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Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 7 - Evidence

OTTAWA, Wednesday, November 27, 2002

The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:05 p.m. to study the public interest implications for large bank mergers.

Senator E. Leo Kolber (Chairman) in the Chair.


The Chairman: Honourable senators, we are reconvening our study on the public interest implications for large bank mergers.

It is with great pleasure that I welcome, from the BMO Financial Group, Mr. Tony Comper, Chairman and Chief Executive Officer. With Mr. Comper are Ms. Karen Maidment, Executive Vice-President and Chief Financial Officer, and Mr. Tim O'Neill, Executive Vice-President and Chief Economist, whose stuff we always read.

Mr. Tony Comper, Chairman and Chief Executive Officer, BMO Financial Group: Mr. Chairman, honourable senators, I would like to thank each of you for inviting me to be part of these important deliberations.


Let me say how very much I appreciate your decision to hold these hearings. As far as the banking sector is concerned, your diligence is proof of the attention afforded by the members of the Banking, Trade and Commerce Committee and by the Senate to our growing need for flexibility. We eagerly look forward to the release of your report and to that of your colleagues on the Finance Committee. Together, these two reports should shed some light on how a proposal to merge the five biggest banks in Canada will safeguard the interests of the public.


Speaking for BMO Financial Group now, I would like to strongly endorse this process. We recognize that however proud we may be of our 185 years of exemplary corporate citizenship, defining and protecting the interests of Canadians is government's role and mandate, something that Canada's government does uncommonly well.

I hope what I have to say, both in my brief opening remarks and in response to your questions, turns out to be of help as you frame your definition of the public interest in bank mergers.

I will address the four main areas of concern in the order they were set out by Mr. Manley and Mr. Bevilacqua in the letter that put this process in motion, that is, access, choice, competition and growth, and transitional accommodations.

In BMO's view, Canadian bank mergers that are designed to address these four areas of legitimate public concern can be and should be in the public interest.

On the matter of access, BMO is guided by the principle, because we helped create the expectation, that in Canada, public interest includes reasonable access to a full-service bank branch offering reliable, high-quality products and services.

Accordingly, BMO believes it is in the public interest for merging banks to outline their plans to serve the rural communities they already serve individually, and to make a commitment to retain a branch presence in these communities for a reasonable period of time, which in our view is about three years.

As with every other case I will be making on behalf of mergers here today, I would like to observe that by all logic and most experience, the bigger and more robust bank would be better able to maintain rural branches.

Another guiding principle holds that individuals and small businesses should continue to have a choice of providers of financial services and access to credit.

BMO believes it is in the public interest for merging banks to outline the role of personal and small-business banking in their business mix and the impact of the merger on availability of credit.

As the past year has shown, I think conclusively, personal and business banking customers are BMO's bread and butter, as well as the foundation of the entire Canadian banking industry. At BMO, we do not need any incentive or prodding to do our very best by them. That is why I would to like to state for the record that however the future unfolds, BMO has every intention of continuing its longstanding commitment to serve Canada's small-business community. We would be prepared to allocate at least the same proportion of our overall capital to this sector as we do today.

On the matter of competition and growth, BMO is guided by the knowledge, confirmed and reconfirmed by the polls, that Canadians appreciate the importance of a strong, healthy and, not least, home-grown financial services industry in this country, and they want to keep it that way. Whatever other reasons they may have, there is a heightening awareness of the importance of being a head-office country generating high-quality, head-office jobs along with high-quality spin-off jobs, opportunity for suppliers and other ripple effects.

The polls also confirm that most Canadians would be pleased to see Canadian firms succeed abroad, which is something that BMO for one has been engaged in for a long time now, largely in the United States, which is the source of approximately 35 per cent of our net income.

As we detail in our background paper, the stronger and more internationally competitive the financial services sector, the more we are able to keep great jobs at home and the more likely we are to succeed beyond our borders.

BMO believes that it is in the public interest to have internationally competitive banks with head offices in Canada and a strong domestic presence and, therefore, it is in the public interest for merging banks to outline how their international expansion plans will affect investment in their Canadian operations.

Turning now to the transitional issues, how to accommodate customers, employees and the wider community during the transition to a stronger and more competitive bank, the first and guiding principle here is to treat everyone with fairness and respect.

BMO believes it is in the public interest for merging banks to outline the impact of a proposed merger on pricing, products and service levels, and to undertake to put the interests of customers first in creating the new bank. Customers deserve no less.

What is more, our own experience tells us that it is possible to manage a smooth changeover for customers. When the Competition Bureau ordered the TD Canada Trust to divest a number of branches, BMO acquired 12 of them, mostly in the Kitchener-Waterloo area. To make this deal work, we were determined to get it right with customers. On the day scheduled for account conversion, for example, we automatically switched direct deposits and automated payments to the new accounts without the customer needing to worry about it.

We also established a special call centre to address the questions and concerns of our new clients. We made a commitment not to close branches, change branch hours or alter pricing for a transitional period.

Did this work from our new customers' perspective? Today, the service quality index for the acquired branches tracks slightly above BMO's national average.

While I would not for a second attempt to minimize the impact that a merger might have on any individual employee, it is worth noting that BMO and the other Canadian banks can rightfully lay claim to an enviable record of human resource practices.

BMO believes it is in the public interest for merging banks to outline how they will make full use of attrition, retraining and redeployment to mitigate job losses in those cases where there is some short-term overlap or duplication; and to specify the number of positions that will be lost in the short term and the principles under which severance packages will be made available to those who are affected.

Again, we speak from experience. To return to the Kitchener-Waterloo example, we knew that in order to get it right with our customers during that changeover, we first had to get it right with our employees. We therefore maintained existing salaries, benefits, seniority and pensions, and created a personalized learning plan for each employee.

Did this work from our new employees' perspective? Of the 186 TD Canada Trust employees who came to BMO, only six left, three of them voluntarily.

It is also worth noting that mergers are a tactic to support a growth strategy, the long-term purpose being to get stronger and more successful, allowing the new bank to hire more people and offer all employees better jobs. BMO believes it is in the public interest for merging banks to provide projections for the longer-term employment growth that will result from the transaction.

So far as commitment to our communities is concerned, I will repeat and expand on what I said earlier — access to banking and freedom of choice should continue unabated.

BMO believes it is in the public interest for merging banks to undertake to sell surplus branches to competitors with smaller Canadian branch networks. The same principle would apply if the Competition Bureau requires the divestiture of branches or other businesses. We speak from considerable firsthand experience in selling branches to smaller competitors, with positive outcomes for employees, customers, communities and overall competition.

To give you an example, in 2000-01, BMO sold a series of branches to credit unions in B.C., Alberta, Saskatchewan and Manitoba, and to the National Bank in Quebec. This was a creative solution to a business challenge. It provided for continued branch banking services in these communities; and it provided for continued employment for employees, all of whom were offered jobs with the purchasers, and nearly all of whom accepted and continued to serve customers. It also allowed smaller competitors to expand their retail networks.

Another thing to consider is that, thanks in large part to the technological revolution that my industry continues to heavily underwrite, financial services customers in Canada have never had a greater variety of high-quality, increasingly popular banking options, most no farther away than a bank machine, telephone or Web site.

In closing, I would like to reaffirm that in BMO's view, carefully thought out and managed bank mergers should be and can be in the public interest, a position our background paper supports in greater breadth and depth.

With respect, I will decline to comment to honourable senators on any specific merger rumours or speculations, since to do so would serve neither BMO's interests nor the public's. However, I would like to make it clear that at BMO, we are not counting on a merger to secure our future. We are building that future right now with a very focussed and dynamic strategy of investing in Canada and expanding in the United States. For us, a merger would be a way of increasing capital strength to execute this strategy even more rapidly and effectively.

If, at some point, a merger opportunity comes along that would enable us to accelerate progress toward our strategic goals, we would give it serious consideration. With or without a merger, however, we at BMO will continue to be mindful of our very long and special relationships with Canadians, and respectful of their rights and needs and how they think we should behave.


Once again, thank you for asking us to take part in these hearings into this important subject.


I look forward to answering your questions.

Senator Tkachuk: Mr. Comper, thank you very much. That was very good. This public interest subject that the committee is studying was structured shortly after media reports of a potential merger between the Bank of Montreal and the Bank of Nova Scotia. Of course, we wanted the ministers to come before us and explain how the process works now and what the problem with it is. Both the Minister of Finance and the Secretary of State for International Financial Institutions have declined to come. In your initial remarks you said that you do not want to talk about that. I do not want to ask you about potential mergers. However, I will try to find out how the process that we have now works or does not work.

Both the BMO Financial Group and the Scotiabank were reported in both national newspapers, the Globe and Mail and the National Post, to have had merger talks.

Did you and the Bank of Nova Scotia have discussions, either formally or informally, on merging your two institutions?

Mr. Comper: As I said, senator, in my opening remarks, I will decline to comment on speculation about mergers.

However, coming to your point on the process, it was clear at the time of the proposed mergers in 1998 that the government said, ``Look, you guys are jumping the gun. We have to get through the MacKay task force. We have to lay out the groundwork. We have Bill C-8 and a whole process.'' The government articulated the merger approval process in February 2001. There were three elements to it.

One was that the Competition Bureau would opine on matters of competition. The Office of the Superintendent of Financial Institutions would opine on the safety and soundness issues. As well, there would be a public interest test.

The fact is that the process elements are very well laid out, but there has been lack of clarity around the definition of the public interest test. Frankly, it would be irresponsible of anyone to proceed with a merger proposal absent some clarity around that definition. That is why the government, and I would commend them for it, has initiated this process, to get some clarity and more specificity around that definition of the public interest test.

Senator Tkachuk: Are you telling me that the stories in the Globe and Mail and the National Post on your proposed merger were pure speculation on their part?

Mr. Comper: As I said, senator, I will decline to comment on any speculation or rumours about mergers.

Senator Tkachuk: Mr. Comper, I do not understand why you say that. We are trying to come to some resolution here on public interest. I do not want to grind an old axe or anything like that. Surely, as one of the leading financial institutions, you have some responsibility to those of us in this room to talk about whether you did have a process, how it worked, why it failed and how we can make it better, so this does not happen again. You have all your employees to consider. There are people who have money in your bank in their pension plans. This information was in the newspaper. Then the Globe and Mail and the National Post were making it up, which is possible. I am not saying it is impossible. I am just asking what I think are some pretty ordinary questions. I will follow that up with a third question.

Did you or any of your key personnel have meetings, formally or informally, with Minister Manley and/or his staff or Minister Bevilacqua and/or any of his staff regarding a merger with the Scotiabank?

Mr. Comper: Senator, I decline to comment on that specific matter, as you would expect. I think you would expect me to not comment on any matters of that nature. That is speculation and rumour. I will not comment on that.

Senator Tkachuk: I understand that the merger talks are dead, or at least that is the impression I got from Scotiabank, which was not very forthcoming either. Does BMO Financial Group employ the services, by contract or retainer, of a company called Strategic Counsel?

Mr. Comper: We have many relationships with many different consulting firms. In fact, we do have a relationship with Strategic Counsel.

Senator Tkachuk: Did a representative of that company, Peter Donolo, as reported in one of the major papers, visit the Prime Minister and/or the Minister of Finance on your behalf and report on the government's intentions on the question of a merger between you and Scotiabank?

Mr. Comper: Mr. Donolo is not a registered lobbyist and would never lobby for us. He has acted in some consulting capacity for us on several occasions.

Senator Tkachuk: Did any other member of the firm do that?

Mr. Comper: Given that I am not going to comment on speculation or mergers, it would be inappropriate to comment on any activities that might have been undertaken by other people, but I have no knowledge of that.

Senator Tkachuk: I am not asking about a security matter. I am just asking whether this story was true, whether it happened.

Mr. Comper: As I said, senator, with all due respect, it is just not in our interest for me to comment on speculation or rumours.

Senator Tkachuk: You cannot have it both ways, sir. You are a leading financial institution. You are here to argue the case of why banks should merge. If you made an attempt and it failed because the process did not work or you were told ``no'' for some reason, since the ministers will not talk about it, I think you have an obligation to tell not only us, but also your shareholders, what transpired. I d not think you can get away with saying, ``Well, I am not going to comment on something.''

Mr. Comper: The purpose of —

The Chairman: The witness has made his position abundantly clear. I do not want to embarrass him.

Senator Tkachuk: I am not trying to do that.

The Chairman: You have asked him four or five questions, and he says he cannot comment.

Senator Tkachuk: He said that he will not comment. That is his prerogative. I will ask him again.

Mr. Comper: I thought we were here to discuss the process. As I said earlier, I think that process is not complete yet. We said, back in 1998, that we needed to put the process in place. We said in 2001 that it would have three elements: a competition test, a test from the Superintendent of Financial Institutions, and a definition of the public interest. We have not had clarity around that so far. This part of the process, therefore, is to put in place that definition. The Minister of Finance and Minister Bevilacqua have asked this committee and the House of Commons committee to help in that definition of the public interest test. I fully support that.

As I said before, and I would reinforce it, senator, it would be irresponsible to proceed with any merger proposal absent the definition of those three elements of the test.

Senator Kroft: Good afternoon and welcome, Mr. Comper. You will be relieved to know I am not going to pursue the same line of questioning.

In your background paper, you say that while it is clear that increased exports of manufactured goods contribute to the improved performance of the national economy, it is less clear why expanding bank operations abroad lead to improved economic performance.

I would agree, and I would also suggest to you that probably one of the more difficult things to convey, and so perhaps it has not been conveyed successfully, is why expanding bank operations abroad serve the broad Canadian interest. In the last go-around in 1998, Canadians generally and Canadian business were not greatly impressed by the idea. I would like to pursue that macro area. I do so while at the same time acknowledging — and thanking you for it — that you have raised some very interesting and specific points and suggestions about conditions. There is a lot of valuable material there. However, I will use the small amount of time I have available to pursue the macro area.

Let us, as they say, follow the money. First, as an industry, do you have a sense, in both percentages and dollars — obviously you do within your own bank — of what you earn in your foreign operations? I think you said one third.

Mr. Comper: It is approximately 35 per cent, yes.

Senator Kroft: I think we heard from another witness in the case of another bank, perhaps the Scotiabank that it might have been as high as 50 per cent. I would like to get an understanding, and I think it would be helpful to Canadians in looking at the impact of foreign operations, of what happens to that money. First, does that money you talked about earning come back to Canada? Obviously you cannot answer that because you may be making another foreign investment, but barring a large capital commitment for a new venture, how much of those foreign earnings would you repatriate in an ordinary operating year?

Mr. Comper: We would repatriate, in our consolidated income statement, 100 per cent of it. However, it flows in different ways. There are a couple of benefits to your point on the macro issues, which I think is very important. One is the income flow. On average, we have data that suggests that one out of two Canadians is either a direct or beneficial participant in Canadian bank shares, either in their pension funds or through their mutual funds or other things of that nature. Between 30 and 40 per cent of the net income we receive is paid out in dividends to those shareholders of the Canadian banks. The more we earn, the higher the dividends, the more the pay-outs and returns to the shareholders, and about one-half of Canadians are beneficial or direct owners of shares in Canadian banks. That is the dollars and cents part of it.

On a more important and macro level, though, the fact is that when we have significant operations in the United States, we have support functions in place to support those activities. Let me take the example of our technology division. The technology requirements of our operations in the United States are managed from our technology operations in Canada. The more we expand in the U.S., the more investment we make in information technology and the more technology jobs we have, and those jobs are primarily in Toronto and Montreal. For example, it might come as a surprise — it does to some people — that BMO Financial Group employs 1,000 software engineers. The more we expand and grow, the more we are creating jobs back here in Canada to support those operations.

Senator Kroft: You talked about the value to the shareholders, that is, what flows through to dividends, and possibly share appreciation. I am interested now in the growth of the reinvestment in Canada of money earned abroad.

Would you expect, looking into the future, that as your international operations grow, that the Canadian support base — and I know you touched on this and I would like to come back to it — what might be called ``support operations'' or ``backroom operations,'' would tend to be disproportionately higher? Would you expect that even though you are expanding your operations, your Canadian business, your investment in people and software and hardware and everything else, would continue to grow substantially?

Many Canadians might confuse financial institutions with other businesses that go abroad and their next plant expansion will be in the Southern United States or somewhere else. The head office remains, but the growth is somewhere else. You are saying it is leveraged the other way. As your international growth develops, the reinvestment in people, services and, probably, bricks and mortar, would tend to be in Canada. Is that the case?

Mr. Comper: Correct. There is another example of that. One of the functions we perform in our bank, as do other banks, is called ``international money market and foreign exchange activities.'' The people who actually do the trading for us are located inter alia in Chicago, New York, Toronto, London, England; Singapore, Hong Kong, et cetera. The processing for all those trading activities in all those different locations is located in Montreal. There is one centralized unit. Modern telecommunications allow you to support those kinds of activities from one location, and we do all of that in Montreal. Several hundred jobs support those activities. In the era of previous technologies, a lot of those support activities were decentralized into different operations around the world. With modern technology, our business, financial services, is basically information processing. I like to think that we are in the business of moving information about money, and with today's telecommunications technology, we can do it in one location in Montreal.

Senator Kroft: That leads me to another question. Taking your money market traders as an example, or your investment bankers or whoever, is there a risk that you are exporting your high-end or high-cost or high-income or high-powered people abroad and that the lower end of the salary scale functions stay in Canada?

Mr. Comper: The reverse is the case. Some of the data in our detailed report suggests that while Canadian business has been expanding abroad, the growth in the higher-paid head-office jobs has been greater in Canada than the growth of the businesses outside the country.

We put people on the ground where the business is to be done and where the customers are. That is why we have operations in Canada, the United States and around the world. Much of the intellectual capital is located in our domestic activities here in Canada.

Senator Kroft: The growth abroad would result in a relative build-up of the intellectual capital in Canada, and not somewhere else?

Mr. Comper: That is correct.

Senator Kelleher: I would like to question you about mergers, assuming they will be permitted. Various concerns come to mind. If the Competition Bureau, for example, in the event of a merger ordered a divestiture of branches, concerns have been expressed that it might not be possible to sell off those branches and people will be without a bank in their hometown. Would this be a problem? You have some experience in this area, as you have picked up some branches.

Mr. Comper: We have picked them up and divested them. We have experience both ways.

Senator Kelleher: Do you see this as a problem?

Mr. Comper: I do not see this as a problem. In fact, there is a ready market, and several people have expressed the view before this committee that they would be interested in acquiring branches. Our experience in the marketplace is that that is the case. In Western Canada, it was the credit unions. In Quebec, when we divested some branches, it was National Bank. When TD Canada Trust divested branches in Ontario, we in fact were the purchaser. It has gone both ways. I do not see that as a concern.

Senator Kelleher: Have you found it necessary to close any of those branches that you acquired as a result of the TD Canada Trust merger?

Mr. Comper: I think there might have been one branch, senator, that was closed. If you had two branches as a result of a merger or proposed merger across the street from each other, and they were both suboptimal, you might look at building a third location that would be larger and more functional. You would combine the people, the assets and the client base of the two branches into a larger third location. It is one of the options when you look at tuning the network after a merger. There are different ways of going about it.

Senator Kelleher: According to your notes, you appear to have taken good care of the new employees you acquired. The other important element, of course, is the customers. What has your experience been? Were they satisfied after you took over these branches? How would you characterize the situation?

Mr. Comper: As I said in my comments, we are measuring customer satisfaction scores that are above the BMO national average. We feel pretty good about it.

Our philosophy and strategy is that, if we get it right with our employees, they will get it right with the clients, and the clients will reward us with more business. It is in our interest to keep the clients and employees happy, and to do it in a manner that is as stable as possible. The assets here are the clients and employees. It is in our interest to do as good a job as possible of getting that right.

Senator Kelleher: When Mr. Clark from TD appeared before us, he expressed the view, and I hope I am paraphrasing it correctly, that he was not so sure that this type of hearing is necessary. The rules seem fairly clear, so why do we have to go through all this? Why could we not just go ahead based on what was there? He felt there was sufficient clarity of the public interest, and he was concerned that as a result of hearings of this nature, somebody might decide in a backroom in Ottawa to pile on new rules and regulations in attempting to define ``public interest,'' making it more burdensome for the banks in question. Could I have your opinion?

Mr. Comper: I have a contrary view. I believe this is an important process. I have felt for a long time that we did not have clarity around the definition of the public interest. I agree that it would not be productive to have all sorts of rules and regulations. That is why it is important that an august body of thoughtful people such as this articulate the principles that would inform the public interest test.

Senator Mahovlich: Mr. Comper, thank you for appearing before us. I am not a member of this committee. You mention mergers and banks. What happens if you merge with a much larger bank in the United States? How do you stay on the farm? How do we keep the head office in Canada? BMO Financial Group does not even sound like a bank any more. It used to be the Bank of Montreal, correct?

Mr. Comper: It still is the Bank of Montreal.

Senator Mahovlich: BMO sounds like a bad deodorant.

Do you always merge with a smaller company?

Mr. Comper: The history of the Bank of Montreal has been one of amalgamation and consolidation starting in 1846, including the amalgamation with the Molsons Bank, the Merchants' Bank of Canada, the Bank of British North America and the Bank of Toronto.

Senator Mahovlich: They are all Canadian banks.

Mr. Comper: They are all Canadian banks. Right now, technically it is not possible to merge with an American bank.

Senator Mahovlich: What if we approve mergers? What if it is approved and you merge with a larger bank?

Mr. Comper: It would still be against the Bank Act as it is currently structured in terms of foreign ownership.

Senator Mahovlich: Do we have a law in place?

Mr. Comper: Yes, there is a law in place. That was Bill C-8, and foreign ownership was extended.

Senator Angus: Welcome. Congratulations on your excellent results reported today.

There is a bank right next door to this building. Is that one of your branches?

Mr. Comper: Yes, it is.

Senator Angus: It has not been sold?

Mr. Comper: No, it has not. We do not own the building. It is owned by the Government of Canada.

Senator Angus: My window upstairs looks out on that building. It is the only building on the street that does not fly a Canadian flag.

Back in June or early July, we looked out one day and there was the flag. It had fallen down or something and was at the bottom of the flagpole. It has gradually disintegrated. We watched it with horror, and it has never been replaced. I thought maybe you had sold that branch off, or perhaps the real answer is that it is not your building. You do not need to answer, but you may want to take note of that.

Mr. Comper: Thank you for drawing that to my attention. I will attend to it.

Senator Angus: The issue that Senator Kelleher raised with you is a serious one. You said you disagree with Mr. Clark, which is fine, and we are here and there is an ongoing process. The word ``clarity'' seems to be the key word. Notwithstanding the letter that we received, after nearly three days, I am not sure what is not clear in Bill C-8 and the merger guidelines, both from the Competition Bureau and Department of Finance. Perhaps you can tell me, because you said you believe this is a good process. What is not clear?

Mr. Comper: There is talk of the public interest, but then it stops there. What should happen in the case of a merger in terms of access to services, availability of credit and transitional support? It is important for this committee to advise the government that those areas should be addressed in the formal public interest impact assessment document as part of the merger process.

Senator Angus: As I have noted, and do not feel you have to necessarily agree or disagree with us, ``public interest'' is a subjective term. What you may think is in the public interest I might not, or what one politician might think it is another might not. We could sit here for years talking about the concept of public interest, but relative to what?

The evidence we have heard so far suggests that if one or more of our major $5-billion-and-up banks are in the process of combining and they get through the Competition Bureau process, which will deal with most of those points you mentioned, and then the prudential issues of safety and soundness under OSFI, what is left, other than is this a politically good idea or not for our party, whoever we may be. I am having a real problem with that, and I believe we all are. Would you comment on that?

Mr. Comper: You made the point that the definition of ``public interest'' is subjective. I agree totally, absent some clarity. It is incumbent on this committee, as well as the Commons committee, to help the government reduce the degree of subjectivity in the definition, because I do not believe it is unreasonable for Canadians to expect that their interests will be looked after in any proposal that might come forward. It is perfectly reasonable for Canadians to ask how this is in their interest. How can they be assured that they will have access to branch services in their small towns? How can they get assurances that their friends who work at BMO Financial Group in Lethbridge, Alberta, will not lose their jobs as a result? How can I take comfort that my small business will have access to credit in the local communities?

Those are the areas of public interest that I think are legitimate sources of questions from Canadians. They have a right to have any proposed merger partners address those issues in their public interest impact assessment document. We can quickly come to a consensus on the major principles that should inform the public interest.

Senator Angus: I put it to you, Mr. Comper, that to go through this kind of process at OSFI and the Competition Bureau and then to be turned down is not in the public interest. When two major Canadian enterprises that are responsible businesses consider something to be in their best interests — one of them being in that business for 185 years and quite sophisticated as to what is the right way to behave in our financial services sector — to go through the expense, time and the effort that has been described to us as arduous, and draining on the infrastructure and the employees of the organization, and then to be told no, is not in the public interest. Therefore I am asking you, would it not be better, as Mr. Clark said and as Senator Kelleher was trying to get at, to be told upfront by whoever is the inhabitant across the street at the time, ``Look, we think it is in the public interest to have bank mergers, so go for it,'' or otherwise, and save all this angst, expense and waste?

Mr. Comper: I do not agree. I happen to believe that the government has laid out the process, part of which will be a requirement to meet the test of the public interest, and I think it is a legitimate item for Canadians to consider. As long as that is part of the process, it is important to add more clarity. You are right; it would be crazy to proceed with any kind of a proposal with only a subjective definition of an important part of the process. As long as that is part of the process, it is important to give it specificity.

Senator Angus: Just so you understand where I am coming from, some of my colleagues here, for example, do not think it is in the public interest that the government, in its first month in office, just willy-nilly cancelled the helicopter contract when gazillions of dollars had been invested, and now we have a problem because we do not have helicopters. It is a political decision of the government, whose job it is to decide in cabinet what is or is not in the public interest. We think that they spent a lot of money on Bill C-8, which I suggested was 38 inches thick, and much work was done by all the stakeholders, by us, and by MacKay before, and a process was laid out. That was followed by the guidelines that were issued and debated, and then the government had a job to do. The government was elected by the people to decide what is or is not in the public interest.

I do not understand why we have to do their work for them. Does that make any sense, or are we in a polarized situation?

Mr. Comper: I am sure you understand why if would be inappropriate for me to be critical of the process that the government has laid out and on which they want to proceed.

Senator Angus: Mr. Clark did not have a problem.

Mr. Comper: I happen to believe there is an element called the ``public interest,'' which is an important factor that has to be considered by the government, and the government has decided that it wants to take advice and counsel from the Senate committee and the Commons committee on what that public interest should look like. We are here to support that, and given that the government has laid out the process they want to follow, I happen to believe it is legitimate for Canadians to ask the government to show them how this is in the public interest. We have pointed to specific areas.

Senator Angus: That is fair.

When the process is in place that enables you folks to say a merger is a legitimate business strategy for Canada's major banks, and it is legal, that process provides for this committee to do an analysis, but that, as I understand it and as we understand it, was to be part of a process to judge whether a specific merger proposal was or was not appropriate or in the public interest. That is troubling and that is not what we have here today.

Do you deny, sir, that the government rejected a proposal for a merger between the Scotiabank and BMO Financial Group?

The Chairman: Senator, that question is out of order. He said 22 times —

Senator Angus: Nobody has asked that question.

The Chairman: Yes, we have, many times.

Senator Angus: I have been ruled out of order, but the record will show that nobody else has asked the question in that way, which is perhaps why you did not get the answer.

The Chairman: Exactly.

Senator Meighen: Welcome, Mr. Comper, Mr. O'Neill and Ms. Maidment, whom I have not met before. I have met the two gentlemen before. We have had very pleasant associations over the years.

Surely, Mr. Comper, I misunderstood something. Did I hear you say that because the government has proposed something, your position is not to criticize it, even if you felt it was wrong?

Mr. Comper: I am sorry if I implied that, senator. I happen to believe it is a legitimate process and will serve the public interest.

Senator Meighen: Following along on what Senator Angus was asking you about, a public interest impact assessment has to be filed. I think your definition of ``public interest,'' to which you have alluded in your paper, is excellent. It is as good or as bad as anybody else's. I think it is fine. We could all choose a different word here or there. However, I do not see that there is much division of opinion. There may be differences of emphasis, but going back to the earlier line of questioning, it is surely for the government of the day to decide where their emphasis lies. In my view, we cannot possibly define ``public interest'' forever, any more than we can define ``beauty'' forever. The public interest impact assessment that you would be required to file in the event of a proposed merger sets out most of the things that we have been talking about, including impact on service in a particular area, how to contribute to international competitiveness, et cetera. We have had that from the Department of Finance for quite some time.

I am having trouble seeing how we can add to it, other than you proposing a good definition, and I proposing a good definition, and we all propose a definition that turns around the same nub. Is it not just a war of semantics? Ultimately, what we get down to is: What is the opinion of the government of the day as to whether it is in the interest of Canada to go forward with the proposal? Am I wrong?

Mr. Comper: My only response to that is that the government has laid out the process. You may recall, senator, during the last proposed merger there was considerable public debate around what is in the public interest. There was no clarity around that.

With regard to your point, Senator Angus, about subjectivity, there was a lot of subjective discussion about whether this is in the interest of Canadians or not. The government said, ``To address that, we will have something called a `definition of the public interest test.' We would like to be as clear and specific as we can, so that when the public impact assessment documents come forward, they are hitting the points that we, both in the Senate and the House of Commons, would like to see addressed in any proposed merger.''

Senator Meighen: What is wrong with the paragraph in the PIIA as laid out by the Minister of Finance? There might be words you would like to take out or add.

It is impossible to define ``public interest'' for all time, because it is a shifting thing, surely. We can sit here for days and talk about it, but it will come back largely to what is here. In any event, I doubt we will be able to resolve that question here today.

Let me put to you a couple of other propositions to get your reaction. One of the difficulties seems to be that the various processes outlined are all happening concurrently. For example, in the merger review guidelines it talks about the bureau and OSFI reviews, and the House of Commons and the Senate will do their thing. It is all happening at the same time. It has been suggested to us that perhaps it would be preferable for the merger proponents to clear the issues with the Competition Bureau and OSFI first. That makes sense to a number of us. Once that has been done, we can then move on to public interest, perhaps. Does that idea commend itself to you?

Mr. Comper: There are different ways we can approach it. Frankly, it is for the government to determine how they would like to proceed with the proposals. I would be open and receptive to any proposal the government thought appropriate.

Senator Meighen: Let me try another one on you. This was suggested by one of your colleagues in the financial industry. It goes like this: Rather than going through what we went through in the last round, where there was one proposed merger, and then another one came along some time after, there should be some statutory requirement that once there is a merger proposal on the table, within X days or weeks, anybody else contemplating a merger should also put their proposal on the table. The Competition Bureau and OSFI could then deal with everything at the same time. They could pick the one that commends itself to them, or pick none. At least they would know what they were dealing with, rather than waiting for another shoe to drop.

Mr. Comper: The only thing that confuses me about that is that it flies in the face of a commercial transaction. If a merger proposal comes forward, and it is a commercial determination that has been made by two entities, it does not necessarily imply that there should be another one.

Senator Meighen: Fair enough. What if somebody is contemplating one, waits, and then comes forward, as happened last time?

Mr. Comper: I would expect that it should be dealt with on its merits at the time it comes forward.

Senator Meighen: At the same time? Four banks seeking to merge are a different kettle of fish, surely, than two banks seeking to merge. That sets up different criteria and priorities in the public interest consideration. Why not deal with everything at the same time?

Mr. Comper: That is a function of the workload and the resources of the Competition Bureau, I imagine, and the Superintendent of Financial Institutions. We would have to treat whatever comes forward on the merits, as we do with consolidation in other industries in this country. There are times when there are many transactions coming forward. There are other times when there are fewer. I believe it would be up to the Competition Bureau to determine the best method of handling that.

Senator Meighen: I think I detect a consensus in your answer, that is, you do not see any particular merit in obliging all merger proposals to be put forward within a specified time frame.

Mr. Comper: I do not see that that is particularly practical.

Senator Meighen: This was suggested to us in the context of disposing of lines of business or branches. Let us say that if two banks are getting together, for example, in Edmonton, and the Bank of Montreal and another bank are merging, and it was determined that some of the branches had to be disposed of, there could not be any cherry picking. One of the two merging banks would have to dispose of all their branches, which means the good, the bad and the indifferent, at the same time. Does that make any sense to you?

Mr. Comper: I do not think so. That is exactly what the Competition Bureau would do. It has certain fairly formulaic definitions of what constitutes concentration in different areas. The Competition Bureau would specify where there was an offence against the Competition Act and which branches would have to be disposed of. We would not have the ability to cherry pick unilaterally, senator.

Senator Meighen: That is interesting. Would they be as concerned with the quality of each individual branch as they would be with the number?

Mr. Comper: They would be more concerned about the concentration in different lines of business. They have some fairly specific rules — for example, 35 per cent in different lines of business. As I said, their definitions of what would constitute concentrations and what we would have to do to remedy those are fairly formulaic.

Senator Meighen: When they come down with their ruling, as it stands now, do they say, ``You have to get rid of X number of branches in Y geographic area''?

Mr. Comper: Let me take a specific example. When the TD Bank and Canada Trust were merging, because there was over-concentration in Kitchener-Waterloo, the Competition Bureau said, ``You will have to divest 12 of your branches in Kitchener-Waterloo.'' In fact, there were six from Canada Trust and six from the Toronto Dominion. That is how specific they get about the divestiture.

Senator Meighen: Who picked the branches?

Mr. Comper: The Competition Bureau.

Senator Meighen: Did they not just say, ``Get rid of six''? Did they say, ``Get rid of this one and this one and this one and this one''?

Mr. Comper: I could not tell you, senator, whether they said precisely which six.

Senator Meighen: That is the point of my question.

Mr. Comper: It was 12 branches in total between the two of them.

Senator Meighen: I understand that. The point of my question was whether the Competition Bureau got to choose which branches or whether the divester got to choose.

Mr. Comper: I think it is a matter of how far they go in terms of the definition of the market area. Just off the top of my head, senator, I cannot recall exactly how far down it goes.

Senator Kroft: We have been struggling as a group with one concept, and I would like to follow it up while we have the opportunity. It is this idea of process.

Senator Kelleher was asking you about the appropriateness of this process and defining the public interest. Senator Angus took it to the next step, which is what I have been grappling with for two days. Assuming we are able to give even further definition and come back with a report, then given a specific merger proposal, I would be concerned. Although you say you think it is legitimate for the public to be concerned, et cetera, I share more of Senator Angus's concern.

I want to be sure, before we let this go and before we make our recommendation, that by leaving it open to OSFI and to the Competition Bureau — and then it will come back to the two committees — that you and others who may be contemplating a merger will not be saying two years from now that it has to go to those two committees, and there is not enough clarity and not enough certainty about how those political committees will react. That is what worries me. I would rather face it now than then.

If I were in your place, I would recognize that ``public interest'' is a political decision, because that is what politicians are supposed to do, assess the public interest. I would like to know why you would not be more comfortable with a lot of work on defining ``public interest'' and then saying, ``OSFI, okay. Competition Bureau, okay. Government, you decide whether it fits the public interest or not.'' I am concerned that we will have you here two years from now with your proposal, and you will say, ``We cannot deal with this. There is too much uncertainty and unpredictability because it is has to go through the Commons and the senators, and everyone will have a kick at it.'' I am confused. I would think that you would rather have a decision from a government whose job it is to answer one way or the other.

Mr. Comper: What was the question?

Senator Kroft: Do you feel that, through this work that you have complimented, we can develop a set of criteria whereby, in a prospective situation, you would still think it helpful to have that judgment go back to two political, parliamentary, legislative committees?

Mr. Comper: To me, it is quite simple. We have established through quite a lengthy process that mergers are a legitimate form of business activity, and you can refer to the MacKay task force report. The government has in fact put the process in place. We define this as legitimate commercial activity, but there is uncertainty. Therefore, business people will want the rules of the game to be as well established as possible, such that before you proceed with any proposed commercial activity, a merger or anything else, you know that if you follow those rules, you will get to a successful conclusion.

My view is that one of the elements of the rules of the game is that a proposed merger should meet the public interest test. What is the public interest test? My view is that the more clarity we can achieve about the rules of the game under the rubric of the public interest test, the more likely we are to make an informed decision that if we follow these rules, we will get to the end of the road.

Senator Kroft: I agree entirely. Once the rules are established, who should be the referee? Would you feel more comfortable with the government as the referee, or two more political committees?

Mr. Comper: It will be how the government chooses to invoke its authority, and referring it to the committees is my understanding of how the process will work.

The Chairman: Could I ask a follow-up, but much more simplistic question? Let us say hypothetically that this committee comes to the conclusion that bank mergers are in the public interest, with certain caveats. You have to look after the little guy, et cetera. Then you are only left with two things. You are left with the access and competition, and there is a whole bureau set up to take care of that. You are left with prudential considerations, and there is a whole bureau set up to take care of that. It is not a public interest discussion any more. We are saying it is in the public interest. Would that not simplify matters? Would the government not then have to stand up and say, ``Mergers are in the public interest; let us hear it.'' The Competition Bureau and OSFI adjudicate all the other stuff. Instead of beauty being in the eye of the beholder, we simplify the process. Do you find that appealing?

Mr. Comper: That certainly is a very clear way of dealing with the issue, senator.

Senator Oliver: Senator Kolber, you caught the essence of my question. Perhaps I can try to rephrase it.

We are here because of alleged political interference. Mergers are big business. Mergers are legal in Canada today. We have been told by a number of CEOs who have come before us, ``Please do not confound this public interest test with the work that legitimately will be done by the Office of the Superintendent of Financial Institutions and the Competition Bureau, which have a huge infrastructure of formulas and other tests to decide whether you should divest of branches, whether you should get rid of a credit card line, and so on. They can do that.''

What, then, is left? It seems to me that there should not be much left for us to have to decide, because even in your paper today, you say that for banks to articulate how the merger will affect customers with respect to pricing, products and services should be a condition put on by the Competition Bureau, which could also impose conditions in relation to small-business banking.

Why could the two conditions that you call public interest impact assessment on page 8 of your brief not be imposed by the Competition Bureau rather than have to come before political committees?

Mr. Comper: Well, senator, it would be presumptuous of me to tell this committee how to go about its business.

Senator Oliver: They are legitimate business decisions that fall within the rubric of the Competition Bureau, and CEOs told us, ``Do not call ``public interest'' things that are already being studied and fall within the jurisdiction of both OSFI and the Competition Bureau.''

Mr. Comper: I agree with that totally.

Senator Oliver: Why could the Competition Bureau not deal with the two conditions on page 8 that you call public interest impact assessment?

Mr. Comper: As I said, the government has asked this committee for input and advice on what that public interest is. It would be presumptuous of me to tell you how to do your job. If that would be your view on how that public interest test could be met, then that would be one legitimate outcome of this proceeding.

Senator Oliver: It seems to me that at least three other CEOs have suggested to us that these are business decisions that should be looked at and analyzed by the Competition Bureau, and perhaps by OSFI, so why not make that a condition, in the same way that you might have to get rid of a credit card line or certain branches and build in protection for small business?

Mr. Comper: I certainly agree with you that if the Competition Bureau or the Superintendent of Financial Institutions were to address certain areas, it would be redundant to do it again. It is those areas of the public interest that might not be included in that kind of process.

Senator Oliver: Can you name one that might not be included under OSFI and the Competition Bureau?

Mr. Comper: For example, small-business access to credit.

Senator Oliver: The Competition Bureau could issue such an order.

Mr. Comper: You would have to look at the Competition Act to see what precisely it would cover or not cover. I am suggesting there may be areas of public interest that are not explicitly covered by the Competition Act, and my belief is that that is why the government would like to get some clarity around the definition.

Senator Oliver: I agree with Senator Kolber. The less that is left at the last minute to political committees made up of different parties with different points of view, the better it is for a major, multi-billion dollar business decision on whether two institutions should merge.

Mr. Comper: I agree completely with that, senator.

Senator Kinsella: Mr. Comper's testimony has responded to some of what I was going to probe. I have but one question, which is subdivided into three parts.

First, have you or any others in your industry ever asked the Government of Canada for its current criteria as to what would constitute public interest on the question of mergers? If the answer is ``yes,'' what did they tell you? If they were to make that judgment today, what criteria would they use?

Second, what outcome would you like to see specifically from the study being done by this honourable committee, of which I am happy to be an ex officio member, and the hard work of my colleagues opposite and on this side? Are you looking for a checklist as to what constitutes the public interest that the government will have to use in meeting its parliamentary responsibility, which is an executive responsibility under our system of governance? It seems to me passing strange that they have no criteria today.

Senator Oliver: They did not when they came before us.

Senator Kinsella: There you go.

Third, I would suspect that any government would have to ensure that a public interest decision is congruent with its policy in a variety of areas: for example, foreign policy, and in particular, as it relates to global economic integration or continental integration. I have not heard any mention of those criteria, but I have read in your presentations that continental economic integration is a pretty important dynamic for 35 per cent of your own business.

Mr. Comper: Interestingly enough, our chief economist has just completed a major study on North American economic integration, which we undertook precisely because, as you may know, we are by far the largest of the Canadian banks in the United States. We see this economic integration as a good thing for Canadian businesses and individuals. I was particularly pleased to see the way in which our Canadian companies are in fact not threatened by the arrival of the Americans, who are coming here and taking over, but are competing effectively in the United States with American companies. That is a great success story.

As to why we need more clarification, the more the rules can be laid out, the more likely we are to make a decision and understand clearly that we will be able to get to the end, i.e., that it will be approved. Therefore, I would expect — and this is speculation on my part — that the government, after asking this committee and the House of Commons committee for some input on the definition of the public interest test, will then have a means of charging those committees with what to look for in the public interest impact assessment documents and what it would like them to consider during hearings on any merger transaction that might come forward.

Senator Kinsella: If there is an explicit set of criteria and you meet that test, do you envisage a shift in the burden of proof? If the industry has done all this work with due diligence, has met the criteria as articulated and the answer is ``no,'' then the burden of proof shifts, and the government will have to defend its position in coming to a different conclusion on the application that meets the standards of the test?

Mr. Comper: It would be speculation on my part. I will tell you for a fact that the clearer the rules of the road are, the easier it is for us to make a decision that might pass the commercial test. I do not think that the commercial viability of any proposed merger is up for grabs. That is pretty self-evident. The issue is to ensure that whatever we come forward with will pass whatever screening or criteria the government will use to assess whether it should proceed or not.

Senator Hervieux-Payette: Since I have been on the committee for seven years, Mr. Comper, perhaps I can help you to understand why some people here do not want to conduct these hearings. The Senate Standing Senate Committee on Banking, Trade and Commerce did not want the political class to intervene in this process and was trusting that both OSFI and the Competition Bureau would be able to handle it. The decision was made in the House of Commons that parliamentarians should examine this question. Since we are parliamentarians, we had to comply. This explains some of my colleagues' reluctance today. When the criteria are well established, it is easier for someone in the private sector to go through the technocratic examination as well as the political process. I hope that we will find some criteria that will be clear enough for you. Some of my suggestions would be, of course, that any merger would serve both small business and private people as well as large business, and also that your venture will eventually serve Canadians abroad. I do not say it would be a flow-through, but at least you will be able to make the corporate decision on whether to present your project.

I think it is important that we understand why we are in this discussion. Otherwise, the frustration of this committee will just be repeated at every meeting.

We will try to do our best to comply with what the ministers have asked both chambers to do. We hope to help you out. I gave an interview to CBC this morning. I said that the more mergers in the private sector, and other businesses, perhaps the more we would have to look at them. You have to make the case. I asked the other bankers yesterday to do that. You have to make the case before the public. We cannot make it.

Senator Tkachuk: On reflection, I would like to ask that Senator Angus be allowed to ask his question. I was wondering if, on reflection on your part, you would let him.

The Chairman: Go ahead, Senator Angus.

Senator Angus: Mr. Comper, do you deny that sometime within the past three or four months the Government of Canada, or someone on its behalf, told you, or someone involved in your organization, that it was not yet prepared to consider the combination between the Scotiabank and BMO Financial Group?

Mr. Comper: Senator, as I said before, with respect, I do not intend to comment on speculation or rumours about that situation.

The Chairman: We have another witness coming up right away.

Our third witness for this evening, from Canaccord Capital, is Mr. Michael G. Greenwood, President and Chief Operating Officer. Welcome to the Senate Banking Committee. Mr. Greenwood, do you have an opening statement?

Mr. Michael G. Greenwood, President and Chief Operating Officer, Canaccord Capital Corporation: I wish to thank you and the members of this committee for hearing my comments and suggestions pertaining to required pre- conditions for any prospective bank merger.

Allow me to offer a brief description of Canaccord. Canaccord is the largest independent, fully integrated investment dealer in Canada. We have approximately 1,200 employees and 24 offices across Canada, as well as in Chicago, London, Paris and Barbados. We are the sixth largest dealer in terms of retail investment advisers. We are the sixth largest investment dealer on the TSX, with approximately 5.54 per cent market share in terms of volume. Canaccord has grown rapidly over the last few years through training and hiring brokers, and during that time we acquired 10 other investment dealers. Employees own approximately 80 per cent of Canaccord, while Manulife Financial purchased 20 per cent of our fully diluted capital earlier this year. We possess approximately $100 million dollars of equity capital.

Canaccord offers a full complement of professional products and services, including retail brokerage, investment banking, research, institutional sales and trading, international trading, fixed income and capital debt markets, estate planning and insurance services.

Finally, we are Canada's largest financier of small capitalization companies, having completed 354 financings, raising $262 million in the under $5 million category, and 24 financings raising $166 million in the $5 million to $10 million category for the period September 2001 to September 2002. The venture capital and small capitalization areas represent approximately 10 to 15 per cent of our business.

I would like to say that Canaccord is in favour of a limited number of bank mergers. We recognize the need for Canadian banks to have the critical mass and presence to take advantage of global opportunities as well as the capacity to withstand various external shocks. However, there must be a balancing of these needs with our desires as a country for, one, a strong international banking presence that understands the dynamics of Canada; two, a talent pool of financiers, lawyers, accountants, technology specialists and others fostered and developed in the banks and associated services; three, a vigorous and dynamic internal market place that encourages innovation, risk-taking and the formation of capital. We are concerned by the prospect of Canada, post bank mergers, becoming too much like Germany, which will result in a stifled competitive environment, particularly for small business.

There are four broad areas of concern that Canaccord, and we believe other smaller investment dealers, have vis-à- vis allowing one or two bank mergers. These include wealth management, capital markets, credit and policy.

Wealth management: Investor Economics has estimated that the wealth management market for Canadian securities is approximately $515 billion. The big six banks have approximately 86.4 per cent of the full service and roughly 91.5 per cent of the discount brokerage market. More importantly, the banks have more of the profitable business lines, such as fee-based accounts, which are the fastest growing in Canada. The reason for this dominance is simple; the banks have a large technology and marketing infrastructure in addition to large client bases. This allows the banks to amortize product development and the risk of product failure over a much broader asset base.

In addition to the significant advantages of technology and marketing, the banks are routinely using their significant balance sheets to compete via the practice of forcing up balance sheet concerns of independent investment dealers, notwithstanding the fact that Canadian Investor Protection Fund provides cash coverage of $1 million per account and the Canadian Deposit Insurance Corporation of $60,000 per bank account. This affects the ability of independent investment dealers to attract cash balances, which are by far the most significant profit source. As an independent investment dealer, we already experience a number of practices where Canadian banks have a tendency, whether consciously or unconsciously, to skate either over or very close to the line in terms of abuse of marketing practices. For example, we experience the abuse of tied selling in the guise of cross selling every day.

As outlined above, market concentration is a very significant issue when it comes to wealth management. Assuming a bank merger, regional concentration could be above any reasonable threshold amount. It is self-evident that at these concentration levels, it will be difficult for competitors to achieve a viable foothold, which will ultimately be harmful to Canadian consumers.

Wealth management solutions: We believe the only possible way to allow for one or two bank mergers is to force the divestiture of assets. These could include wealth management assets as well as bank branches. Wealth management assets can be sold separately.

Investigate the application of mechanisms to prevent or limit additional tied selling/cross selling practices, which are included in the Competition Act, although I think there are issues surrounding that.

Capital markets: As a result of acquisitions and bankruptcies, there has been a substantial erosion of the number of publicly traded companies on the TSX. The TSX estimates that 60 per cent of the listed companies are now classified as junior. The financial sector represents approximately 22 per cent of the commissions paid on the TSX. Obviously, one or two bank mergers would affect the profitability and overall market liquidity of the TSX.

Market liquidity has been materially reduced due to greater institutional concentration, a growing number of inter- listed stocks on the U.S. exchange, higher execution costs, exponential growth in regulatory costs and a shrinking number of publicly traded companies. Further, there has been a very significant consolidation of capital market participants, resulting in the six major banks representing approximately 80 per cent of the equity trading market, 87 per cent of the new issue market and more than 90 per cent of the debt market in Canada.

To put these statistics in perspective, 178 independent investment dealers represent less than 20 per cent of the equity trading, 13 per cent of the new issue market and less than 10 per cent of the debt market. The banks also represent the vast majority of regulated capital, at $9 billion, versus $2.5 billion for all the independents. Because of their market dominance and cross selling practices, the banks garner substantially more of the industries' operating profit and thus incur less volatility in income. In other words, the banks have been very successful in marginalizing other Canadian competitors to businesses that have been substantially more volatile and less profitable.

I have some statistics that show this at the back here from the IDA.

This should be of grave concern to this committee. We need a thriving and profitable environment in Canada for the independent investment dealers. We are not arguing for subsidization, but we do want a more level playing field. If Canada does not provide the appropriate mechanisms to level the playing field, there will be increasingly fewer market participants, local and regional services will diminish and the pool of equity research independent of any bank's lending conflicts will deteriorate. Finally, the lack of participants will affect the cost and availability of capital and the viability of public markets, particularly for small cap companies that are the engine of Canada's employment growth.

The Bank of Canada and this committee should be even more concerned when one considers the impact of a bank merger on the debt markets. Today, the majority of the independent investment dealers do not actively participate in the debt-making markets. For the most part, they shop the debt inventories of the large Canadian banks at retail spreads, i.e., after mark-up. The six largest banks, and to a lesser extent the National Bank and HSBC, dominate this market area.

Most U.S. competitors have abandoned the Canadian domestic markets, given bank competition, the lack of profitability and the shrinking size of the Canadian debt market as federal governments and more provincial governments operate with budget surpluses. It is plausible that two merged banks could be so dominant as to completely squeeze out any other competitor, cornering the market and making profitability of this market area for competitors even more questionable.

The United States has become more concerned about tied selling/cross selling as a result of a number of recent debacles by Citibank and others. You may be aware that the United States removed many of the protective features of the Glass Steagall Act in 1999. The original purpose of Glass Steagall was to separate banking and investment banking activities due to perceived conflicts that occurred prior to the Depression of the 1930s. As a result of a series of recent, very significant breaches relating to conflicts of interest, the U.S. Senate and the House of Representatives are looking to put back in place many aspects of Glass Steagall. One would think that, if the United States with approximately 17,000 financial institutions is concerned about this, Canada, with a few hundred investment dealers and far fewer relatively dominant banks, should be even more concerned.

Capital market solutions: We recommend that Canada put back in place a connected issuer rule that has more meaning, and I will get into some more detail about that, but we suggest that independent investment dealers must be at least 20 per cent of an issue when the other parties are connected.

Canada should investigate additional protective mechanisms similar to those being considered by the United States. The Bank of Canada, the federal government and provincial governments have the ability to monitor and construct their debt syndicates to allow for a more competitive environment.

Credit providers: Unlike any other industry, the banks are not only competitors to the independent investment dealers, but also important providers of credit. Credit is facilitated directly as subordinated loans and lines of credit for margin purposes against securities. These lines of credit are utilized daily to underpin any retail or institutional trading activity. In addition, other more specialized lines are provided in the form of bank letters for underwritten bought deals or daylight overdrafts. These facilities are very specialized products outside of those normally provided to other industries. In essence, the banks provide liquidity from a capital perspective for our transaction-based business. Recently, the banks have lobbied vigorously to change the risk model for the Canadian Deposit for Securities. CDS is the central clearing agent and depository for all Canadian securities trading in Canada or between other clearing/ depositories, such as DTC in the United States. The net effect of these suggested changes is to radically increase the collateral requirements. We believe these changes have the potential to further eliminate independent investment dealers from the Canadian landscape.

Not all of the big six banks are active credit providers to the independent investment dealers. As of today, only two, RBC and the Bank of Montreal, will extend credit. If as a result of a bank merger one or both drop out of this business in Canada, it will have a dire result for the Canadian capital markets. The impacts would be most severe for small businesses, where independent investment dealers represent 70 to 80 per cent of this equity market area. As you may be aware, banks have not had a tremendous track record in support of Canadian small business. Any further failure or consolidation of existing independent investment dealers could result in significant negative impacts on Canada's GNP growth.

Credit provider solutions: Canada needs some type of guarantee that the banks will continue to provided credit to the independent investment dealer community at competitive rates. The Business Development Bank could be a stand- in as an alternate source of credit, and we could allow foreign banks or Canadian insurance companies to acquire large Canadian banks, as well.

Policy: We all agree the Canadian banks play a very important role in the Canadian economy. However, the banks are extremely well organized, with huge dollars and departments of individuals available to lobby for changes in their favour. Others less well capitalized or with fewer internal resources have a great deal of difficulty in either formulating their points or actually meeting and exchanging ideas with policy makers to counter-balance the bank's interest. The banks not only affect policy through the Canadian Bankers Association or via direct intervention, but the banks in our industry also dominate many other related organizations such as CDS, CIPF, the IDA and the TSX. The banks have been very effective at making other industry organizations' agendas their agenda. As a result of dominating these related organizations, the banks have achieved a steady stream of biased changes over relatively long periods of time. Good examples of this are the banks' lobbies to change the cash account rule, which materially reduced the free credit available to smaller investment dealers on stocks that had appreciated considerably, but which had not yet settled; the previously discussed CDS risk management rules being proposed by the banks; and the discounts negotiated by the banks with RS Inc. for block trades in excess of 30,000 shares.

Typically, the effect of any one rule change or modification lobbied for by the banks is, in itself, not significant, with the exception of the cash account rule and the current CDS discussions. However, what is far worse is the continuous plethora of changes that, when combined, are extremely detrimental to competitors and, ultimately, consumers.

Policy solutions: Policy makers, including the federal government, provincial governments, the Bank of Canada and the securities commissions must create appropriate forums with more open access and proffered resources to carefully solicit and hear other competitors' suggestions. The independent investment dealers have proven to be their own worst enemy in not creating a viable industry lobby. We as an industry group must create a vehicle outside of the IDA that does not represent the banks.

Conclusions: We believe that Canada cannot endlessly debate the merits of a limited number of bank mergers. We need to progress, evolve and allow our Canadian banks to secure, to the furthest extent possible, a substantial position in the world marketplace. They and Canada deserve it. In the same breath, however, we must ensure that Canada as a country does not surrender its interests to a limited group of shareholders at the expense of every Canadian. The banks need critical mass to compete externally, but we need indigenous competition internally to provide the maximum benefit to Canadian consumers. To achieve this requires some intervention by the federal government. This intervention should come by way of specific requirements, for example, divestitures, specific policy requirements, et cetera, and by way of continuous moral suasion, along with greater openness to other groups outside the banks.

To reiterate, we have concerns pertaining to the bank mergers in four specific areas. We have offered possible solutions in each of these areas as well as an increasing awareness of them. The considerations of this committee should extend beyond how a Canadian bank will serve a small community. They should also focus on how to better serve the community at large. Consideration should be given to the survival of the independent investment dealers, which provide a very important support and intermediary function in financing Canadian growth and risk taking. Others who are more knowledgeable or more sanguine than ourselves will come up with other solutions we have not thought of. However, our areas of concern, issues and suggestions are outlined on the table in our brief.

Mr. Chairman, I hope this is useful to you and the committee, and I am open for questions now.

Senator Angus: Welcome, Mr. Greenwood. Thank you for that presentation. Are you still active with the IDA?

Mr. Greenwood: Canaccord is a member of the IDA, yes.

Senator Angus: You mentioned that you are the sixth largest dealer on the TSX. I can think of RBC, BMO, Nesbitt, CIBC, Wood Gundy, Scotia McLeod, and who would be the other one?

Mr. Greenwood: That would National Bank.

Senator Angus: Then you folks?

Mr. Greenwood: That is right.

Senator Angus: How recent is this 20 per cent investment by Manulife?

Mr. Greenwood: That was closed around June of this year.

Senator Angus: Then you are on the same track.

Mr. Greenwood: Not necessarily on the same track.

Senator Angus: Last time we looked at this, I had the impression that the independents would welcome mergers because it would take one more player out of the game. I remember during the BMO and Royal discussions, there was great concern about what was going to happen to the people at Nesbitt. Where would all the people go? There would be a great source of talented investment banking people available to firms like yours. Would that not be the case again?

Mr. Greenwood: Yes, there may some available again.

Senator Angus: More business, also. More business for you.

Mr. Greenwood: Potentially more business.

Since the last time this surfaced, by the way, the TD Bank acquired Canada Trust, CIBC acquired Merrill Lynch Canada and Scotiabank acquired Schwab Canada. The consolidation has continued to take place at the bank level.

I think five investment dealers dropped out three years ago, seven last year and 17 firms have gotten out of the business this year.

Senator Angus: I share your concern. I was told that for a while, there were only two intermediate-size independent firms, your firm, Canaccord, and Yorkton. Then I see Yorkton getting into trouble, and that kind of scares off people. Who else is left? I suggest that with Manulife, you are getting out there. However, who would you say are the five main independents?

Mr. Greenwood: The main independents would be Desjardins, Raymond James, Rockwater, which has just bought the Yorkton assets, and Gundy. HSBC would be a little further behind.

Senator Angus: That leads me to this question. We have been trying to consider the public interest, what is and what is not in the public interest, and the whole question of divestiture is raised if there is a merger of two of the major banks. In your view, would it be in the public interest to require, for example, if Royal Bank was going to merge with CIBC, that they divest of RBC Securities?

Mr. Greenwood: The fact is there will too much concentration — yes, absolutely. There is too much concentration in the capital markets and wealth management areas today.

Senator Angus: Would it be in the public interest in this area, because I realize how difficult it is, too. You have firms like CS First Boston, Lehman Brothers and Goldmans starting to come up and get into your backyard, and the boys do not like it too much. I am wondering what your comments are?

Mr. Greenwood: Most of the larger investment dealers in the U.S. have actually abandoned their positions here in Canada and are servicing now from New York. They typically focus on the top 20 or 25 companies in Canada. They do not focus on the mid-market to small capitalization areas.

The real issue here in Canada is that it is the small independent investment dealers that typically finance the majority of the equity portion of the smaller capitalized companies. If there is not a viable nucleus of those companies left in Canada, we are going to have a much bigger problem.

Senator Angus: A viable nucleus of what kind of companies?

Mr. Greenwood: Of smaller investment dealers servicing companies, raising capital and independently researching those types of companies. We are going to have a much bigger problem here in Canada.

Now you have so much dominance. There is no other country in the world where that is the case, other than Holland — ING Bank was here the other day — there are two banks in all of Holland. However, although there are two large banks, it is in the geographic region of Europe, where there is a lot of other competition.

In Canada, we do not have that. We have way more concentration in a country that is the second largest in the world. We have regional disparities in this country as well.

More importantly, in the capital markets area, here in Canada we have the concentration not just in the banks, but also in a whole bunch of product lines. There are no trust companies left today, there are no investment dealers of any real size, other than one or two of us. The next thing is insurance. That is the issue.

Some of the discussions that I have read and was listening to today concern what is in the public interest? For example, when I read the Competition Act and the Bank Act, I see that certain aspects of the banks fall between the cracks and that has not been defined. That needs to be done.

We are for bank mergers as long as a definition is developed. The Competition Act today speaks to most companies. It does not speak to the influence, size and capacity of the banks. I will give you an example. The banks in Canada today spend about $3.6 billion annually on technology. Part of the benefit of the merger would be some rationalization on the technology side. Our firm spends maybe $15 million a year on technology, and that is probably the highest of any of the small investment dealers.

There are a lot of issues outside of simple concentration and a particular bank branch in a certain location in a city. There are specific issues that go beyond the Competition Act.

Senator Angus: It is very helpful to us to have you bring these to our attention. We are hearing a party line. I use the word ``party'' advisedly. It is the same. It is like a record.

You are saying there is a group of things that fall between the cracks?

Mr. Greenwood: Yes, I am.

Senator Angus: I would be interested in knowing what they are, sir.

Mr. Greenwood: Again, the banks are credit providers. It is not like they are running a small or large business. They provide credit to certain industries that are fundamental to Canada. That is partly what you have to define. This is the public interest. Is it important that a number of banks provide credit to independent investment dealers? If it is, it must be made available.

Senator Oliver: You said only two do now.

Mr. Greenwood: Because it is very specialized.

Senator Oliver: The Royal Bank and the Bank of Montreal.

Mr. Greenwood: BMO and the Royal Bank are the only two. It is a very specialized business. You have to understand risk management, risk practices and things like that. I assume there are other types of bank lines that are offered to other industries that are very specialized, such as agriculture.

If you have a bank merger and a consolidation, what happens to that public market area that has now been eliminated? If they decide to move out of the business on a global basis and it is not practical for them pursue small business within the business line of the banks, you have now not met the public interest policy issues.

Senator Angus: Correct. Are there a couple of other issues that you can think of that fall between the cracks?

Mr. Greenwood: Again, it is the concentration — we talked about it in terms of new issues. For example, looking today at the new issue market, there is a very high degree of correlation between the debt market, the debt lending and who participates in the equity financings. In the past, the independent investment dealers used to represent about 20 percent of a syndicate. Over the last couple of years, it has been whittled down to about 5 to 10 per cent. Recently, on all of the royalty trust issues, and other types of issues, the small independent investment dealers represented probably around three per cent of the total market. Typically, we cannot achieve more because the company says, ``Unless you are prepared to be a lender, you cannot have a higher equity participation in this financing.''

We may be number 1, 2 or 3 in terms of trading. We may have the only research report out on the company, and we may have the best view of that company, and yet we are not in the syndicate.

Senator Angus: You would be able to distribute easily to some of your retail customers?

Mr. Greenwood: Absolutely.

Senator Angus: You would be in favour of mergers. You would say they are in the public interest provided that certain issues are resolved. I am fascinated by your suggestion that we go back to Glass Steagall. It was only 10 years ago that we had a ``big bang'' in Canada and started getting away from the old rules. Now you are saying maybe that was a mistake.

Mr. Greenwood: We had our big bang in 1987. That is when the Canadian pillars of trust companies, investment dealers and the banks basically were deconstructed. The only part not deconstructed was insurance companies. I believe one of the mistakes that Canada made was in not allowing the insurance companies to partake and create some competition by acquiring investment dealers back then. It was a fundamental policy flaw. There were some connected issue or related issue rules that came out of that period — the independent investment dealers had to be equal to the total of the other connected issuers, being the banks, and the largest percentage the bank could have had to be equal to the largest percentage held by an independent. The purpose was to try to deal with these conflicts of interest.

This is the issue in the U.S. today, and back in the 1930s — how do you protect a bank that lends to a corporation that wants to pay down debt? They know there is risk problem attached to that company and they want to get off their debt position and put some equity into that company.

They are not sure whether that will work any more, because if they want to remove the debt they get a bad loan, or they think they may have a perceived problem loan, so they will go and raise equity in the equity market. All the Canadian consumers buy the equity interest in that underlying issuer and maybe there is a conflict there that is greater than necessary.

In the past, the independent investment dealer would research it, help set the price of that security, and determine whether or not it was reasonable to go to the marketplace at that time, so you had a check and a balance. Today you do not necessarily have that.

Senator Angus: Today everyone is talking about the lack of investor confidence. Some people attribute it to Enron, in particular, and others to a malaise in corporate governance practices that is bound to catch up to us sooner or later.

I am listening to you describe this concentration in your industry, where the little guy is not getting a kick at the can on the new issues, for example, and some of the gravy; the big institutional investors are taking it off the top and the poor investor just says, ``No way. I am going to get shafted no matter what I do.'' Is that not a large part of the decay of investor confidence?

Mr. Greenwood: I do not know if it is a large part. Recently in Canada we have actually, as a result of Bre-X, put in place some different practices. This was before the experiences in the U.S. Frankly, we had a better environment here in Canada. There are existing conflicts that will cause one big blow-up some day, where a bank has lent money to a company and then tried to de-leverage that company to the benefit of their own balance sheet. That conflict of interest is greater here today than it has ever been.

Senator Angus: That is very interesting.

Senator Meighen: I do not remember being quite so discouraged after listening to a very excellent presentation, because you have outlined it extremely well, Mr. Greenwood. The only thing you have not outlined, because perhaps none of us are wise enough to know the answer, is the solution. You have offered some solutions and I commend you for that.

Perhaps we made the mistake back when we allowed the banks to buy the dealers, although had we not there would have been other consequences. Institutions from elsewhere might have bought them.

Maybe the only other part of the financial industry where there is a large amount of capital is insurance companies, and you alluded to that. Perhaps there are things that can be done to encourage insurance companies to get into your business. I see that, as Senator Angus pointed out, and you mention in your brief, Manulife Financial owns 20 per cent of you now.

Mr. Greenwood: It is a very small minority investment in our firm. It is a portfolio investment from their perspective.

Senator Mahovlich: Where is Clarica now?

Senator Angus: Manulife.

Mr. Greenwood: No, Sun Life.

Part of what I think you are trying to grapple with here is, snapshot one, the issue of whether the banks getting together is in the public interest. The real issue is if we do not allow a bank merger, it will hurt public policy. We probably have to have some larger banks that ultimately represent and understand Canada in the global marketplace. As businesses get larger and more successful, they are looking for credit for offshore purposes, letters of credit, large project financing and that sort of thing. Banks need to be bigger to be able to withstand that.

Canadian banks are getting smaller and smaller. The whole world is consolidating. From a public interest perspective, Canada will probably damage itself if it does not allow a bank merger. Notwithstanding all of that, we must take into account protecting our own internal marketplace, which is really what we are saying.

Senator Meighen: I do not hear a great deal of argument around this table with both your propositions. Generally speaking, bank mergers are in the public interest for the reasons you outlined. However, we are not insensitive to the questions you raised on the other side of the coin. The argument has been made that when two come together, there is a shake-up involved. There is an opportunity for other players to get into a market. Perhaps we could handle that better, require more divestitures and try to build up the second tier of financial institutions in Canada.

I for one, and probably you in your heart of hearts, do not like quotas, but that is what you are advocating almost, a 20 per cent quota of new issues for the independents. I can see the merit in that. However, the next thing we know, it will be suggested that it should go up to 35 per cent, and that is an artificiality, it seems to me.

How would you respond to that?

Mr. Greenwood: There is no question it is an artificiality, but again, you are going to end up with banks with multi- billion-dollar balance sheets and being able to use them. I do not care if Canaccord gets the 20 per cent; it is the whole industry that has to get the 20 per cent. It is an artificiality, but it recognizes the concentration and the mass of those entities. They will be so huge in the context of the Canadian marketplace, show me what other country will have that type of relative concentration.

Senator Meighen: Perhaps the counterpoint should be that if you want to merge and grow elsewhere, you have to give up a significant amount of your home base.

Mr. Greenwood: I suspect they will have to give up something like 15 per cent market share. That has to take place. The issue today is that there are only two other foreign banks of any real size, the ING Bank and HSBC. Sure, they would love to buy those bank branches. We are not in the banking industry because the barriers to entry are quite significant.

We now can become members of the Canadian Payments Association, but how come there is no other independent investment dealer in Canada who is? It is too expensive to set up the technology and the infrastructure. We may have the right of access, but actually gaining access is difficult. Perhaps it is not profitable for us right now. There is so little profit opportunity in that line today that it is not a way of developing your business.

Senator Meighen: Could expenses not be shared in some way?

Mr. Greenwood: We have looked at it from an industry perspective, but do I not see it, no.

Senator Meighen: In your solutions to concentration, et cetera, and capital markets, you referred to the Glass Steagall Act, and similar solutions for Canada. Do you have any that you could mention to us?

Mr. Greenwood: I cannot come with up with specifics outside of our industry. I am focusing on the investment dealer side. I have some views on the banks, but I cannot come up with other solutions off the top of my head, no.

Senator Meighen: If you do, and if the spirit moves you, let us know in writing, because as I say, many people share your analysis of what is right for Canada. We have to have bigger financial institutions. At the same time, we cannot have an absence of domestic players, and it is certainly going that way. Without getting too artificial, I think everyone would be interested in finding ways and means of allowing for more entrants into the domestic scene.

Mr. Greenwood: It is important particularly for the financing of small businesses in Canada that small investment dealers maintain a viable business. Every day, our firm and others must incur a regulatory nightmare, whereas the banks can absorb those costs because of their size. They have a bigger percentage share of the individual business.

They receive fees on mortgages and on lines of credit. They have credit cards at 18 per cent and then the wealth management fees. If you add that all up, it is a big wallet share. We can provide a comparable service to only one slice of the wallet. That is the case for all the independent investment dealers.

Senator Tkachuk: You mention credit providers, which interests me. On page 5 you state that not all of the big six banks are active credit providers. You say that two of them, RBC and the Bank of Montreal, will extend credit.

When you were answering Senator Meighen's questions you talked about the 15 per cent and how we cannot have so few dominant players. I notice you make no mention of any foreign banks here. You do not mention HSBC or ING. Are foreign banks not a solution?

Mr. Greenwood: They are not.

Senator Tkachuk: Who would take that 15 per cent?

Mr. Greenwood: That is not a solution. Today, there are two banks that understand the risk assessment and the very specific types of business that we utilize. It is a very specialized service.

Our bank is the Bank of Montreal, and we get phenomenal service from them. They do a great job for us, but the knowledge base is very limited. Perhaps they might be able to expand that knowledge base and provide that service to participants outside Canada. With a limited number of investment dealers, and the likely possibility of further consolidation in the next couple of years, those lines of business may be less profitable for them. Thus, they may close them down, which would not be in the interests of Canada.

Senator Tkachuk: You have raised a really important issue for your industry, but you also mention something to which I have given a lot of thought, that is, the agricultural industry. In the Prairies, we have two suppliers of service, the credit union and the Royal Bank of Canada. They are the experts in agri-business. In a merger situation, if one of the other players does not want to be involved in agriculture, what would happen to all those customers? The providers can withdraw from that business. I know it is a profitable business and someone will be in it. However, when there is only one service provider, it is a pretty scary proposition.

Mr. Greenwood: Also, the credit unions do not have the same credit quality. Therefore, they cannot entertain certain lines of business because they lack the necessary balance sheet. That is an issue. Those are the kinds of things about which these banks should be giving undertakings. If they want to be able to do these mergers, capture all these benefits and compete internationally, then the costs have to be set out. I think that is what they want to know. They want to know what commitments they have to make to be allowed to make the decision to merge.

The Chairman: Thank you for being with us, Mr. Greenwood.

Honourable senators, I am pleased to welcome, from Concordia University, Mr. James McIntosh, Professor of Economics.

Mr. James McIntosh, Professor of Economics, Economics Department, Concordia University: Mr. Chairman, first, I want to thank the committee for giving me the opportunity to express my views on bank mergers. Honourable senators have my written brief. They also have a copy of a paper I wrote recently and which appeared in the Canadian Journal of Economics. I will be brief in summarizing my findings and why I believe mergers are in the public interest.

I want to talk about what is, perhaps, the most important issue here, that is, scale efficiency in Canadian banks. There are three salient points here. I want to try to convince you that there are increasing returns to scale in the chartered banking sector and, because of that, there are a number of extremely important consequences that follow.

First, the research I did that appeared in the Canadian Journal of Economics supports this type of result. I also developed some methodology on Canadian trust companies, which was published in a paper in 1997. The procedure there also revealed that there were increasing returns to scale to Canadian chartered banks.

Second, not much research has been done on Canadian chartered banks, for reasons that I will be happy to go into if you want me to, but which, at the moment, are not necessary to explain.

There is one other academic type paper by three economists from McMaster who also found that there were increasing returns to scale to Canadian chartered banks.

Since I did this work, a number of papers have appeared. The most recent one on large American banks, by Hughes, Moon and Mester, also found that there were increasing returns to scale to large U.S. banks. Large U.S. banks are the only banks that would be considered reasonable in terms of comparison with Canadian banks.

Fourth, there is a company called Symcor Incorporated, which is a venture started by TD Bank, BMO and the Royal Bank. It processes back-office operations for those chartered banks. Last week, there was an item in the newspaper that indicated that Scotiabank was going to participate in this. That is a clear piece of evidence that supports scale efficiency, because it says that the banks find that the best way to deal with their back-office operations is to outsource them to one individual agency that can do it all for all the them. That is, in my view, a clear indication that does not require any academic input. It just strikes me as being a fact.

The consequences of increasing returns to scale, and I should say there are probably some people here who are not economists or who do not know economics, but the implications of increasing returns to scale mean that as a company expands and produces more output, it does so at a lower unit cost. It means that bigger is cheaper in terms of production.

In the case of the chartered banking situation, it means that there will be efficiency gains if we allow mergers, provided the mergers work out well. Whether the mergers work out well is unrelated to the question of scale if there are increasing returns to scale. Of course, if there are not increasing returns to scale, there might not be too many efficiency gains, or even gains to the individual banks. They become more profitable simply because they are taking more away from the consumers, which is what happens when there are decreasing returns of scale.

When there are increasing returns of scale, we have the possibility that consolidation in the banking industry can lead to lower prices for consumers. That is what I found in the paper I just mentioned to you. I found, looking at the Royal/BMO merger, the TD/Commerce merger and at both of them together, that all three scenarios would lead to a price for banking services that was below the pre-merger price. That is a very controversial result, at least here in Canada, and especially in terms of how the Competition Bureau views it.

Another consequence is that encouraging more players into the market will not necessarily be a good idea in terms of increasing consumer welfare.

As I said, my results are different from the Competition Bureau's views as the way bank technology is described. In its letter to the bank presidents on December 11, 1998, where it failed to support the mergers, the bureau basically suggested that there were not going to be any efficiency gains at all, and, because of a reduction in the number of players in certain markets, it would be bad for the consumer because it would cause price increases. That runs exactly counter to my results. I do not believe that bank mergers will lead to higher prices. I have a major difference of opinion with the Competition Bureau on what the effects of mergers will be.

I spent some time in my brief trying to explain why I come up with a different result from the Competition Bureau, and part of it is that the Competition Bureau based its opinion of the technology characterizing Canadian banks on what they saw in the United States. I heard in the testimony on Monday from a member of the Competition Bureau that the bureau invited an American expert to give his views. I think it was probably David Humphrey, but I may be wrong on that. He is a distinguished economist and knowledgeable about U.S. banks. However, the problem is that U.S. banks do not tell us very much about what will happen here in Canada.

Much of the research in the area of bank mergers and scale efficiencies in U.S. banks has a lot of problems. I have quoted in my brief a number of articles that highlight the difficulties we have in evaluating the research based on American banks. The most telling is a quote by Allen Berger and Loretta Mester. In 1997, they came to the conclusion that there are not enough large banks in the United States to make any inferences as to whether or not there are scale economies in the U.S. banking system for large banks. That is probably reasonable.

The answer is we do not really know what is happening in the U.S. banks, and we probably should not be too interested.

The Australians considered bank mergers in 1997. They had a comprehensive review of the situation. Ian Harper, a staff economist at the financial services inquiry, came to the conclusion that, from Australia's point of view, American studies on bank mergers and scale efficiency are not informative. The reason is the Australians have a branch banking system, as we do, and the American banking system is not like that. Therefore, there is not a great deal of relevance in the American experience in trying to indicate what we should do.

I spent some time in my brief discussing what the future holds for Canadian banks. Of course, that depends on the situation. If we have mergers, it is possible that Canadian banks would certainly gain, one of the reasons being that branch duplication is a serious problem. That would be solved to a certain extent if we were to allow one or two, or possibly more, mergers. That would relieve that problem. It would also allow the banks to bulk up. Bigger banks seem to be able to take on more risk. They seem to be able to expand in foreign markets.

I read the testimony that Mr. Hunkin gave here on Monday. Those of us who have financial interests in banks knew about CIBC's difficulties with the Amicus banking system in the United States some time ago, but he said they had to withdraw because they were not big enough to deal with the risks involved. I believe that is a real problem. I think that bulking up in Canada as a strategy first, and then getting bigger in the United States and in Europe is an important and reasonable strategy to follow.

Banks and financial services are an area in which Canadians could specialize. We could be an exporter of banking services rather than an importer. It is an area of specialization, and as forward-looking policy makers and economists, we want to have policies in place that encourage our best corporations to become big, better and profitable, and to be job centres and profit centres for Canadians. The banks can play that role with respect to financial services.

Certainly, my study of insurance companies also indicated that there were increasing returns to scale in the insurance business, and that business has done quite well. The large insurance companies, such as Canada Life, Manulife Financial and Sun Life, all do more than 50 per cent of their business outside Canada. They are exporters of financial services and the jobs associated with head offices that have high pay, high prestige and high quality stay in Canada.

That seems to me to be a sensible way to proceed. We want to have policies that not only consider the consumer and special interests, but we want to take a long-run perspective on this and have sectors in the economy that can be leaders in the next 20 or 25 years.

That briefly describes my written summary, and I am happy to entertain any questions.

Senator Oliver: Welcome, Professor McIntosh. I read your paper called ``Canadian Bank Mergers and the Public Interest'' over the weekend with great interest. In your testimony today, you referred to some of your criticism of the tests used by the Competition Bureau. I was the senator who put questions to them based on your criticism in the paper.

You did say that in doing their analysis of Royal Bank and BMO, they used information on small American banks that did not really apply to Canada. I told them about your criticism and the conclusions you reached, and I asked them if they were going to change their modelling or tests in the event that new merger applications came before them. They said, ``No, we are going to stick with what we have.'' Can you foresee any better results if they used the same kind of data and literature based upon examples of small American banks, given the size of Canadian banks today?

Mr. McIntosh: If they insist on drawing the same conclusions about American banks as they did before, they will come up with the same results.

It is interesting to read the letter that they sent to the bank presidents. They said, ``First of all, the onus is on you to provide evidence that there are efficiency gains.'' Then they said, ``Anyway, we do not believe there are efficiency gains, even if you did want to do that. Even if you could provide efficiency gains, you are not going to know what they are until Paul Martin tells you what conditions we are going to impose on you, so basically there is no consideration at all of efficiency gains.'' Then Paul Martin said, ``Sorry, since you did not provide any evidence on efficiency gains, we are going to turn down the mergers.'' That strikes me as being a very good application of the Catch-22 principle.

Senator Oliver: Later on in your paper, after you said they based their literature and their modelling on the wrong sample, that is, small American banks, you went on to say that one of the things that the Canadian Competition Bureau should have been looking at was samples from large Japanese banks. We all know what has been happening to some of the large Japanese banks. I was wondering if you could explain why you would choose them rather than small proximate American banks.

Mr. McIntosh: The American banks that appear in a very large number of papers are much smaller than Canadian banks, but they also do not have branch-banking service. They are not coast-to-coast banks like ours. The Japanese banks are certainly much bigger. Their size is a good reason for wanting to use them.

I am not saying that we should exclusively look at Japanese banks. In the submission, I also mentioned that people had found increasing returns to scale for Norwegian and German banks, and also the most recent study had indicated that for large American banks, there were increasing returns to scale. There are certainly differences between Japanese banks and Canadian banks, but what I am looking at here is a hypothetical situation. If we have increasing returns to scale, there is certainly the possibility of efficiency gains. Now, if banks acquire add bad loans, if their practices are bad, just because the technology exhibits increasing returns to scale does not mean they will be free from financial problems.

Let me give you an example. Confederation Life was in my sample of insurance companies. It went broke. I believe Confederation Life had a technology that was characterized by increasing returns to scale. I also know that Confederation Life had a very bad loan portfolio. No amount of good or bad loan portfolios will allow you to be profitable. The questions are really quite different.

The question is, do we have an option here to allow banks to provide lower-cost services. You have to ask yourself, are bank mergers going to be successful, and successful from the point of view of Bank A and bank B being able to put together a merger, accept each other's corporate structure and do things efficiently. My guess is that that would be the case.

Senator Oliver: You made a very interesting comment in terms of the public interest, in relation to individual Canadian shareholders and their assets, by making the strong suggestion that there will be efficiency gains. Therefore, if individual Canadians do have shares in banks, it would be in their interest to allow mergers because these efficiency gains will probably mean enhanced returns on their investments. Other witnesses who appeared before us have not made this argument, and I would like you to expand upon it, because it is fairly unique.

Mr. McIntosh: First of all, what I am saying is conventional economic theory, if you have read any book on mergers. How do you evaluate mergers? You look at the cost to consumers, a loss in consumer service because of a decline in competition, and if this causes price rises. You look at producer circles. ``Producer circles'' is bank profits, in this particular case. Everyone in this room, I suspect, benefits from a healthy banking sector in the following ways. You either own bank shares directly or through mutual funds or pension funds. I know that my pension fund at Concordia has a good chunk of its money tied up in bank shares. If the banks do well, my pension fund does well. If the banks do badly, it will not do so well. To say that we do not want the banks making high profits, and a lot of people say that, is speaking against our own interests. They do not realize that their mutual funds and their pension funds would do much better if their bank shares did better. That was the point.

Senator Oliver: By way of merger.

Mr. McIntosh: Yes. This has nothing to do with me; this is conventional economic theory speaking.

Senator Oliver: However, it is one of the arguments you made in favour of bank mergers in your paper.

Mr. McIntosh: Yes, of course.

Senator Oliver: I thought it was well done. Thank you.

Senator Kroft: Did you make a comment in the course of your remarks about the wisdom or otherwise of encouraging other players into the competitive market as part of the merger process?

Mr. McIntosh: Yes.

Senator Kroft: Could you just repeat the point you made there?

Mr. McIntosh: We have an imperfectly competitive market here. We are talking about players who have major market shares. The question is, what happens when another small player comes into the market. If that is a high-cost player, it will still be able to participate, but it takes some business away from the low-cost player, and everybody has a little less and costs rise just a little. A new entrant actually raises the cost of the goods being sold in the market. Now, that may seem odd to you, but that again is just conventional oligopoly theory.

Senator Kroft: You are assuming that the new entrant is a high-cost player.

Mr. McIntosh: Yes.

Senator Kroft: What if the new entrant is a player with scale, such as HSBC or ING. ING, as they told us clearly, are not real, but what if they decided to become real in bricks and mortar terms, as HSBC certainly are. Presumably, HSBC brings more scale than any of the Canadian banks. What is the assumption there?

Mr. McIntosh: When you are talking about ING, you are talking about mono-line.

Senator Kroft: They are mono-line in terms of the market strategy they have chosen for the moment in Canada, but they followed many other strategies elsewhere, and presumably they could here. Let us say HSBC, to keep it simple.

Mr. McIntosh: They have a small number of branches. My guess is that HSBC is probably a higher-cost provider than the Royal Bank of Canada. The reason is that the Royal Bank has a much larger number of branches, a much larger number of customers to amortize its capital cost, and the standard kind of arguments of scale efficiency.

Senator Kroft: It comes down to the larger the market share you have, the greater the benefits of scale.

Mr. McIntosh: One of the theorems in this area is that the player with the largest market share has the lowest marginal cost. That is a property of the model.

Senator Kroft: Would that then encourage sequential mergers? Is there in economic theory a limit to the idea that if there is one guy left, he makes a fortune and everybody gets cheap banking?

Mr. McIntosh: I carried out a number of simulations that I did not report in the paper. I started off with a large number of banks and asked what happens, given the scale of economies that we have. We go from nine banks to eight; from eight to seven; from seven to six, and so on. Then I looked at the cut-off point. Where is the cut-off point when the price starts to rise? That is around three. If we have four large chartered banks, there will not be any cost to the consumer. If we go from four to three, we get into the area where the price might increase, where the competition questions might outweigh the efficiency gains.

The banks are there to make money. They will charge the price that is most advantageous to them. Banks are not altruistic. They are charging the oligopoly price, which is the best price they can get.

Senator Kroft: At a certain dominance level, they would begin to raise their prices enough to increase their market?

Mr. McIntosh: We do not want just two chartered banks in Canada. We have to have more than that.

Senator Kroft: That was what I wanted to get clear.

Senator Meighen: You asked the question that I was interested in. Professor McIntosh, is that a number that you are satisfied with today and going forward for the foreseeable future? How long can we say four would be the minimum? Does it depend on external circumstances?

Mr. McIntosh: Technology is changing. One of the characteristics of the last 10 years is the growth of Internet banking and ATM machines. They have made branches less profitable. On Monday, Senator Kolber quoted my telephone conversation with him about the future of the banking system. I am not very optimistic. If bank mergers do not occur, we will have serious problems in five years. However, the five-year time horizon is a very long time under the present circumstances, when technical change is operating so rapidly.

It is possible that with the evolution of new technology, we might be able to get along with three banks, provided other checks and balances are put into place and more players come in offering mono-lines. I would like to see the Royal Bank of Canada going into Holland and offering virtual banking in exactly the same way that ING offers mono-line banking here. Why do they not do that? Probably they are not yet big enough to take on that risk. It would be a possibility if the Royal Bank were bigger.

Senator Meighen: Can we conclude then that Professor McIntosh's view is that it is in the public interest for bank mergers to be approved, down to no less than four or three banks?

Mr. McIntosh: Yes.

Senator Meighen: When you mention ``other players,'' do you include non-mono-line players such as credit unions, regional banks, insurance companies and the like?

Mr. McIntosh: My model was called an ``oligopolistic model with a competitive fringe.''

Senator Meighen: That is a good, snappy title.

Mr. McIntosh: The ``competitive fringe'' contains things like other players and banks, and also credit unions and other providers. They do not have an effect on the price. They sell to a group of consumers based on the prices set by the major players in the market. These people are taken account of, but I cannot say very much about the fringe because I did not spend a lot of time looking at that area.

Senator Meighen: In your view, they do not really have a fundamental impact on the thesis you are advancing?

Mr. McIntosh: The price is determined by the big six or the big five. Credit unions react to that price. They may charge different prices, offer different services and have a special clientele. Why do we not have more competition to the banks? Why do credit unions not spread? Why do they not catch on and have more customers? There must be a reason for that. I suspect they have a hard time competing with the banks. Everybody has a hard time competing with the banks.

Senator Meighen: You would have seen other jurisdictions, such as Holland and Switzerland, where there is a very active — I do not know how competitive it is — second tier and third tier: the post office, deposit-taking facilities and the like. Do you have any theories as to why we do not have those in Canada?

Mr. McIntosh: I cannot explain why you might have a very strong second tier in one country and not here, except that people have suggested that the post office gets a little help from the government, which is advantageous in that circumstance.

Senator Meighen: Our convenience stores get a little help from the post office in this country.

Mr. McIntosh: Yes.

The Chairman: I know we had this telephone conversation and I did mention it to the committee, but for the record, if you could wave a magic wand and there were no mergers, what do you think would happen in the next five to ten years?

Mr. McIntosh: The prognosis is not good. I think CIBC is having difficulty cracking the American market. There are many big players out there now. I think the Wal-Mart of financial services has already arrived. That is Citigroup. That is a model that will be followed by others.

There are a huge number of mergers in the United States, but also big players are playing with other big players and forming mergers. If Canadian banks cannot get big at home, they will have a hard time getting big in the United States. As preparation for coming here, I read Les Whittington's book The Banks, in which there is a long interview with John Cleghorn. John Cleghorn said he had difficulty trying to find the proper U.S. partner because they were too expensive. That is another way of saying the Royal Bank is too small to acquire U.S. partners. I am not optimistic.

Let me conclude by saying that we have fundamental problems in Canada. The problem is that we are Canadian. We have a small market and we have increasing returns to scale. That means you cannot have a large number of profitable players. We have a difficulty here. There are many things we would like to have, but they are not feasible.

The good news is that the Canadian financial sector probably has a reasonable prognosis, whereas the airlines sector is a total disaster. I do not see any solution there. However, there are solutions to the Canadian financial services sector.

Senator Tkachuk: I would like to end with an explanation. You talk about the Japanese banks. I am sure I could ask Senator Oliver, who read the paper and might understand it, but I thought I would get it from the author. You say that the first reason we should be looking at Japanese banks is because they ``employ the composite cost function which nests the separable quadratic translog, and generalized translog functional forms as special cases.''

Of course. Could you help me out? I think I understood your second reason. I got lost on the first one. What does that mean?

Mr. McIntosh: It means they used more general methods than were used in the study of American banks.

The Chairman: Thank you for attending.

The committee continued in camera.