its opinion on whether the code conforms to the expectations of the CSA code.
In addition, we have been much involved, through the CSA implementation committee, in the development of our workbook and operations manual. We are continuing our work in this area so as to provide our companies with as informative and helpful a guide to fully implementing the code as possible.
To further consumers' understanding of privacy, IBC is developing a pamphlet which will set out the type of information required by the industry for underwriting policies and settling claims, and for identifying the persons who would have access to that information. The intent is that this brochure will be given a very wide distribution.
As part of the oversight process, and to protect the privacy rights of consumers, we also intend to expand the role of our consumer centres in monitoring privacy issues. Our five regional consumer centres will ensure that privacy issues are recorded and directed to the appropriate person within each insurance company who has been designated to deal with them.
While we continue to believe that the industry can self-regulate in the area of privacy, we do not object to regulations governing the collection, use, retention, and disclosure of consumer information, nor are we opposed to a legislative framework to protect personal data. However, we strongly urge that regulators avoid trying to micromanage the information systems of financial institutions.
The Honourable Allan Rock, in a recent speech to the Eighteenth International Conference on Privacy and Data Collection in Ottawa, made the point that total privacy will never be achieved simply by legislation. To be effective, he argued that the system must engage the whole-hearted support and cooperation of the private sector in general. We are committed to giving that support and cooperation.
Mr. Rock recognized the potential for jurisdictional conflict and stressed the need for consultation with the provinces and territories, with business groups and with the public. We look forward to being involved in that process.
Senator Meighen: Perhaps you have information which I do not. In your executive summary, Mr. Anderson, you mentioned the word "commitment" in the budget and that existing regulations will continue until at least 2002. I was just looking at the white paper. On page 14, it refers to the task force study and states:
This study will shape the next round of amendments to the legislation which the government proposes will take place no later than five years after the passage of the 1997 legislation.
This presumably means no later than 2002, which is somewhat different from a commitment to keep existing regulations in place until 2002. What do I not know that you know?
Mr. Anderson: We pursued that line in the report with the Department of Finance. We know that you cannot develop and pass regulations or new legislation in two months. However, it is our understanding that the process will culminate in the effective date of any new regulation being 2002. I think there would be a clear, major misunderstanding with some of the key financial services groups, including ourselves and perhaps the brokers, if that were not the case.
We know that elements being studied here, such as the CPA and certain elements outlined in the task force, are slated for legislative change. However, it is our view that we have already accelerated this from a ten-year cycle to a five-year cycle. Moving to a two- or three-year cycle would in effect mean that you have your financial services business sector engaged for long periods of time in distracting debate about financial powers. I do not think that is productive. I think it would be the view of our members that it is not productive to continue to seek to accelerate these reviews to the point where, after a while, they are continuous.
The Chairman: I strongly disagree with you on two grounds.
First, it is hard to regard this current round as a review. It is a technical fixing-up, but it is not any major change. Indeed, the major change issues have all been turned over to the task force. If there were to be a major change in the year 2000, for example, it would represent the first significant change in eight years. It would not be a three-year change.
Second, on the assumption that the task force reports mid-1998 -- and this committee has planned an extensive set of hearings on its report in the latter half of 1998 so that the government will have advice from the task force and this committee at the end of 1998 -- to then not respond to that advice with legislation for four years would be foolish. The government would end up developing legislation on the basis of information that is two, three or three-and-a-half years old. It would be in everyone's interest to remove the uncertainty that will inevitably linger once the task force has reported and once this committee has completed its assessment of the task force report.
It is not in anyone's business interest to have uncertainty linger. I, for one, would passionately hope that you would get legislation fairly soon following our report arising from our hearings on the task force report, which, in practical legislative terms, means late 1999 or early 2000.
Do I know that that is the government's plan? No, I do not. I do not make announcements for the government; I am merely doing a logical analysis of the situation. I would think that the business community, collectively, would want that kind of scenario to unfold rather than a scenario where a task force report remained out there for approximately four years with no government response.
I tell you that because there are different views, and you should understand that. You should not be stunned if someone makes that announcement in late 1999 or 2000. At that point, it would not be fair for you to say that you were surprised. I am trying to eliminate that possibility.
Mr. Anderson: I am surprised now.
The Chairman: Better now than later.
Mr. Anderson: I do not think that is the widespread understanding out in the business community.
The Chairman: I am not announcing government policy. I am announcing what I think is a reasonable proposition. The government can disown me, but it seems to be a plausible scenario.
Senator Angus: I should like to hear your association's understanding once the white paper comes out, should the government choose this segmented approach. There has been the study on the payments system, the task force, and then this set particular set of hearings. You have covered it already, but I should like to be sure that I understand your understanding.
Mr. Anderson: First, it was never our understanding that there would be a legislative freeze on everything to do with financial services for the next five years. We read in the white paper, for example, with respect to a number of designated issues, such as the Canadian Payments Association, that there would be a separate, special report which may be the subject of some legislative change in the interim period.
In respect of the major issue that arose over business powers, we have been debating that issue in this country since 1987. The review of the Bank Act was originally every 10 years; now it has become every five years. We think that is good enough.
The testimony, both here and in front of the House of Commons Finance Committee, suggests that, on the whole, the financial sector in Canada is working well. Why we would seek to accelerate these reviews except in the areas that are designated in the white paper for specific review, I really do not know.
Senator Angus: What do you think the role of the task force is, then?
Mr. Anderson: It is to lay the groundwork for the next round of legislative review which, given recent history and our understanding of the decision made on March 6, 1996, would be effective in the year 2002.
Senator Angus: In 2002 instead of 1999, as the chairman divined?
Mr. Anderson: Yes.
Senator Meighen: You say that you support the government's intention to develop a framework legislation, but you remind the government that confidentiality is a business necessity in financial institutions in general, and in the property and casualty insurance sector in particular.
What are you putting us on guard against? Is it overweening legislation in this area? Also, what is your view on the white paper's suggestion that the government proposes to permit financial institutions to carry on both information processing and specialized financial activities in-house rather than in a subsidiary? If those functions were being done in a subsidiary, regulations could say, for example, "Thou shalt not transfer any confidential personal information from the subsidiary to the parent," whereas if they were being done in-house, presumably all that information would be there for you to look at and use as you see fit.
Mr. Anderson: I will ask Mr. Kennedy to answer this. He has been dealing with privacy issues for a very long time.
Mr. Kennedy: We are concerned that the uniformity commissioners are currently developing a uniform law on privacy, which will probably come forward next year. The federal government has announced a need for framework legislation. The Canadian Standards Association has done an awful lot of work in developing a model code. We would hope that, with any legislation that goes forward, the government would lean very heavily on the work that has been done by the CSA rather than try to develop a whole new set of approaches.
Senator Meighen: What about my in-house suggestion?
Mr. Kennedy: I am not quite sure what you were getting at there.
Senator Meighen: I was wondering if you had any information to help me understand what the white paper is getting at.
Mr. Kennedy: There are a number of ancillary business activities that companies were allowed to do but, to do them, they had to set up subsidiaries. The government is now saying these things can be done in-house. We would want -- and certainly our code would ensure this -- safeguards to be in place within the company so that information is only seen by the people who need to have it and it is only used for the particular purpose for which it is wanted. It must not be available just to anyone. There must be restrictions on access, for example, and things of that nature.
Senator Meighen: Do you conclude that the reason for this suggestion is to save on costs? Do you think there would be a substantial saving on costs if the information were kept in-house as opposed to being kept in a subsidiary?
Mr. Kennedy: I suspect there would be quite a substantial savings on cost.
Senator Meighen: I wonder about that, and I invite you to wonder about that. The cost of incorporating a subsidiary is not overwhelming. Modern technology -- the fine points of which I find very difficult to understand but my children do not -- seemingly would not cause any problem in having access to that information for those who are entitled to it, but if it were in-house, would it not be more difficult to set up Chinese walls, or walls of any other kind, around that information?
Mr. Kennedy: I do not think so. The property and casualty industry is well used to this situation of having to put Chinese walls in place. We are accustomed to situations where one insurer is involved, for example, in an accident between two parties where both have that insurer. Companies must appoint separate adjusters and must put Chinese walls in place to ensure that confidential medical information, for example, does not transfer across.
Senator Meighen: Is it your experience that that works effectively?
Mr. Kennedy: To my knowledge, that is working quite well.
The Chairman: At the end of your executive summary, you make a statement that I should like you to clarify because I did not understand it.
You say that future discussions of financial services reform will have to be based on a greater appreciation by policy makers of the distinct nature of P and C business. What is it you feel that policy makers -- and in part that includes us -- do not understand about the nature of your business? It was my sense that we did understand it, but for the record it would be helpful to explain the unique part of your business versus other parts of the financial services sector.
Mr. Anderson: Fundamentally, it boils down to the fact that we are not an intermediary financial service. We do not raise deposits, re-lend and live off the spread. We are a short-term risk assessment business. Most of our contracts, as you know, operate for a year. The kind of skill sets that we bring to bear in terms of risk assessment and risk management, in effect, do not exist in deposit-taking institutions. The economy-of-scale argument that deposit-taking institutions use to further their own business aims does not apply to the same extent in the property and casualty business as it does, for example, in the banking business.
The overhead cost of serving customers is very much higher in the property and casualty business because we are out at disaster sites helping people recover and providing services beyond financial services. We provide aid and comfort to accident victims; we rehabilitate people who have been injured and many times have lost everything of value to them. It is a completely different business.
The Chairman: You have made clear that it is a completely different business from the deposit-taking business. It would help us if you would explain how you see your side of the business as different from the life insurance business. I realize that you are insuring different things, but could you explain it from a business standpoint?
Mr. Anderson: There are two things that set us apart. One is the nature of the contracts, being short-term versus long-term, although some of them are becoming longer when you deal with long-term liabilities for accident victims. There is as well the extent to which settling a claim in this business does involve, many times, much more extensive inter-personal interaction than it does in the life business. I do not want to trivialialize it in any way, but in their case it is sometimes simply a matter of writing a cheque; in our case it is not.
The Chairman: That is a difference in service, but not necessarily a difference from a regulatory standpoint.
Mr. Anderson: In the history of regulators adopting regulations in the field of P and C, there has been a tendency, although this is now improving, to apply solutions which work for life insurance to P and C as well.
Senator Angus: I inferred from your comments that you believe there to be overregulation in your field and that the burden of regulation is out of step with the burden in other countries.
I am aware that a number of your members do business in other jurisdictions. Are the Canadian regulations more onerous than those in other countries?
Mr. Anderson: It would seem so, based on the preliminary work that we have done. We have asked OSFI to work with us in looking at this in other jurisdictions. With regard to the degree of systemic risk involved in our companies, no one in our industry has more than about 7 per cent market share. There are 240 companies operating in this field. The degree of risk to the system, given that the assets constitute 3 per cent of all financial assets, is nowhere near what it would be with the failure of a major life insurance company or the failure of a major bank.
In that respect, applying the same regulatory regime seems to be overkill. We are simply arguing that we should look at that from the point of view of how efficient it is to be examining these companies on such a regular basis, perhaps dragging resources away from where they could be more usefully put.
I have given you some examples which we feel could use further study. The superintendent has been quite open to examining those questions. We are paying a lot of money for regulatory supervision in this country and some of it is simply duplication of effort between the federal government and the provincial governments.
Senator Angus: Are your members concerned at all about entry of non-Canadian P and C insurers into this market?
Mr. Anderson: No.
Senator Angus: I understand that a number of foreign underwriters in your field do find the regulatory burden to be out of step with other jurisdictions and, indeed, find it an inhibition to coming into this market, therefore depriving, in my view, Canadian consumers of a greater capacity of certain risks. Do you agree with that?
Mr. Anderson: I would have to know the specific circumstances, but on the whole I would say no. The barriers to entry in Canada are pretty low, in terms of capital requirements. We have 240 companies in this field and a relatively small population.
Senator Angus: Once in, though, the additional regulatory burden which they do not find in the U.K., Europe or the U.S. is inhibiting.
Mr. Anderson: That is the case I tried to make in my remarks. What worries us about doing international comparisons is the tendency of regulators to jump to the higher level. They start leap-frogging one another in pursuit of purity, and in the meantime the costs get loaded on to our sector, and those costs ultimately flow back to the consumer.
Senator Angus: We heard some witnesses yesterday from other areas of the financial services sector who appeared to want to have it both ways. They say, on one hand, that they are open to competition and let the barriers fall. On the other hand, they say that we should not do things to inhibit their growth or their opportunity to get into other areas and to be competitors in other branches of the sector.
Are you able to say unconditionally that competition is not a preoccupation with your people? You favour open compensation?
Mr. Anderson: Yes, as long as it is fair. When there are 240 companies fighting for market share, that is a pretty good sign that there is a lot of competition in the marketplace.
Senator Austin: I have two questions which you can probably answer almost with a "yes" or a "no".
You had no comments to make about the reinsurance industry. Is that because there is nothing that you would suggest be changed in the relationship between the primary insurers and the reinsurers?
Mr. Kennedy: I think it is a reflection of the fact that the Insurance Companies Act itself does not distinguish between insurers and reinsurers.
Senator Austin: So the regulatory regime is the same for both types of entities?
Mr. Kennedy: Yes.
Senator Austin: What about the investment standards allowed to P and C companies, that is, what you can invest your reserves in? Do you have any comment to make on that, or are you content with the regulation?
Mr. Anderson: We are satisfied with the new investment rules and the scope. We have not seen a problem there.
Mr. Kennedy: At the time the changes were made, the property and casualty industry was quite content with the previous rules and was not pressing for the changes that were made.
Mr. Anderson: We have made a number of technical amendment suggestions. We have not dealt with them here, but they are in the report.
The Chairman: Thank you for coming, witnesses. Our next group is from the Canadian Institute of Chartered Accountants.
Welcome again, Mr. Rutledge. I should like to take one issue off the table at the very beginning. I propose, and prefer, that you not get into the joint and several issue. I only say that because I know that it was a major focus of your testimony before the house committee. As you know, we not only had a long discussion on that subject during our meetings in Calgary, but we have a series of hearings on that subject scheduled for October 28, 29 and 31. We also know the subject can lead to a lengthy debate. I noticed you have two paragraphs on that issue in your report. I would ask you to skip that issue now and deal with it at the end of the month.
Please proceed.
Mr. Graeme Rutledge, Chair, CICA Financial Institutions Reform Study Group, Canadian Institute of Chartered Accountants: Mr. Chairman, we appreciate the opportunity to appear before you today and to discuss the government's consultation paper on the 1997 review of financial sector legislation. We had not intended to talk about proportionate liability.
The Chairman: I raised it today because you raised it before the house committee.
Mr. Rutledge: Mr. Chairman, our written submission, which was provided to the committee yesterday, has been developed from submissions which we have made to this committee before, as well as also from comments that we are making in connection with the proposed amendments to the Canada Business Corporations Act, and the proposals in the white paper.
It also reflects the most recent mission and vision statement for Canada's CA profession, developed by the institute's vision task force, which is a task force made up of senior chartered accountants. This task force was created to address the challenge of leading our profession into the next decade.
At the outset, let me say that the CICA generally supports the changes proposed in the white paper. There are, however, some areas to which we believe improvements can be made. I do not propose to go over our recommendations in detail, but there are three areas which I should like to emphasize in my remarks today.
First, improvements should be made in defining the fiduciary duties of directors. The classic corporate governance model currently focuses on protecting the rights of owners of the corporation. However, the degree of protection for depositors and non-participating policyholders is less clearly defined.
The proposed reforms to the Canada Business Corporations Act recommended that no changes be made in defining the fiduciary duties of directors and the matter of defining "best interests of the corporation" be left to the courts to interpret. We believe that in the case of financial institutions it will be important to clarify the duties of directors with respect to depositors and non-participating policyholders. We believe it would be helpful to state explicitly that the directors, in addition to representing the interests of shareholders, also have the responsibility to consider the interests of depositors and non-participating policyholders.
Second, the duties of the board of directors and the audit committee with respect to control and information systems need to be clarified. The duties of the board of directors are being addressed under the Canada Business Corporations Act reforms. The CICA supports efforts in the white paper to clarify the statutory duty of audit committees of financial institutions with respect to internal controls. However, in order to respond to evolving trends, we feel the legislation must go further than the proposals suggested in the CBCA reforms and in the white paper.
The CICA supports the view of the Toronto Stock Exchange committee on corporate governance. The board has a broad responsibility for control and information systems and the committee recommends that legislation be amended to include the provision that the board shall review and evaluate whether the corporation has effective control and information systems to manage its affairs and to support the board's discharge of its responsibilities. We believe this recommendation reflects current thinking as to the role of the board.
The CICA has committed significant resources to develop guidance on the designing, assessing and reporting of the control systems of organizations. Our publication entitled, "Guidance for Directors - Governance Processes for Control", provides practical guidance to directors on how they can discharge their are responsibilities for control within an organization. The publication is attached to our submission for your reference.
We recognize that the CBCA does not deal with responsibility of audit committees, whereas the financial institutions legislation sets out specific responsibilities for this committee. We believe that the duties of the audit committee set forth in financial institutions legislative reform should be made to conform to the model of the recommended provision just mentioned regarding the duties of directors. In particular, financial institutions legislation should state that the audit committee shall review and evaluate whether the corporation has effective control and information systems for financial reporting and satisfy itself that management has taken appropriate action on any deficiencies that have arisen.
Finally, I would like to comment on reporting to stakeholders. The CICA supports the government's efforts to facilitate the disclosure of information to stakeholders. However, we have some concerns. As I explained earlier, the current corporate governance model focuses on protecting the rights of owners of the corporation. Information requirements in the legislation are similarly focused and designed for less technologically sophisticated times. As technology changes, so do the needs of stakeholders.
Furthermore, the TSE report on corporate governance recognizes the need to communicate with a broader range of stakeholders, such as depositors, non-participating policyholders, and so on, and the need for new ways of communicating with stakeholders over and above the annual financial statements. Although OSFI and others are making efforts to improve the information that goes to these stakeholders, disclosure requirements are evolving like a patchwork quilt on the existing system. We are concerned that this approach will lead to an inefficient and costly system.
What type of financial and non-financial information do stakeholders need? How frequently do they need it and in what format? The vision of the CA's profession is to provide guidance, advice and leadership in the evolution of corporate reporting in a digital world. Efforts are already under way to help provide the answers to some of those questions.
The CICA recently initiated a research study to investigate the impact that electronic systems are having, and are likely to have, on financial and business reporting. The CICA is also initiating research to develop new non-financial and broader financial performance measures, which are needed to track organizational behaviour in the new economy, and reporting frameworks which will enable CAs to report to senior management, to boards of directors and, eventually, to shareholders on a broader basis. The CICA also intends to develop guidance on the role of the auditor for providing assurance on the reporting entities, something which we refer to as "continuous disclosure system".
These studies will not provide all the answers. The CICA is certainly prepared to work with regulators and others in improving the relevance, timeliness and reliability of financial and non-financial information that is communicated to stakeholders.
That completes my opening remarks, Mr. Chairman. We will be pleased to address your questions.
The Chairman: Have you seen the recommendations in the final report of this committee on the CBCA corporate governance hearings which we held?
Mr. Rutledge: Yes, we have.
The Chairman: Are there any of those recommendations with which you disagree? I know from earlier testimony that there are a number of them with which you agree. It would be helpful if you would let us know in writing if, in fact, there are some of our recommendations with which you disagree.
I recognize that we were dealing with CBCA companies, not financial institutions. I believe that your organization probably found all of them acceptable, but if there are disagreements, it would be helpful if we knew what they were.
Mr. Rutledge: Yes, we will certainly send you that information.
The Chairman: We would like it relatively soon.
Senator Kolber: I am left with the impression, after your statement, that you are trying to slough the responsibility that accountants should have on to boards of directors. I am probably wrong, but that is certainly the impression that I get.
It seems to me that the public's expectation, or perhaps your expectation, of the efficaciousness of a board of directors, especially in a large institution, is not realistic, in the same way that the public's expectation of an accountant's statement verifying the accounts is probably beyond what it can be.
Having been involved with a number of very large companies, I know there are limitations to what the board can do and what they cannot do. They can only get reports from management and decide that they look right, because most company directors with which I am familiar are not experts in management information systems. Am I being too simplistic?
Mr. Rutledge: I appreciate the question, because it is a very important subject. You are absolutely right that, today, the duties of directors, particularly with regard to very large organizations, are such that they cannot get into the detail of transactions.
We are suggesting you be careful in framing the legislation so that you not impose on directors the responsibility to manage. Their responsibility is at an oversight level. We believe that in order to carry out that oversight role, one should be pushing to learn about the systems that an organization has in place, particularly the information systems.
Senator Kolber: I suppose the most exaggerated example is the Canadian chartered banks. In the agendas of chartered banks' board meetings, almost half the subjects are government-mandated, including things which OSFI insists upon, et cetera. Directors are given these voluminous reports -- which I read, although I cannot tell you I understand them 100 per cent -- about how we give out credit, how we evaluate credits within industries, within companies, within countries, et cetera. I do not think boards are totally equipped to do things like that.
I think that the accounting profession should be more involved because their background gives them the wherewithal and the equipment to judge those reports better.
Mr. Rutledge: I think we can play a role in that regard, but I believe the legislation today has responsibilities placed on the shoulders of directors with regard to the organizations of which they are directors.
Senator Kolber: I know where the responsibilities are placed, but I am not sure they can be carried out.
Senator Angus: He is saying the same thing.
Mr. Rutledge: I would hope that those responsibilities can be carried out, and I hope that our guidance on directors helps you to do that.
Senator Kolber: The best guidance would be that you only put people on boards of directors who have specific training in certain areas.
Senator Austin: Only chartered accountants and lawyers.
Senator Angus: And senators.
Senator Austin: Only if they have served on this committee.
Senator Kolber: For example, you mention "communicate with depositors". What does that mean?
Mr. Rutledge: Today, what information should depositors have? That is the question.
Senator Kolber: It seems to me their chief concern is the solvency of the institution that is taking their money. Beyond that, what else can you communicate?
Mr. Rutledge: What do you give them in the way of information?
Senator Kolber: You give them a balance sheet and a P and L statement, and you say that according to the best standards of how much capital a bank should have -- and there are world standards <#0107> the company is meeting those tests. Beyond that, what are you supposed to say?
Mr. Rutledge: This is an area in which further study is probably necessary to determine how to meet the need for communicating to depositors. We have raised certain questions, and we are doing certain work in this regard.
Senator Kolber: I would be fascinated to see that, because beyond solvency and beyond adequate capital requirements that are being met, I do not know what other interests a depositor has. If you think there are other ways of doing it, I would be interested to learn of them.
Mr. Rutledge: I come back to the nature of the information you give them and how often you give it to them, the timely basis of doing that.
Senator Kolber: They receive that information every three months in their quarterly statements and reports. One has to assume that either they know or a friend knows how to read the report. Are you saying that we should change the format of the report and send out a nice letter saying, "Your bank is in good shape"?
Mr. Rutledge: No, I am not suggesting that.
Senator Kolber: I am not trying to be a wise guy.
Mr. Rutledge: I am speaking of something that would guarantee the solvency of the organization.
Senator Kolber: I think you are putting up standards that would be very difficult to meet. First, I do not understand what you mean by communicating with depositors, using your words, beyond telling them that their money is safe.
Mr. Rutledge: This is the area of consumer protection and how much data we give them and when. I do not know the full answers to those questions either.
Senator Kolber: There is one other thing. I forget the percentage, but an enormous percentage of the depositors have less than $60,000 on deposit, and they are insured. The government insures them. I think we are in danger of dealing in overkill here. That is all I am saying.
Senator Austin: I am intrigued with a paragraph in the letter that was written to Mr. D. Tobin, director general, on July 12, which appears in the submission that you are making to this committee.
Mr. Rutledge: Yes.
Senator Austin: It is the second point in the paragraph on page 2, the recommendation granting directors a due diligence defence. Your reasoning moves on to argue that directors would seek opinions on the financial information on which they have a due diligence defence to ensure is available, and you say that if this defence is to be useful, there must be experts willing to undertake the work. If experts are to undertake these assignments, it is logical to provide them with the same type of protection from liability as the directors.
What kind of protection do you believe is appropriate to that expertise which, of course, brings the accounting profession very much on to the deck?
Mr. Rutledge: I think you are embarking on the area of proportionate liability, and the chairman has said he does not want to talk about that until later this month.
Senator Austin: That is where your reasoning goes?
Mr. Rutledge: We will have appropriate people here to talk to you about that.
The Chairman: I have one last question which relates to the final recommendation in your report.
On page 8, you talk about the regulatory capital framework being made consistent across all financial institutions. Given the fact that various parts of the financial services sector are in somewhat different businesses, why do you think that is the case? How significant do you think the current differences in the regulatory capital requirements are across the various parts of the financial services sector? Having read your report and thought about it a bit, I do not understand what led to that recommendation.
Mr. Rutledge: What led to that was trying to maintain a level playing field regardless of the area of the financial institution activity that the particular organization is involved in.
The Chairman: We have discovered that "level playing field" is in the eyes of the beholder, in the sense that it is like the notion of what is fair or unfair. It seems to depend entirely on whose subjective values are being used to define "fair". "Level" seems to have that element to it.
If you are going to level the playing field with regard to capital regulatory requirements, are there not other areas where you would want to level the playing field?
How big a difference do you think the current rules really make?
Mr. Rutledge: I will have to ask Ms Hillier if she knows the magnitude of the difference at this point.
Ms Diane R. Hillier, Director, Auditing Standards, Canadian Institute of Chartered Accountants: I do not.
Mr. Rutledge: I am sorry, I will have to go back to the research paper to find the magnitude.
The Chairman: We always examine the recommendations of the CICA very carefully and it is hard to support you on something when we do not understand it.
Mr. Rutledge: I apologize for not having that information. I will send it to you.
The Chairman: Thank you for coming.
Senators, our next witnesses are from the Investment Dealers Association of Canada.
Welcome, and please proceed with your presentation.
Mr. Andrew G. Scace, Vice-President and Director, RBC Dominion Securities Inc: Thank you, Mr. Chairman. I should begin my remarks by introducing myself and my colleagues who are appearing before your committee this morning on behalf of the Investment Dealers Association, the IDA.
My name is Andrew Scace. I am here today in my capacity as a member of the IDA executive committee. I am a vice-president and director of RBC Dominion Securities Inc. In this capacity, I am responsible for the fixed income division of the Royal Bank's investment banking affiliate, RBC Dominion Securities.
On my right is Peter Marchant, managing director of CIBC Wood Gundy Securities Inc., who has responsibility at the firm for the issuance and distribution of the commercial paper and other debt securities offered by major corporations in the Canadian domestic money markets.
Mr. Marchant and myself both have more than 20 years of experience working on behalf of issuers and investors in Canadian capital markets.
Also with us this morning is Ian Russell, Vice-President, Capital Markets, in the Investment Dealers Association.
Our purpose in appearing before your committee this morning is to ensure that federal financial legislation is compatible with the encouragement of efficient, liquid and safe markets in Canada. Our remarks will be directed to specific aspects in the federal white paper which are technical in nature but which have far-reaching and serious consequences for Canadian capital markets.
The white paper proposes a less intrusive regulatory regime for foreign near banks operating in Canada, institutions which fall under the jurisdiction of the federal government, generally by virtue of their affiliation with a foreign banking affiliate.
More streamlined regulation of these institutions is a commendable objective. However, the white paper intends to impose a minimum threshold amount on the funds raised in capital markets by these near bank institutions to ensure that the investing public is not put at risk by the proposed policy approach.
We believe the proposed $200,000 minimum funding threshold will have serious repercussions on the liquidity and efficiencies of domestic money markets. It will be disruptive to the lending and leasing operations of these near bank institutions and will have disadvantageous consequences for individual investors and borrowers alike.
Our purpose this morning is to amplify our concerns and suggest to the committee a more effective policy approach to meet the regulatory objective, while mitigating the negative financial consequences arising from the proposal. It goes without saying that my colleagues and I will be pleased to respond to any questions.
As a group, the foreign near banks have been active borrowers in the domestic commercial paper and medium term note markets for many years and have been instrumental in the development of broadly based and sophisticated capital markets in Canada. Many of these institutions routinely issue money market securities in amounts less than the contemplated $200,000 minimum threshold in response to strong demand from retail investors, investment counsellors managing the funds of individual investors, and smaller institutional investors such as pension funds, for these investment grade and highly liquid securities.
The proposed funding restrictions would deny these financial institutions access to this retail marketplace and, in turn, result in higher-cost financing for these institutions, as well as reduced liquidity and secondary markets. The flip side of these developments is to preclude individual Canadian investors and small institutional investors the opportunity of purchasing comparatively high-yield and safe investments for their retirement portfolios and other requirements.
The white paper proposals would mean that foreign near bank institutions operating in Canada would be disadvantaged vis-à-vis their competing domestic counterparts offering consumer lending and leasing services, as these domestic institutions would not be subject to the proposed funding restrictions.
The clients of the foreign near banks would be disadvantaged by the proposal in terms of higher-cost loans or reduced availability of credit.
It should be of concern to federal authorities that a valid argument can be made that these restrictions, which are to be imposed retroactively, will abridge the principle of national treatment and, therefore, contravene the North American Free Trade Agreement.
We believe the white paper proposals to limit the regulation of foreign near banks are well intentioned and concerns about protecting the retail investors well founded. However, since the foreign near banks fund their operations through marketable securities offered in capital markets rather than through deposit-type instruments, investors are already protected through the reliance on existing provincial securities regulations, thereby obviating the need for arbitrary minimum thresholds for the issuance of securities.
Moreover, reliance on provincial regulations would avoid the negative market consequences of the proposed minimum funding threshold. Federal officials can be assured that provincial regulators are acutely aware of the market and credit risks arising through securities issuance and have imposed and, indeed, recently modified disclosure requirements and other measures to protect investors.
We believe it will be useful to engage provincial officials in discussions on the adequacy of existing disclosure requirements, and professional standards imposed by self-regulatory organizations on salesmen distributing securities, to protect the investing public.
We also understand OSFI's concerns to preserve a distinction between funding through marketable securities by unregulated entities and the deposit-taking activities of the regulated banks and trust companies. However, we believe this objective can be met without disruption of the commercial paper and medium term note programs of the foreign near banks.
In the past week, OSFI officials informed us that they intend to develop revised proposals which would not interfere with the capital market borrowing activities of the foreign near banks. OSFI has given the IDA an opportunity to review and comment on these proposals before they are finalized, and we have accepted this offer.
We are optimistic that a solution can be found to enable foreign near banks to carry out their capital-raising activities, protect the investing public and enable the government to discharge effectively its regulatory obligations.
A solution should be designed to promote the efficiency, liquidity and integrity of Canadian capital markets. These markets have served investors and issuers effectively for many decades.
We hope our comments have provided you and your colleagues with some perspective on our concerns and suggestions for remedial policy action.
We would be happy to take any questions from the committee.
The Chairman: On page two of your statement, you say that in the past week OSFI officials informed you that they intend to revise what was said in the white paper. Is that correct?
Mr. Scace: Yes.
The Chairman: Did they tell you that in writing or on the phone?
Mr. Scace: We had a meeting with them a week ago.
The Chairman: They indicated that some of the points in the white paper which were discussed by the foreign near banks yesterday would be dealt with to the satisfaction of the foreign near banks?
Mr. Scace: They said they were going to review our concerns and work with us in proposing some alternative.
The Chairman: Are your concerns identical to the concerns expressed before this committee yesterday? I am just talking about retail funding. I realize other issues were expressed yesterday, but on the retail funding issue, are your concerns identical to those of the companies which appeared before us yesterday?
Mr. Scace: I am not aware of all the details.
The Chairman: That is why I asked the question specifically with respect to retail funding. The institutions that appeared before us yesterday had a number of other issues. The retail funding issue was elaborated on in some detail by Ms Wolfenden from Avco on behalf of a group of foreign near banks. I just want to make sure I understand the differences between your view and theirs.
Mr. Scace: There are none.
Mr. Ian C. Russell, Vice-President, Capital Markets, Investment Dealers Association of Canada: Our arguments in connection with this retail funding issue, Mr. Chairman, are congruent with those of the foreign near banks. Last week, OSFI indicated to us in a meeting that they were revising their proposals, and that their proposals, once they had been revised, would be intended not to disrupt the commercial paper market and the medium term note markets in Canada. They indicated that revised proposals would be forthcoming within a two-week period. They gave us an opportunity to comment and enter into a consultation process with them to ensure that those revised proposals addressed the concerns that they seemed very aware of, and only at that point would those revised proposals go to the minister.
The Chairman: I just point out to senators that the IDA met with OSFI last week, and OSFI is about to find out they are appearing here on the 21st, which will be after the two-week period. I presume that means that we can look forward to hearing those proposals at that time.
Senator Angus: Would it be your sense, Mr. Scace, after having met with OSFI, that they generally agree with the points made by you in your statement?
Mr. Scace: That was the sense they gave us.
Senator Angus: I think you have put the problem in a most succinct way. It was my instinct to refrain from questioning you on it. However, it is very helpful for us to know that you believe you were able to persuade the regulator that this makes sense. That will help us when they appear before our committee.
Mr. Scace: That was our clear impression.
Senator Meighen: If OSFI is backing away from what is an apparent search for a responsibility where there need not perhaps be one and if it is left to the provincial securities commission regulations, does the slight lack of uniformity across the country cause any difficulty in the markets?
Mr. Peter K. Marchant, Vice-President and Director, CIBC Wood Gundy Inc., Investment Dealers Association of Canada:I think it is fair to say that it is a small issue. It is not convenient because we have to make our staff aware of the rules in different jurisdictions. Clearly, the majority of business is done in certain pockets. Ontario is the largest market. Saskatchewan, which has different rules and higher standards, is not as big an issue because the retail side of the business is not as large.
Mr. Russell: I think you make a very important point. In the event that OSFI did agree to our proposal -- which is to say that they would back away and allow the provincial regulatory regime to operate and protect investors -- that will underline the fact that there are differences across the country in terms of the way those regulations apply. That is something we have been acutely aware of. Clearly, it is in the interests of the IDA to push towards much greater harmonization of those rules, which are very much in the interests of efficient and liquid markets.
Senator Meighen: The only minor addition from the federal perspective that you are suggesting is that the CDIC guarantee should be stamped on the prospectus. Am I drawing a blank there?
Mr. Scace: No.
Mr. Russell: If you issued an instrument that had material information in it relevant to the investor, which, in this case, would be the fact that something was not insured.
Senator Meighen: You state here in the last sentence of the penultimate paragraph on page two of your brief:
It would be a straightforward matter for the offering memoranda and prospectuses related to these securities to stipulate they are not subject to the CDIC guarantee.
At the present time, you state that they do not have that stipulation.
Mr. Scace: That is correct.
Mr. Marchant: The securities are issued under prospectus. Therefore, the regimes for mid-term notes and debentures are pretty well the same across the country after the prospectuses have been filed in the different jurisdictions. Commercial paper is the only one to have the variance. Bonds, debentures and mid-term notes are uniform.
Senator Meighen: Still, visions of a federal securities commission dance in your head.
Mr. Scace: Our organization supports a national securities commission.
Senator Angus: But not to the exclusion of other markets and other commissions; is that correct?
Mr. Scace: I do not understand the question.
Senator Angus: Your organization supports the creation of a national securities commission. Would this be to the exclusion of local commissions, or would it be in addition to local commissions?
Mr. Scace: The formulation of a national securities commission is forthcoming. There have to be discussions between the federal government and provincial governments, and we will respond to those proposals after those discussions. We are not aware of the framework. This organization supports a national securities commission as it reflects capital markets and the efficiencies of capital markets within this country nationally.
The Chairman: I have a question to Mr. Scace and Mr. Marchant in light of some testimony that I understand by this morning's papers we are likely to receive this afternoon. Since your investment dealers are in fact owned by banks, how big a problem, if it is one at all, is the tied selling issue between investment dealers and their bank parents?
Mr. Scace: At this time, I would have to see the testimony before I could comment. I am not up to speed as to what people view as tied selling.
The Chairman: Let me ask the question slightly differently. Are specific rules in place with respect to the linkage between the investment dealer and the bank parent which cover tied selling? Is there a policy?
Mr. Scace: Chinese walls have been put in place between the investment bank and the commercial bank. Those are clearly adhered to across the board.
The Chairman: Are they effective?
Mr. Scace: I believe they are.
Mr. Marchant: Prior to the banks assimilating the larger dealers, we had Chinese walls within our own organizations. They are effective, and have to be. Our organization is the same, I believe, and it works.
I am not up to speed either, but I go to my banker who looks after my paltry amount of money. I have more loans than deposits.
Every time I go in, it seems, he asks me why my RRSP is not at the CIBC and why I do not buy insurance through the CIBC. Not surprisingly, I have my RRSP at Wood Gundy. I do not think the question is tied to anything. They are not saying that they will not give me the money unless I move my account because, in effect, they already have it.
There seems to be a misunderstanding, from my interpretation of what I read in the press. One wonders whether you can read the press and just accept what they say as correct.
I feel this is just normal business. It is important to recognize that the dealer has a separate set of clients and they are in the securities business. The banks are also in the mutual fund and deposit-taking business, separate and distinct from their dealer.
Does the bank have the right to ask anyone to move their account to them? Why not? It is surprising to me, in the scheme of things, that we are restricting competition.
The Chairman: Thank you very much, gentlemen.
The committee adjourned.