Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 11 - Evidence - Morning Session
OTTAWA, Thursday, October 3, 1996
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:00 a.m., to examine the state of the financial system in Canada (review of financial sector legislation).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Honourable senators, our witnesses this morning from GE Capital are Michael Davies, Vice-President and General Counsel, and Bob Weese, Vice-President, Government Affairs .
Welcome.
Mr. Michael Davies, Vice-President and General Counsel, General Electric Capital Canada Inc.: As you will have noticed, we have quite a large entourage this morning. That is because GE Capital is involved in 14 or 15 totally different financial services businesses in Canada and we thought it best to bring people who have knowledge in each of those businesses in order to be able to answer any questions that might arise.
The Chairman: Before we start, are your various companies, such as your equipment financing line and your retail financial services, actually separate companies?
Mr. Davies: Some are and some are not. In the case of equipment finance, yes, it is a separate company. In the case of retailer, it carries on business under GE Capital Canada Inc., which houses five or six different capital businesses. Some have their own corporate entity. There are approximately 12 different corporate entities. However, they are all wholly-owned subsidiaries of GE Capital.
The Chairman: So when I hear of GE Capital doing something, it may be the parent company or it may be one of the subsidiaries.
Mr. Davies: Yes, all 100 per cent owned; all under the same umbrella.
Senator Angus: Are they all in financial services or are you in other businesses as well?
Mr. Davies: They are all in financial services, senator, as we describe financial services. Computer sales and leasing is one of our businesses, called Technology Services. We consider that a financial services business; part of the GE Capital operations. However, only a few of our businesses in Canada overlap with what banks do, although we treat them in the wide sense as financial services businesses.
Mr. Bob Weese, Vice-President, Government Affairs: If I might just add a supplementary comment, General Electric does have other businesses in Canada that are not financial services businesses and not part of GE Capital.
Senator Angus: I understood that you at one time owned a courier or overnight express business, such as Purolator. That is why I asked that question.
Mr. Davies: Yes, we did own that for a while, then it was sold. That was just one of our regular businesses.
On behalf of GE Capital Canada, and our parent company, GE Capital, we welcome this opportunity to present our views on the white paper.
First, a little more background on GE Capital might be helpful. It is owned 100 per cent by General Electric Company and now accounts for slightly in excess of one-third of the worldwide revenues of General Electric. I am talking about the worldwide business. GE Capital, our parent company, is headquartered in Stamford, Connecticut. It is a diversified financial services company with approximately 25 businesses, approximately $200 billion in assets and a triple-A credit rating.
GE Capital, through its Canadian affiliates, has been in Canada since 1937 and at the current moment has approximately $5 billion in net earning assets through various Canadian businesses and over 2,000 employees in Canada. Our headquarters are in Mississauga, Ontario, although we have offices across the country. We are involved in over a dozen different financial services business. These include equipment leasing and financing, auto leasing, rail car leasing, retail sales financing, industrial project funding and commercial real estate financing, among others.
How does what we do relate to what banks do in Canada? Actually, there is a relatively minimal degree of overlap between the Canadian businesses of GE Capital and what Canadian banks do. Some services offered by GE Capital, for example, particularly our equipment financing business, overlap with the businesses that Canadian banks carry on, but usually our services tend to be complementary rather than directly competitive with the banks. We usually serve different customer needs.
We tend to lend on the basis of debt-to-operating-cash-flow ratios rather than debt-to-equity ratios. Therefore, we often provide funding in situations outside a bank's comfort zone.
We have a very detailed knowledge worldwide of the equipment we are financing. Therefore, we are quite prepared and able to offer higher financing ratios.
We have a global reach in the remarketing of our equipment because we are located around the world. This often enables us to offer financing to small and medium businesses where financing might not otherwise be available.
We have also followed counter-cyclical investment strategies. When the banks are getting out of a particular area, such as commercial real estate, we then step into that particular area and fill a gap.
Finally, we are also a full-service provider of bundled services and value-added services to Canadian business. In addition to financing, we also offer equipment maintenance, management reporting in our fleet leasing where we manage the entire fleet for numerous major industries, discount purchasing and then remarketing of the equipment at the end of the term of the lease. It is a full-service type of operation.
Is GE Capital a bank? No, it is not. It is not a bank in the United States or anywhere else, and it does not take deposits. It does, however, fall within the very broad definition in the Bank Act of what constitutes a foreign bank because the nature of the services it carries on in the United States overlap with some of the services a bank can carry on. As a result, on several occasions we have had to obtain cabinet consent under section 521 of the Bank Act either to acquire a business in Canada or to reorganize one of our financial businesses here. Two years ago, we were obliged, as a condition of obtaining one of those consents, to sign an undertaking with OSFI which restricted our activities in certain ways and, in particular, prohibited us from engaging in retail funding.
That brings us to the white paper itself. The proposal in the white paper which is of particular interest to us is that which relates to near banks. A near bank is defined in the white paper is a foreign entity that does not take deposits, is not regulated as a bank in its own jurisdiction, but provides one or more type of banking services. That is what GE Capital is; that is what GMAC or Chrysler Credit is. Our parent companies are not banks, and we do not take deposits, nor does our parent. However, we do overlap and provide one or more banking services.
Since the inception of the Bank Act review about a year ago, it has been our public position that companies such as GE Capital, which do not take deposits, should be totally free from the provisions of the Bank Act and from any regulation or oversight under the Bank Act. This is for a number of reasons.
As I mentioned, GE Capital is not a bank. We are not regulated in the United States or elsewhere as a bank. We do not take retail deposits, nor do any of the Canadian subsidiaries. We do not participate in the payment system, and we do not expose the system to losses under CDIC insurance. Therefore, there are really no deposit or protection issues.
In our view, regulatory oversight in these circumstances imposes needless administrative costs, delays and uncertainties for both the government and the company and serves no apparent public policy purpose.
Cabinet approvals under the Bank Act are currently required for inter-company reorganizations. If we want to transfer financial service assets from Company A to Company B in Canada, both of which we own 100 per cent, we have to go through the OSFI approval process and up to cabinet for approval.
Similarly, if we obtained approval to acquire the assets of a particular company and then a couple of years later wanted to expand that business within the same type of business, the Bank Act, as worded, would trigger the obligation to seek approval and go through this cumbersome process of going up to cabinet to do so.
Another reason that we believe we should be totally free from regulation is that our major competitors in Canada are not banks but other asset-based lenders. Canadian-based and Canadian-owned companies such as Newcourt Credit Group are our principal competitors. They are not subject to any bank oversight in Canada. When they go to the United States, they are not subject to any oversight as a bank, but they are subject to exactly the same regulations as is GE Capital.
In our view, the notion of national treatment under NAFTA and the WTO suggests that foreign banks such as GE Capital should be entitled to treatment similar to that received by the domestic asset-based lenders with which we compete.
Finally, the white paper proposal as put forward, insofar as it applies to near banks, will result in all foreign near banks being treated in the same manner. At the moment, only those foreign near banks which have had to apply under the Bank Act for approval have had to sign this undertaking and restrict their activities in Canada. Those which have not made an acquisition have remained unregulated and have not had to sign an undertaking. The white paper proposes to treat all near banks the same. In our view that will eliminate this discrepancy.
We agree and strongly support the white paper proposal in principle that near banks should be freer from regulation in Canada. How is this greater freedom proposed to be accomplished?
The white paper contemplates that once a foreign near bank has received approval under the Bank Act to enter into Canada -- which approval we received many years ago -- it would be free from future regulation provided that its activities remain outside of retail funding.
It just so happens that GE Capital Canada has gone to market now for several years with instruments in excess of $100,000. That was the proposed definition by OSFI for retail funding. That proposal relating to the prohibition against retail funding did not create any problem for us personally. However, we appreciate that it created serious concerns and problems for many others who were borrowing money in the commercial paper market and mid-term market in amounts of $5,000, $10,000. I believe the investment dealers may have appeared before this committee expressing the same concerns about this definition of retail funding.
We understand that discussions are currently taking place with OSFI and the Department of Finance regarding these concerns and that OSFI intends to devise a revised proposal for differentiating between a near bank and a bank. We anticipate having the opportunity to provide comment on those proposals as they are brought forward.
We also appreciate that concerns have been expressed to this committee by other companies, which are in fact foreign banks, as to the impact of the white paper on them. The white paper, in its proposals, distinguishes between two categories. The first is a near bank, such as GE Capital, Chrysler Credit and GMAC, whose parents are not foreign banks and who are not involved in doing real banking activity. We are one of them and we are the furthest removed from being a bank.
There is, then, the second entity that is a foreign bank in its home jurisdiction, for example, Capital One Financial Corporation, TransCanada Credit, et cetera. The issue for them under the white paper proposal is whether or not they should automatically, as the proposal puts forward, be a bank and have to become a bank in Canada. They argue that the real policy issue is whether they carry on a real banking business in Canada, not what they are at home. But that issue is a totally different consideration from the ones that near banks have. We are not a bank at home or here, and that is the near bank policy that we support.
In conclusion, GE Capital is involved in a variety of financial services. None of them attract regulation under the Bank Act when they are conducted by similar domestic companies. We are not in the banking business. Our major competitors in Canada are not banks. As well, the notion of national treatment suggests that we should be subject to no more regulation than similar domestic near banks in Canada.
Although we are of the view that there should be no regulation or conditions whatsoever relating to near banks carrying on business in Canada, subject to resolution of this retail funding issue and on the understanding, which 0SFI has confirmed, that existing undertakings will be terminated, we support the principles of the white paper relative to near banks. Those on foreign banks are a different matter, and we are not impacted by that.
Subject to resolution of these matters, we support the proposal which would free near banks from regulation in Canada.
Mr. Chairman, we would invite any questions.
Senator Angus: I should like to welcome you, Mr. Davies, and your colleagues.
You have been following our deliberations and the issues arising from the white paper. If I fully understand your conclusion, you are quite comfortable with the white paper as it is drafted, subject to the resolution on retail funding.
Mr. Davies: As it applies to us, yes.
Senator Angus: But even that resolution is of marginal concern to you because you are not in the market at those lower levels. Am I correct on that?
Mr. Davies: Yes, although we do understand that, as a result of the retail funding definition creating such serious problems for others in the marketplace, we need to wait to see what is brought forward as an alternative. We anticipate that we would be comfortable with what is brought forward, but we must wait to see that definition.
Senator Angus: Do I understand that, basically, the 12-plus businesses that you carry out in Canada in the financial services industry are all unregulated and that the only regulation to which you have been subjected is at the entry level, where you have had to give an undertaking or get the Order in Council?
Mr. Davies: Yes. It is really a gatekeeper type of control. If you want to enter a business or make an acquisition, you must go through this process, which can be quite lengthy and cumbersome.
Senator Angus: I understood you to say that even that is unnecessary.
Mr. Davies: The white paper confirms that that is necessary, as long as you meet these two requirements.
Senator Angus: As a FNB, or a foreign near bank as defined in the white paper and in some of the other documentation, by definition you are not a foreign bank. Yet, witness after witness has told us that they are being categorized as a foreign bank under the said definitions, even though the things they do involve even less bank services or bank-related services than the ones you provide. That occurs strictly because of their so-called parentage. In other words, somewhere down the chain of ownership to their U.S. parents, there is someone who, in some remote fashion, according to our government, walks, smells or looks like a bank. They then become subject to all kinds of regulation, and not on a level playing field with you.
Mr. Davies: We appreciate their concern, and we do not disagree with the positions they are putting forward. We are not on the opposite side. We are saying that we are not a bank in the United States. Therefore, the policy issue which seems to be before yourselves and the government at the moment is whether, if you are considered to be a bank in your home jurisdiction, you should be considered a bank in Canada for all purposes, or whether, regardless of what you are in your home country, you should address the services being offered in Canada as the basis of regulation. On either test we meet the criteria because we are not a bank and the services we offer in Canada are not core banking. They are the same type of services that unregulated Canadian companies offer.
The issue is whether foreign banks that should be regulated automatically as banks or whether the current policy should continue, namely, that if your parent is a "foreign bank," there is a review on an ad hoc, case-by-case basis, as has been done in the past. Capital One went through this process as a foreign bank and obtained approval. That is a policy issue that must be determined, but it is not one which impacts directly on our case. Our parent company is not a foreign bank.
Senator Angus: I also understood you to say that you are sympathetic to the position of your competitors who are falling into that anomalous definition, and you are not here to take issue with their position.
Mr. Davies: We are not here to oppose their position at all. If they manage to convince people that, as a foreign bank, they should have access to Canada on a selective basis, or that there should be a review to see what they are doing and to determine their status on an individual basis, we have no opposition to that whatsoever.
Senator Angus: And you are aware that many of them came into Canada with the understanding that it was a free and open market?
Mr. Davies: Yes. I am very sympathetic to their concerns, but it is not a problem which impacts on us because we do not fall into that situation.
Senator Angus: You mentioned, for example, the 12-plus businesses and financial service industry. You emphasized in your opening that you are not a bank. Am I missing anything, or did you do that simply to make it clear that you qualify under the definition as an FNB as opposed to some other thing?
Mr. Davies: It is for that purpose, because there has been some confusion. It is not always easy to understand the difference between a near bank and a real bank.
I also want to make it clear that when we say we support the white paper proposal, we do not support the proposal to keep foreign banks out of Canada. We support the proposal insofar as it frees things up for near banks. If it turns out that things are freed up for foreign banks as well, that is fine by us. We are not opposed to that, but it is a different issue.
When we say that we are not a bank, we mean that we are not regulated as a bank in the United States. The U.S. does not consider GE Capital or any of its businesses to be a bank. Similarly, it does not consider GE Capital in other countries to be a bank. The wide definition of "foreign bank" in the Canada Bank Act takes in General Electric Company due to its parent company. The white paper proposal recognizes that there should be a distinction, and they have drawn it at the near bank level. It may be that it needs to be withdrawn.
Senator Angus: You mentioned some of your unregulated competitors. I want to be sure we understand who they are. You have mentioned Newcourt.
Mr. Davies: There is Newcourt and ComCorp.
Ms Diane Hébert, Vice President Legal Affairs, Equipment Financing, General Electric Capital Canada Inc.: All asset-based lenders be would be the most important competitors.
Mr. Armin Sachse, Vice President, Marketing, Equipment Financing, General Electric Capital Canada Inc.: There is also the large range of captive finance companies which are operating in Canada, such as Caterpillar Credit.
Senator Angus: Are you familiar with Congress Financial or the company owned by Corestates, or are they not a competitor of yours?
Mr. Sachse: No, they are not.
Mr. Davies: I am not familiar with them myself, senator. I believe that they are appearing or have appeared. I understand that they have this foreign bank issue.
Senator Angus: They are an asset-based lender and they do have a lineage to a bank in the United States.
Mr. Davies: Their parent is a bank and they got caught by this foreign bank definition.
Senator Angus: Are there any other issues which are of interest to you in that white paper? Let us take, for example, the intention to set up a task force on the financial services industry generally in Canada.Would it be your intention to appear there? Do you have any other issues that may be of interest to us?
Mr. Davies: I do not believe, senator, that the agenda for the scope of the investigation by the task force has yet been defined. To the extent that they are looking at matters which impact on us, or in which we have an interest, or to which we have a contribution to make by putting forward suggestions, we certainly would look to the possibility of making representations to the task force. It is a little early in the day. We have not made a definite decision.
Senator Angus: Basically you are happy. You are operating in a free and open marketplace in a substantially unregulated way and you would just be happy with the status quo?
Mr. Davies: No, actually, senator, our concern with the status quo has been that when we make a move, whether it is an internal reorganization or adding another company, we have to go through this lengthy process, which is cumbersome, time consuming and costly for both the government and ourselves, in order to get approval to carry on a business which most of our Canadian competitors carry on without any such approval. We are saying the same as the white paper is saying, that there is no real public policy purpose today to maintain this gatekeeper regime over people who are not banks in their own jurisdiction and are not really carrying on core banking here. We are not saying that that should necessarily not be extended to banks. You must look at what they are actually doing in Canada. As I mentioned, we are not opposed to that. That is why we support the policy brought forward in the white paper that continued regulation and oversight of organizations which really are not banks is not necessary, does not serve a purpose and should be done away with.
They have said that retail funding is the criteria. That does not work. The other question is: What is core banking? What is the deposit-taking-like activity that we can use as a measure of what they are not allowed to do? After initial approval for coming into Canada, we should be allowed to carry on our activities without having to seek further approval.
Senator Angus: I take it from your statement that there is almost no overlap with the banks and that in fact what you folks do is complementary to what our banks do here in Canada.
Mr. Davies: We are in the same marketplace, in the same way as Newcourt is in the same marketplace as the banks, but it is not too often that we meet each other head on in competition. There are three or four businesses in which we are involved that overlap with what banks are in. There is commercial real estate, the equipment financing business and the retailer financing business in which Mr. Brennan is involved, although it is a different aspect; that is private label credit cards. Although the banks are into credit cards, it is a different aspect of the business that we are doing primarily. There is as well project financing that the bank gets into. To a certain extent I would say we are competitors, but we tend to fill different needs for the most part.
Senator Angus: They are always telling us that they are happy with any kind of a regime as long as it is a level playing field. They use these buzzwords.
Mr. Davies: Yes.
Senator Angus: Is there anything you could tell us about how these big regulated banks might resent you being out there?
Mr. Davies: We do not get the impression that they resent us very much, senator, although they bring up from time to time, albeit not that strongly, the level playing field argument. They say that they are regulated and it is not fair that other companies such as GE Capital are not regulated, that that is not a level playing field.
The answer to that is that the banks are regulated not because they are carrying on equipment financing business like we are or Newcourt is; they are regulated because they take deposits, because they are part of the payment system and because they have CIDC insurance. If they say that they are over-regulated and that is not fair, then the issue is to look at the degree of regulation and whether they should not be regulated as much, but not to regulate Newcourt and ourselves in an area where there is not any public policy need for regulation.
Also, the banks, because they take deposits and have CDIC insurance, have access to low-cost deposits, a much lower rate than we get. There are factors which balance the fact that they are regulated. They also have greater access to low-cost money. I am not sure how that balances out, but there certainly is a balancing factor.
Senator Angus: Where do you get your funding from; from the business of making airplane engines?
Mr. Davies: We have two sources. We have about $1 billion in the commercial paper market and the balance in Eurobonds.
Senator Stewart: I am very interested in this evidence. I am trying to understand the long and costly gatekeeper function which has been described. I am trying to find a justification for the present need for approval. Could it be that what is contemplated by the present law is that there is a need to ascertain whether what the witness has called "a move" will have the effect of introducing genuine banking features into the operation of the company? Is that a reasonable guess as to why the law is as it now is?
Mr. Davies: I believe that what the white paper contemplates, senator, is that the law as it is today provides that if you are a foreign bank, as GE capital is because of definition, and want to get involved in a business or acquire a business that overlaps with what a bank can do, the Bank Act provides for obtaining approval from Canada. To take it to the extreme, our argument is that banks are allowed more and more to become engaged in commercial-type activities as opposed to non-banking activities and their powers are expanded. Those activities become banking activities. Foreign companies that participate in them then become foreign banks.
For example, if banks were to enter the auto leasing field, which we do not oppose, foreign companies engaged in auto leasing would be engaged in banking activities, and if we wanted to expand our auto leasing, which is a commercial business, we would have to go to Ottawa and get approval for a business which really is not banking. I think that is what the Department of Finance is attempting to addresses in the white paper. It wants to come up with a definition for core funding where near banks should be.
Senator Stewart: You seem to be implying that as the banks diversify their activities, the definition of banking becomes more and more inclusive.
Mr. Davies: That is right.
Senator Stewart: Perhaps running a farm will eventually be banking, provided the banks are directly into the financing of it.
You say the process is long and costly.
Mr. Davies: It can be, although it is not all the time, senator.
Senator Stewart: I am trying to find out if this is just bureaucratic work making or if they have genuine questions which require you to engage in difficult and protracted examinations of your operations.
Mr. Davies: The extent and the time that is involved depends on the particular transaction or the size of the acquisition. I think OSFI and the Department of Finance have concluded, somewhat as we have, that in this particular area where you are not involved in core banking there really is not a policy need to continue this gatekeeper role, something which is recommended in the white paper. What is recommended is in line with the government policy of today which is to try to eliminate unnecessary regulation where there is not a real purpose. The Department of Finance and OSFI have concluded that this is one area that they really do not need to continue overseeing. We agree with that.
The Chairman: Mr. Davies, with regard to the retail funding issue, you are sympathetic to the problems some near banks have with the proposal, but you are not fundamentally affected by it, is that right?
Mr. Davies: It would be desirable to have greater flexibility.
The Chairman: However, it is not an issue for you, is it?
Mr. Davies: It is not essential for us because we happen to be in that very limited market. However, I understand it has had a serious impact on many others.
The Chairman: You are willing to be supportive but the reality is that you are not directly affected by it.
Mr. Davies: That is right.
The Chairman: To close off one question on the foreign banking issue, you are not directly affected by it, but you would certainly have no objections to moving the branches from the subsidiary requirement; that is to say, to allow foreign banks to have branches in Canada rather than requiring that they have subsidiaries. That is the other foreign bank issue that we have heard about.
Mr. Davies: It is a foreign bank issue that does not impact at all on our operation. We have not taken a position and are not opposed to any greater freedom. We are not opposing the positions taken by others. We are not caught or affected by that provision.
The Chairman: I understand from what you said to Senator Stewart that you are not opposed to expanding the powers of Canadian banks into automobile leasing in particular, or leasing in general, even though that would put them into direct competition with you.
Mr. Davies: That would be fine. We have not taken any position in opposition. As we have said publicly, we are not opposed to that. We are in that business and if it is the will to allow the banks into it, we have no problem with it.
The Chairman: Thank you very much for coming.
Senators, our next witnesses are from the Wells Fargo Bank. They are Mr. Gadi Meir, who is the senior financial consultant to the business banking group, and Ms Louise Pelly who is their lawyer.
Please proceed.
Ms Louise Pelly, Counsel from Gowlings, Strathy & Henderson, Wells Fargo Bank, NA: Mr. Chairman and members of the committee, I would like to thank you for the opportunity to come to talk to you today. Mr. Meir, who is with the business banking group, has flown in from San Francisco to speak with you today. I will let him do most of the talking. I will give a brief summary of why we are here.
As you probably know, Wells Fargo is a real bank. It is one of the most successful banks in the U.S. It is the ninth largest with assets of over $1 billion. It was recently described as the best managed bank in the U.S.
Over the last few years, it has taken the lead in the United States in unsecured small business lending. In fact, in the three years ended 1995 it lent over $5 billion in loans ranging in amount from $5,000 to $75,000.
It has developed a technology based on credit scoring and methods of assessing risk which has enabled it to lend to small business on a mass scale on the basis of a one-page application form, which is in the back of the brief, as opposed to the 11- to 15-page application form normally required by banks.
Wells Fargo wants to lend to small businesses in Canada. I know I do not need to tell you that that is a particularly underserved section in Canada vis-à-vis its lending requirements. Because of the technology involved, Wells Fargo requires a minimal physical presence in Canada.
It was our intention to make an application under Section 521. We had preliminary consultations with the superintendent's office in that regard. We are here because last week we received a letter from the superintendent's office. In spite of the fact that we have not yet made the application, they stated that they would not be prepared to recommend it on the basis of one line in the white paper which says that foreign banks regulated as such in their home jurisdiction will be required to come into Canada through a regulated financial institution. That decision would effectively preclude Wells Fargo from coming into Canada. The requirements for a Schedule II bank would impose enormous expenses and create a very top-heavy structure which would make it unfeasible for them to do what they are planning to do. They have no intention of taking deposits or becoming part of the payments system. We believe the requirement to incorporate a regulated financial institution is unnecessary from any prudential or other point of view.
I will turn the floor over to Mr. Meir who will be happy to take any questions you may have.
The Chairman: I am referring to Appendix 5 of your brief, which is the letter from OSFI dated September 24. It states:
As we have discussed, the June 1996 White Paper does address a proposed modification to the entry policy pertaining to regulated foreign banks that wish to carry on financial services activities in Canada. The entry policy would permit Wells Fargo to carry on its proposed financial services activities in Canada only through a subsidiary that is a federally regulated financial institution. Consequently --
Presumably, the "consequently" refers to the fact that a proposed modification in the white paper says something.
Consequently, OSFI is not prepared to recommend that Wells Fargo be permitted to establish a non-bank affiliate pursuant to section 521 of the Bank Act.
As I understand it, what the government said to you is, "We have put out a white paper," which they themselves have described as a discussion paper, "and on the basis of a discussion paper being put out, we will now interpret that to be the law." Is that a fair or an unfair characterization?
Ms Pelly: I think that is exactly correct.
The Chairman: So then it is not a discussion paper.
Ms Pelly: Apparently not.
The Chairman: You are proposing to offer a single isolated banking service. It is clearly a banking service. I do not think there is any question that small business lending has to be characterized, by however narrow a definition you want to use of "banking service," as a banking service.
Ms Pelly: We have no argument with that.
The Chairman: You propose to offer a single banking service -- not a range of services, but a single one -- and you propose to offer that from San Francisco, I presume, but with no bricks and mortar. Essentially, it is an electronically delivered service. Do I understand correctly?
Mr. Gadi Meir, Project Leader and Senior Financial Consultant, Business Banking Group, Wells Fargo Bank, NA:That is correct. The proposal is to do a mailing of thousands of letters which can be responded to by fax, mail, --
Senator Perrault: E-mail?
Mr. Meir: Eventually by E-mail.
Senator Angus: Would you drop these here in Canada?
Mr. Meir: We would drop them through a mail house either in Canada or the U.S.
As to whether we are doing banking activity, we are certainly doing banking activity, but there is a question as to whether we are doing it in Canada. The mailing, the acceptance of the response, the decision-making, the underwriting, the monitoring of the credit, and the giving of the money all gets done in the U.S. The operations in Canada would be limited.
The Chairman: Do you effectively issue a line of credit, which I presume is a credit card of some kind? Do you issue a credit line to the institution?
Mr. Meir: This is an unsecured line of credit of amounts up to $75,000. It has various access vehicles. It has a card which, to the merchant, looks like a MasterCard, and it also has cheque capability and telephone transfer capability.
The Chairman: Our researcher will show you an ad from today's newspaper for what would appear, on the basis of your description, to be an identical service offered as of this morning by the Royal Bank. They told us about this service when they appeared before us two days ago.
Mr. Meir: I did hear that they were planning on doing this, and I think Bank of Montreal is thinking about doing this. There are some key differences. First, our line of credit goes up to $75,000 American, which would equate to up to $100,000 Canadian. Second, we solicit and do a broad mailing to pre-selected customers. That is a more aggressive form of marketing.
The Chairman: They may be using other marketing techniques as well.
Mr. Meir: Let me highlight one other difference. When we launched our initiative about two and a half years ago in California, several other banks tried to emulate it, which is what we see here. You can see our one-page application form in the marketing departments of all the other major banks in California. Approximately 80 per cent of those banks have withdrawn from that program because they do not have the experience or the amount of data that we have collected which allows our scoring models to take on much greater risk than these other banks.
Senator Stewart: This is a very interesting type of business. As I listen, I come to the conclusion that you are saying that, in this particular kind of operation, Wells Fargo is risking its own money and that it is in no way jeopardizing the functions of the Canadian banking system which justify the kind of regulation which we have--that is, as a deposit-taking system and as a clearing mechanism. Although technically you may appear to be a bank, you do not tread upon those activities of banks which would lead them to be highly regulated for reasons of public purpose; is that correct?
Mr. Meir: Absolutely.
Senator Stewart: You say that you have been successful in California as compared with would-be competitors because you have better data on the basis of which to pre-select -- I think that was the term you used -- customers.
Mr. Meir: There are a few concepts in there which I will try to clarify, but you are more or less accurate.
Because we have been in the game that much longer, we have been able to drop millions of pieces of mail in the last three years. We have put 200,000 such loans on our books. We have tracked the experience of these loans to see whether, in fact, all our original scoring algorithms and risk algorithms are accurate. We have found that not only are we able to take on this much risk, but we have actually taken on a whole spectrum of risk based on the criteria we have thrown into the models on the characteristics of businesses and their payment performances. We have found that we have been pricing accurately. We have been able to predict reasonably accurately who are the lower-risk customers, the medium-risk customers and the higher-risk customers, and then adjust our interest rates. It requires a lot of data and a lot of experience to bear out your initial predictions.
Senator Stewart: One possibility is that the data relates to the nature of the businesses and the particular business environment. The other possibility is that it relates to the nature of the particular potential customer, let us say the age bracket, or a specific personal history, or perhaps both.
Mr. Meir: Yes. The data is from different sources. We get the half-page application form back which gives us some essential data as to the location of the business, the number of years in business, their sales, other types of accounts they have, and whether they have a relationship with Wells Fargo. In this case, there would not be.
We add to that information that we buy in the market. We buy from companies that provide such information on businesses, such as Standard and Poor's, Dunn & Bradstreet, et cetera. From them, in addition to information on number of years in business and type of business, we get information on ability to pay. They have credit risk scores. They tell us how many creditors they have right now and whether they are paying those. That gets merged into it as well as the economic data you mentioned.
It would take me the better part of a week to explain how complicated the models are, and I do not pretend to fully understand how that works. We have all kinds of Ph.D.s jamming out these models. However, that, in essence, is it.
Does that clarify it a little?
Senator Stewart: I think it does.
You are arguing that your company, Wells Fargo, is risking its own money, and that if it is allowed to do this in Canada, it will be of very considerable service to potential borrowers who now are not adequately served by the Canadian banks.
Mr. Meir: That is exactly the point. Our target is not possibly small business but solely small business, and this is an under-served market. We see that in Canada the very low-risk tier companies have all the access to credit imaginable. It is the medium-sized risk tiers and the slightly higher-risk tiers of smaller businesses, which are perfectly bankable, that are being neglected, and they are perfectly bankable because we have been able to measure that risk and account for it within our pricing and still make a profit.
Senator Stewart: Until we hear this argument refuted, we should be in favour of Wells Fargo risking its money to serve small business in Canada.
Senator Angus: It looks to me like the Wells Fargo wagon has come into town. It is really only of interest to me to know in what form I will see it. Is it just through the mailbox? If I am in small business in Estevan, Saskatchewan, and I get your mail, fill out the form and send an application, will you assess the risk and send me a cheque? Do I get a visit? How will it work?
Mr. Meir: There are no visits, no need for appointments with a credit officer and no monthly reporting on your receivables. You get an offer in the mail.
One of the key benefits for small towns, such as Estevan, Saskatchewan, is an option for small businessmen other than the corner bank.
Those small business people whose names make it on to our mailing business or business list will get a letter. They mail or fax their response, or phone it in on the 1-800 number. We will open up an account, if their credit is good.
Senator Angus: You will determine that by your special methods.
Mr. Meir: We will use our models and then we will open up a facility. These details have not been worked out yet, but we will probably be joint venturing with an institution here to open that account.
Senator Angus: This is really my question.
Mr. Meir: Then they will have a credit facility which they can use either through the card which I mentioned or through cheques which say "Wells Fargo Business Line of Credit." The cheque may be drawn on a Canadian bank, but we will make that arrangement on an arm's length basis.
You may also be able to make a telephone transfer. You will call and say: "I need to access my line. Please transfer $25,000 to my Bank of Montreal account."
Senator Angus: You slipped in the words, "we will probably be joint venturing" with a local institution. Could you expand on that, please?
Mr. Meir: We have had preliminary discussions with a bank here.
Senator Angus: With a bank; a real bank?
Mr. Meir: We are a real bank. I am referring to an existing Canadian bank. We have also had preliminary discussions with a systems house which actually does credit-card issuing for Canadian banks but which is based in the U.S. We are discussing with them how this can come about; how we can open up an account and have cheques issued through this particular bank.
Senator Angus: Assuming that you get through all of the current problems or roadblocks which are being put up, would you actually have an office in Canada? Would it be at Gowlings or elsewhere?
Mr. Meir: We have had our branches and our offices in California and the 13 western states since the merger with First Interstate. We are marketing this product throughout all 50 states of the U.S. without setting foot in Missouri or Iowa. That is why we can do this so inexpensively.
That is exactly what we want to do in Canada. There is no need, in our marketing plans, for more than a very limited presence in Canada. However, we will use agents in Canada. If we have collection problems in Canada, we will need to use collection agents here. We will potentially need a mail house in Canada if it is cheaper to mail directly from London, Ontario, than to drop the mail from California. We have to work out those details. Those will be subcontract arrangements.
Senator Angus: I have read your very thorough and interesting brief and also the appendices and articles which have been written about your product. One article in particular was in Forbes magazine.
In your work in the States in this business, you are regulated as a full bank, but to what extent does that regulation impact on this particular product? I am just trying to get into the heads of the regulators and find out what may not be appearing on the face to us.
Mr. Meir: The regulators, I suppose, have the same concerns as with any lending activities: Are you putting depositors' money at risk? Regulators have come in to try to understand our models. I imagine that is the concern of the regulators in the U.S. We are under full regulation under all the banking laws of the U.S.
Senator Angus: I notice that you say in your brief that you are prepared to give undertakings to adhere to all our high ethical standards in this country, and so forth, regarding information and privacy.
If I receive, in my little farming business in Estevan, a document which is pre-approved, it must be based on some information which you already have. Where do you get that information?
Mr. Meir: According to the research I have done here, between 1 and 2 million businesses are registered with companies such an as Equifax, Standard & Poor's, Dunn & Bradstreet, the Credit Bureau of Toronto, the Credit Bureau of Vancouver, et cetera.
If you have applied for credit somewhere, they have a record on you. I did not create that. Those records are purchasable. Those records contain your name, when you came into business, your address, the proprietors of the business, your creditors and whether you have been paying on time. That is all coded. It is a wealth of information.
We do not purchase this to infringe on privacy. We purchase it because we want to extend credit to you. That information is totally confidential. Wells Fargo in the U.S. has never had an issue with breach of confidentiality. We do not sell these lists. If a business contacts us and says they do not want to be contacted by direct mail, their name is flagged on our database and they are not contacted. We have had no such problems.
Senator Angus: I understood that when you originally developed your business plan and decided to come into this market, you made arrangements to make the usual application under the Bank Act, to seek an Order in Council and to make whatever undertakings the regulator felt would be applicable in your case, and then you were told about the white paper. Is that correct?
Ms Pelly: That was before we had even submitted the application.
Senator Angus: So you did not make the application?
Ms Pelly: No. We had preliminary discussions. We never actually got as far as the application process.
Mr. Meir: The preliminary discussions were quite responsive; is that not correct?
Ms Pelly: Yes. This has all happened over the last three or four months. The original discussions were just before the white paper came out and they were on a no-names basis. The response we got from OSFI was that they would certainly consider this; it sounded interesting and so on. Then the white paper came out.
Shortly after that, Wells Fargo's plans were far enough advanced that we were able to give to the superintendent's office the information about who we would be working with and a fairly detailed outline of the plan. It was at that time that we got the letter saying they were not prepared to consider it.
Mr. Meir has been describing how most of this will be done from outside the country. At one point we investigated whether Wells Fargo needed permission under the Bank Act at all.
Senator Angus: I wanted to ask you that.
Ms Pelly: The Bank Act, as you know, says that a foreign bank cannot conduct banking business in Canada. The plan is to do this, by and large, from outside of Canada. However, the superintendent's office takes the view that if you do a sort of global advertising effort, as we just saw in The Globe and Mail, that is not "doing banking" in Canada.
If you do any kind of target solicitation, which is what Wells Fargo is planning to do, that, in the superintendent's view, is crossing the line and that is the beginning of "doing banking" in Canada.
As far as I know, that is a completely arbitrary division.
The Chairman: Do you have a written statement that says that an ad in a newspaper is not being in the banking business, but niche marketing is being in the banking business?
Ms Pelly: That has been OSFI's position for a considerable period of time.
The Chairman: Is that position written down?
Ms Pelly: I have not personally seen it.
The Chairman: You have been told that that is their position?
Ms Pelly: A number of times, and not just in this particular instance.
If it were not for that, I think we could make a very good argument that we were not doing banking business in Canada at all, in which case we would not be here. Obviously, Wells Fargo wants to do things in the proper fashion, which is why we are here.
Mr. Meir: We thought about the alternative of doing a test mailing in some particular market, but the last thing we want to do is run into conflicts with regulators here. We are the ninth-largest bank in the U.S. and we do not need somebody from the Ministry of Finance phoning our chairman asking us what we are doing mailing into Canada.
Senator Angus: We need to make a distinction on the record. There were other witnesses that came before us wanting to carry on certain businesses in Canada, that normally would not be regulated here, but because of their parentage by a bank or a bank affiliate in the U.S. or some other foreign jurisdiction, they ipso facto trigger a policy under which they have to set up as a subsidiary in Canada. In other words, as I understand the policy -- and perhaps you can elaborate on this, Ms. Pelly -- in terms of specific sections of the law, any activity whatsoever being carried out in Canada -- assuming you get to that and it is deemed to be carried out in Canada -- by an entity with a parent in the banking business outside Canada, has to be set up in Canada as a bank. That is what they are saying you should do.
Ms Pelly: If it is regulated as a bank in its own jurisdiction, which, of course, Wells Fargo is.
Senator Angus: How are you going to get around that? That is the issue.
Ms Pelly: There are two ways. One, we simply argue we are not doing banking business in Canada at all because it is all being done from California.
Senator Angus: Let us assume that you are doing it.
Ms Pelly: We are doing it and that requirement is there. Then there is an avenue of an order under section 521 which specifically states that the Governor in Council can give an order consenting to the carrying on of normal financial activities.
Senator Angus: In an unregulated way, subject to undertaking.
Ms Pelly: Yes, there is an undertaking required and some annual updates of the undertaking and so on.
Senator Angus: I believe you were in the room when witnesses from GE Capital were here. They have 12 different businesses. This order in council you would seek is part of the so-called gatekeeper functions just to monitor who is coming into the country. Do you have any problem with that aspect of the policy? GE Capital say that even that is no good, because it goes too far and it is expensive.
Ms Pelly: In view of what we want to do right now, we would not have a problem with making an application under section 521. I could tell you many things about section 521, but they are not relevant to this discussion.
Senator Angus: It is not one of the sections you drafted.
Ms Pelly: As it stands at the moment, if Wells Fargo could get the order under section 521, it would be happy to give the undertaking regarding no deposit taking, and so on. That would certainly solve its present problem until such time as it wanted to do something else. However, that is not on the table right now.
Senator Stewart: At that time, you would go and get a new order in council.
Ms Pelly: Under the present system, yes.
Mr. Meir: And if we had approval under section 521, we would be ready to do business in six months.
Senator Kenny: What sort of assets are you going to keep in Canada in the event that someone is not happy with what you are doing and they would like to have recourse against your organization? Whom would you have in Canada that we could serve with a subpoena in the event that we do not like what is going on? In other words, whom do we arrest and what do we seize if you are operating outside of the country?
Mr. Meir: This is not BCCI.
Senator Kenny: You are Wells Fargo. You are a terrific company. All I am saying is you are on the other side of the border. Whom are you going to have on this side of the border that we can get our hands on?
Ms Pelly: To answer the questions in reverse order, I imagine the person you can get your hands on would be me, although we have not yet decided who would be there to take that particular function.
On the question of assets in Canada, I will let Mr. Meir answer.
Mr. Meir: We do not plan to have assets in Canada.
Senator Kenny: So if someone is unhappy with what is going on, there is nothing to seize?
Mr. Meir: If nothing else, they have our money.
Senator Kenny: I understand they have your money here, but there may be other reasons why people are unhappy with what you are doing. How could they have recourse to you? They have to go to California and do it in your courts down there, right?
Mr. Meir: I am not sure about that.
Senator Kenny: Nor am I. That is why I am asking.
Mr. Meir: If there is an issue here, I am sure they could go to a small claims court here and subpoena us here.
Senator Kenny: And serve it in San Francisco?
Ms Pelly: This is not a matter we have investigated yet, but we will certainly be happy to do so. Again, I am sure Wells Fargo will be prepared to designate someone here on whom service can be made.
Senator Kenny: There is a certain comfort factor when you know that there are folks in the country who are operating under Canadian laws, and there is a certain comfort factor in knowing that there are some assets in the country to which the courts can have access.
Mr. Meir: I am sure that when the negotiations arise under section 521 we would be very willing to entertain any of those conditions.
Senator Perrault: Mr. Chairman, Wells Fargo has been a very innovative entity ever since the days of the wild west. With the exception of a few hold-ups now and again, they came through remarkably well by being an innovative institution then, and they seem to be innovative now.
The questions that I have address how you acquire the body of information. You have already given us some detail on that. Apparently you have an advantage over your competition because you do your homework better than they do. It is rather interesting how that information is obtained. You say that you will obey all of the Canadian rules regarding the confidentiality of information.
You said a few minutes ago that this is what you would like to have until we decide to do something else. The other evening, I downloaded Wells Fargo on my computer. I must say you are really very innovative. You are going massively into electronic banking. Do you plan such a program for Canada? Is that part of your business plan for Canada? It is extremely well done. I must congratulate you. It is one of the classics in that area.
Mr. Meir: Our plans at the moment are just to do this business line of application by mail.
We make a lot of money on that, and it has been a great success. It has been a product unparalleled in the market, until this advertisement this morning, but I think there are still substantial differences. That would occupy us for quite some time.
Senator Perrault: Is it foreseeable in your plans to expand in North America that Canadians would have access to your electronic banking system?
Mr. Meir: That is not within our plans. However, the Business Gateway software developed by Wells Fargo allows people to do their banking from the PC right at their place of business. In our case, it would transfer money between their lines of credit, make payments from their bank onto lines of credit, check their balance and check the last few transactions.
We are not getting into deposit taking. We have no interest in that area. The software would just be a tool to help them manage their accounts with us in an easy way.
Senator Perrault: Have you had a good response?
Mr. Meir: The Gateway has taken off.
Senator Perrault: You are really saying that if this small business lending proposal is successful or supported in Canada, you may possibly go into other lines of banking.
Mr. Meir: That plan is not in place yet, and it is not another form of banking. It is just another service that we may provide.
Senator Perrault: At this stage.
Mr. Meir: At the moment you would have service through a 1-800 number and agents in the United States. This way, instead of the service being through the telephone, it would be through a computer. It is not another banking product.
Senator Hervieux-Payette: Is your software prepared for French-speaking services?
Mr. Meir: I am Canadian. I have just temporarily defected to the United States. I am fully aware, as are our managers, that there is a dual language issue in Canada. We have not yet prepared our material, but at that time we will study the market and put together whatever customers demand in terms of a second language. In California, for example, we have material in Spanish and other languages as well.
Senator Hervieux-Payette: In your proposal to the ministry and to OSFI, there was no such provision.
Ms Pelly: No, it was not specifically mentioned as what we presented to OSFI was not a full-fledged business plan. It was a preliminary description, a general description of what we were planning to do and why we needed section 521. However, if this proposal goes ahead, application forms mailed to Quebec would be in both languages.
Senator Hervieux-Payette: I do not think you are a charitable organization. What kind of guarantee do you require when you make a loan to a small business? Do you require a personal guarantee? On the face of the project, you appear to be lending to small businesses.
With respect to your program for women, what do women who do not own a house use as security for a business loan?
Mr. Meir: This is how we differentiate ourselves from other products on the market. Every other line of credit product is collateralized. Our product is a fully unsecured line of credit. We do not take collateral. We do require a personal guarantee, the same as any other bank. However, taking the collateral out of the equation makes it much simpler. We assess credit based on the merits of the company and the character demonstrated within the credit information.
If you are paying on your other accounts, we are pretty comfortable lending to you. If you have been in business two years and you have sales of "X" and a whole bunch of other criteria, we throw that into our equation. We know where our businesses rank in general in a broad spectrum, and we can say "You are a medium-sized risk customer, so we can extend you credit." If you are outside our perimeter, perhaps we will not extend you credit.
Does that help you?
Senator Hervieux-Payette: Yes. At least I understand better how you function.
What about the business sector? Since you operate with telecommunications and computers, and given that you are in California and its Silicon Valley, are you more knowledgeable about and more ready to make loans to people in the high-tech business?
Mr. Meir: The fact that we take collateral out of the equation also gives us an advantage in the high-tech businesses. The problem among high-tech or information-based companies is that they come to their banker with a business plan. Bankers base half their equation on what they can put their hands on. You cannot put your hands on a software program. We take that out of the equation. We look at how the business has been doing and how it has paid its creditors in the past, along with a lot of other criteria. We lend on that information, which I think gives us an advantage.
We lend across all industries, not based on collateral. I have printed out a list of all the different industries to which we lend. I have not included it in your brief, but I would be happy to show it to you later. We lend in the social services area, which does not have any collateral. Business services have no collateral either.
We have heard from our customers that collateral is a very difficult thing for small business people to get around.
Senator Hervieux-Payette: You have a paragraph about your program for women. Do you have a program for youth, recent graduates or young entrepreneurs?
Mr. Meir: The minimum criteria is that a business has been established for two years. We have found that our competitors do not look at businesses with less than three years of experience. Start-ups would not get financing through this particular product. That may be a problem with youth, but if they have had a business for two years, we would look at it.
Senator Meighen: This letter from OSFI is dated September 24. Not much time has passed since then, but have considered whether such a policy as enunciated by OSFI would be contrary to NAFTA provisions and national treatment?
Ms Pelly: Yes, we have. We believe it is contrary. Wells Fargo, as a real bank, falls under Chapter 14 of the NAFTA. Individual countries are allowed to impose different conditions for prudential reasons, but we cannot see any prudential reason for this. Our view is it is contrary to the NAFTA.
Senator Meighen: Is that an off-the-cuff opinion, or have you provided such an opinion? If so, would you be prepared to let us have a copy of it?
Ms Pelly: I have not provided such an opinion yet because we have not had time. We only received this letter a week ago, but I would be happy to provide it. It is a question I have looked at, and I would be happy to provide an opinion.
Senator Meighen: You must realize we are a penniless committee of the Senate. If you could provide us with that opinion, it may be very helpful.
Ms Pelly: I would be happy to do that.
The Chairman: Thank you for giving us terrific insight and a terrific example of niche marketing at its best.
Following up on Senator Stewart's point, the white paper proposes that you would be governed by a regulatory scheme which would be designed to protect American depositors and American shareholders. Is that correct? In other words, there is no Canadian money at risk in this at all?
Ms Pelly: I do not even think it would necessarily give any protection to American depositors and shareholders. They are already protected in their own country.
The Chairman: If foreign branching were allowed -- that is, if foreign banks were allowed to come into Canada with a branch system rather than a subsidiary system -- would that not solve your problem immediately? You would then set up a shell of a branch that would be deemed to be a branch and your problem would be solved -- that is, assuming there were no stringent capital requirements. Am I correct on that?
Ms Pelly: Yes.
The Chairman: In theory, though, you could come into the country and, instead of having Canadian capital requirements, rely on the capital base of the parent, in this case, Wells Fargo in San Francisco. That would be another way of dealing with your problem. Is that correct?
Ms Pelly: In theory, that is correct. I only say "in theory" because we do not know what other conditions they might add. All things being equal, that would solve the problem.
The Chairman: That is an avenue worth exploring.
Our next witnesses are from the Co-operators Group.
Mr. Terry Squire, President and Chief Executive Officer, The Co-operators Group Limited, Co-operators Financial Services Limited, Co-operators General Insurance Company and Co-operators Life Insurance Company: Mr. Chairman, with me today are Lorne Motton, Vice-President Finance and Controller; and Frank Lowery, Vice-President, General Counsel and Secretary.
The Co-operators is a group of companies owned by a cooperative, The Co-operators Group Limited. Our principal business is insurance, and our largest area of insurance is on the property casualty side, though we do have a significant life insurance company based in Regina.
Co-operators General Insurance is the largest wholly Canadian-owned multi-line insurance company in Canada and we insure more than 1 million policyholders. In 1995, we celebrated the fiftieth year of our founding. Co-operators as it exists today is the result of the amalgamation of two groups of cooperative insurance companies, the former CIS group based in Regina, and the CIAG group based in Guelph, Ontario.
In terms of size, our assets at the end of 1995 were approximately $3.5 billion. However, we are not in the business of aggregating assets so our premium volume is more of a judgment.
We sell insurance in all provinces and territories of Canada, with most of our premium generated in Ontario, Alberta and the Atlantic region. We employ over 3,000 people in Canada.
Our primary intention today is not to lobby you but to come before you as members of a senior management team in a property casualty insurance group. It is our opinion that we are not generally well known among the other financial entities due to a lack of effort on our own part.
Members of our senior management have met over the last few years respectively with senators, Members of Parliament, the Honourable Doug Peters and the Honourable Paul Martin. We have made numerous verbal and written submissions. Most recently, we wrote to the Department of Finance in response to the white paper. Without reviewing the contents in detail or reiterating what we said -- copies of our letters are available -- suffice it to say that we have dealt with each of the areas of concern set out in the white paper.
The Chairman: We just received that document this morning. It might be helpful if you would read it.
Mr. Squire: On actions taken by the government today, we strongly supported the government's decision at this time not to allow banks to directly retail insurance or to use confidential customer information for that purpose. We argued that, before the banks are given further access, there must be a levelling of the playing field and a transitional period to allow other competitors to have the same advantages. We also supported Minister Peters' proposal for a review of the appropriateness of the Canadian financial system for the twenty-first century and even offered to provide a senior person for the task force.
On strengthening consumer protection, we noted that we have taken steps internally to implement the CSA standards on privacy. We noted that The Co-operators has historically served markets such as the rural marketplace which have been poorly served by other traditional providers. We agreed with the balance struck in the white paper between the avoidance of abusive tied selling and the need for low-cost, effective marketing of products to consumers.
On easing the regulatory burden on financial institutions, we commented on the immense cost of regulatory duplication and over-regulation of business. We supported the federal government initiatives to have one registration jurisdiction both in insurance and with respect to securities regulation. We also supported the rationalization of powers as between the federal and the provincial governments and the white paper proposals to simplify and narrow the application of the self-dealing regime.
On fine-tuning, we proposed that tax transactions within a group of companies should be treated more on a group than on an individual company basis.
We proposed that the Insurance Companies Act should allow for the incorporation of cooperative insurance companies. We asked that the role of financial cooperatives be specifically included in the upcoming review of the appropriateness of Canadian financial structures for the twenty-first century. Generally, we supported the positions of our various industry associations.
As I said earlier, our primary objective today is to provide opportunity for a frank discussion. We, as people on the front lines, can talk about how the Insurance Companies Act actually works; about what it is like doing business in Canada's insurance market today; about how to best address concerns for the future, mine as the CEO of Canada's largest Canadian-owned company and yours as senators.
The Chairman: Thank you very much, Mr. Squire. Are you linked in any way to any of the credit union movements?
Mr. Squire: The credit union movement owns approximately one-third of our shares.
The Chairman: Through a credit union central?
Mr. Squire: Yes, through a credit union central.
The Chairman: Through the Canadian one?
Mr. Squire: Yes. Actually, it is all of them.
Mr. Frank Lowery, Vice-President, General Counsel and Secretary, Co-operators Group Limited: Most of the major provincial ones are owners. Credit Union Central of Canada is not a member; however, Ontario, Saskatchewan, Alberta, British Columbia, New Brunswick own shares.
The Chairman: They own shares in the sense that you are a share organization?
Mr. Lowery: They own cooperative shares. If you know the structure of a cooperative, shares are still par value; they only have a nominal value. In the Co-operators Group, there are 2,000 shares per thousand which are divided between six regions across the country and held by members within the region. For example, if you look at British Columbia Central Credit Union, 40 shares out of 100 are issued in that area.
Mr. Squire: There were two points to your question. On the marketing side, in some areas we are friendly competitors and in some areas we are friendly partners.
The Chairman: That is where I was leading. In some cases you are actually competing with organizations which own some of your shares.
Mr. Squire: Yes. It did not start out that way, however. As the financial services business unfolds, other people want to come into the insurance business. That changes the context of how we do business. We now must start thinking about whether we, ourselves, need to get into other financial businesses.
The Chairman: Are you at the point of actively looking at entering the deposit taking side of the business? Are you sticking strictly to the life and health and the P and C side of the business?
Mr. Squire: Yes. We own probably the most substantial, exclusive, agency force in Canada. We have about 500 outlets of our own. We have the bricks and mortar, at least, in offices all across Canada.
As red-blooded Canadians, it crosses our minds that maybe we should be joining the fray and distributing other forms of products, probably on a fee basis rather than as a manufacturer. We are looking into that.
The Chairman: You would use your sales force, essentially, to deliver other products as opposed to being, necessarily, the actual supplier of those products.
Mr. Squire: Exactly.
Senator Meighen: I was struck by your support for the thrust of the white paper measures. You are the sort of person from whom any producer of a white paper would like to hear.
Could you amplify your comments on the regulatory burden? To what extent do you find it a serious, additional cost of doing business?
The Independent Investment Dealers testified that OSFI seemed to be trying to discover further areas to regulate, rather than leaving the regulation to the provincial governments which are already doing it. Do you see that trend at all? Do you have any suggestions on how the burden could be eased? What you would estimate to be the cost and the implications of the overweening regulations?
Mr. Squire: In the first place, the amount assessed by the regulators is an ever-mounting cost. I cannot give you exact numbers now, although we could find them for you.
I happen to have it in my mind that next year's budget of the federal regulator will go up by 9 per cent. We find that to be extraordinary given the less than 2 per cent inflationary economy. We do not like to see our costs, which we must pass on to our customers, inflating at 9 per cent or more. That is on top of large increases in costs in prior years.
When I was younger than I am now, a federal licence really meant something. You could send in all the documentation and the attestations which were required to all of the provincial regulators and you would get your federal licence and, pro forma, you would receive your provincial licences.
Over the last 10 to 15 years, that is all going down the drain. Many provinces have changed their forms to gather the information in a slightly different context by adding a question or requesting an actuarial opinion on this subject instead of that one.
Now we find we must regurgitate the same information on many different forms for the provincial as well as the federal licence. In our company it is Mr. Motton who must fill out all the forms.
Mr. Lorne Motton, Vice-President, Finance and Controller for Co-operators General Insurance Company: I did some homework in terms of the actual assessments which we pay to OSFI, OIC, the provincial regulators, the mandatory filings. It is in the range of $2 million to $2.5 million for our Co-operators General Insurance Company. That is only the tip of the iceberg, though. Many people are involved in preparing what I would deem a great deal of repetitive documentation which is sent to Ottawa and to the various provincial regulators. They review it; they have the analysts here. We have the work of the extra audits. Actuarial opinions are now required. The actuary produces a thick binder of material.
Senator Meighen: That is done annually, is it not?
Mr. Motton: We do quarterly filing as well, but they are shorter forms.
Senator Meighen: We are told that, in other jurisdictions, an audit may take place only every three years.
Mr. Motton: We must be audited by OSFI every two years. We have an annual shareholder audit by external auditors and we are required to provide an actuarial opinion.
We could make some savings by not having OSFI do the examination. We have external auditors. Why do we need actuaries in Ottawa to review actuarial reports when the Insurance Act has put the onus on actuaries to provide an opinion? One would think that would be enough.
Mr. Squire: That should be enough to assess the $2.5 million, if that is the cost.
Mr. Motton: That is only part of our cost.
Mr. Squire: To put this in context, we are probably the third biggest in absolute size. We have 6 per cent of the market. You might be able to multiply that number in your mind.
Mr. Motton: That does not include the premium taxes which we pay to the various provincial organizations and governments, an amount of $8 million or $9 million per year.
Senator Meighen: On the question of privacy, the white paper provides that data processing could now be done in-house, rather than in a subsidiary way.
The suggestion has been made that data processing which is kept in a subsidiary may be more easily distinguished and protected than in an in-house process which may depend on Chinese walls to keep the data segregated. Do you have any view on that? Why would the white paper make that suggestion? Could it be for cost savings?
Mr. Squire: I am not sure that we have a firm opinion. One tends to stick to one's own knitting. In our company, we have always been able to do our data processing in-house. As a practical matter, we have moved from doing it in-house to out-sourcing presently, but we can foresee that changing again in future.
There are definitely cost savings in doing it in-house. GST, for example, is a significant additional cost unless the work is done by a subsidiary which is at least 90 per cent owned by the contracting company.
This really has not been an issue for us. As an industry, we have probably dealt with more private information than has any other sector, in automobile insurance applications or life insurance applications, for example. We have handled the privacy issue well. There have been few complaints from customers about the inappropriate release of information.
The Chairman: In your fine-tuning recommendations, you suggested, as a relatively minor amendment that, under the Insurance Companies Act, the department would allow for the incorporation of cooperative insurance companies. I am surprised that the act does not already provide that. I just assumed, because you exist, that the act allows for that.
What has been the response from the department on that? It is not included in the technical appendices to the white paper.
Mr. Lowery: In 1992, I was representing Co-operators as part of the IBC delegation which met with the Department of Finance to work on the original legislation. It was raised several times then. You might recall that Claude Gingras, former general counsel of Mutual, on the life side, strongly supported it. Mr. Gingras is a strong mutualist and recognizes the similarities and differences between cooperatives and mutuals.
The view of the Department of Finance was that there was so much else on the table at that moment that, although it was an interesting point, we were the only company asking for it. Since it was not an industry position, they would proceed with it at that time. They suggested that we bring it up in the next review.
At various times, we have raised the issue in correspondence. More often than not, the response has been to ask us to draft something for them to look at. Of course, we are in the business of insurance; that is what we generally do. We are not in the business of drafting legislation. I do not say that negatively.
The Chairman: What is the problem? An insurance company is an insurance company. What makes your situation more complicated?
Mr. Lowery: It is a philosophical thing, but let me describe to you our company structure. In the Co-operators, the holding company is a cooperative owned by 30 or 31 member-owners across Canada. All of the other companies are required to be incorporated as either mutuals or as stock companies. In our case, they are stock companies.
Our board is democratically elected from our members; all board members are grass roots, cooperative people. The co-op sector is huge in Canada; it includes the credit unions and everything else.
Our board basically feels that the cooperative sector is currently served by one, strong, cooperative insurance company, which is the Co-operators, but that it is a voice in the wilderness.
In the material I provided to the clerk is a small folder from the International Co-operative Mutual Insurance Federation. In that you will see that cooperative insurance providers in other countries, like France, provide about 40 per cent of the marketplace. These are grass-roots-driven insurance companies owned by ordinary people.
That is what our board was stating: Basically, if you recognize in the Insurance Act a mutual form of organization, why would you not recognize a cooperative form of organization?
I met recently with Claude Gingras on this very topic. It was Mr. Gingras' view that it is a little late in the game. He wondered what exactly would be enough for us. I stated that, at this point, we are not looking for the legislation to be massively revamped to recognize this aspect, but if there is to be a review on the appropriateness of the financial sector in the 21st century, we would like them to consider, at the very least, the cooperative financial sector and the right of people to organize as they choose and to do business as they choose.
If we incorporated any insurance company as a cooperative, we would expect it to be subject to all the same regulatory and prudential requirements as any other insurance company. That is basically our point. We do not see the problem.
The Chairman: The essence of your legal problem is that the Insurance Act recognizes a stock insurance company or a mutual insurance company, but you are neither.
Mr. Lowery: That is right.
The Chairman: To that extent then, the sections of the act which deal industry structure do not apply to you because you are not one of the two accepted breeds, as it were. Is that essentially the problem?
Mr. Lowery: Exactly.
Senator Meighen: What kind of problems does that cause in the everyday life of your company?
Mr. Lowery: It does not lead to any particular problems for the Co-operators. We continue to function. However, you must understand something about the co-op sector. Speaking philosophically, Co-operative people believe that the cooperative way of self-help is the best way to provide services to people. They have principles such as a limited return on capital. They try to ensure that people are served by themselves and that the more business they do with their co-op, the better they are treated by their co-op.
Those are basic principles. If you believe in those principles, you should believe that any form of enterprise can be organized in that way. It is a philosophical issue. For the Co-operators, one way or the other, it will not affect how or whether we will do business tomorrow.
The Chairman: It is essentially a question of seeking recognition rather than having a practical business effect.
Mr. Lowery: Exactly.
The Chairman: Thank you for appearing here today.
Our next witnesses are from the Canadian Real Estate Association.
Mr. Pierre Beauchamp, Chief Executive Officer, Canadian Real Estate Association: Mr. Chairman. I am accompanied today by Ms Shirley Taylor and by Mr. Martin Laplante, a consultant who has done a large amount of research for us on this issue.
The Canadian Real Estate Association owns the trademark "Multiple Listing Service", which is a cooperative listing system of properties for sale in every part of Canada, better known as "MLS". In 1995, MLS accounted for the movement of 252,000 properties worth $38 billion. Those transactions were driven by realtors, that is, members of our association who do their daily business in 115 local real estate boards. Currently, the members number about 70,000.
I mention this by way of introduction, Mr. Chairman, simply to underline that our members are involved with a huge number of home-buyers and housing transactions on a daily basis. They are completely familiar with mortgage financing in all of its aspects. They are in a position to know if there are problems and often are called upon to assist a prospective buyer in arranging financing for his or her property. They hear from consumers and from financial institutions all the time. Their experience leads them to draw two conclusions; one, the consumer is generally well served by the mortgage marketplace; two, the consumer is poorly served by an outdated federal Interest Act.
Our association has supported amendments to the Interest Act since 1984 when the Trudeau government introduced amendments. Roy MacLaren, Minister of State for Finance at the time, introduced a bill and claimed that the recent experiences of home-owners rendered this legislation urgently needed.
He issued a news release stating:
Consumers who found themselves locked into mortgages and unable to prepay under any circumstances are understandably upset. Some claim that a lack of information provided by the lender when they took out their mortgages led to a misunderstanding of their rights.
The 1984 proposal would have legislated a right to prepay and a maximum penalty which could be assessed by the lender. Unfortunately, the bill died on the Order Paper when a federal election was called.
It was not the first time a Liberal government had addressed these issues. In 1976, the government also introduced amendments. Tony Abbott, then Minister of Consumer and Corporate Affairs, stated:
The penalties currently in use in cases of prepayment of mortgages are often excessive and unnecessarily restrictive.
That bill also provided a right to prepay and a maximum penalty. However, it, too, suffered a fate similar to the 1984 bill. Over the years, nothing has been done by way of legislation, but the issue would not go away. Last year, we wondered whether we should continue to raise it.
Through our network of 115 local real estate boards. we asked our members to rate the importance of Interest Act amendments and to give us the benefit of their experience in that area. Even we were surprised by the feedback, Mr. Chairman. Our members rated it the number one issue to discuss in meetings with members of Parliament last year and again this year. They also provided us with a large file full of their experiences with respect to prepayment rights, the cost of prepayment, disclosure and other related issues.
Nineteen years after Mr. Abbott said prepayment costs were often unduly excessive, our members gave us many examples of excessive prepayments. Realtors rank as the biggest problem by far and away, the lack of any right to prepay a mortgage and the penalties for prepaying. It was clear to us that, after showing concern once in the 1970s and again in the 1980s, government may have tuned out. However, the problem remains very real for consumers.
Feedback reported that clients had been confused outright when they tried to prepay a mortgage. Others were allowed to prepay by a variety of penalties. Some were offered a choice of paying three months' interest or the interest rate differential, whichever was more. Others have been given no choice but to pay the interest rate differential which worked out to several thousands of dollars more than a penalty of three months' interest would have been.
We commissioned an expert survey of the policies of six financial institutions as they would disclose them to the consumer. Mr. Chairman, we have several copies of this survey available to the committee. We used an identical example with all six institutions at local branches here in Ottawa. We took the example of a $100,000 five-year mortgage with 25 year amortization fully prepaid after two years without the sale of the house or transfer of the mortgage. We found that the interest rate differential penalty was calculated differently by every financial institution.
Before members of the committee conclude that this is the marketplace working as it should, let me emphasize that these differences were not factors of a healthy, open competition between banks A and B. The formula for calculating the penalties was not spelled out in the mortgage documents. It is certainly not spelled out in legislation. In some cases, it is calculated in centralized computer programs. Therefore, local bank officers are unable to disclose it clearly.
The differences in the method of calculation represented a spread of more than $1,000 from the lowest penalty to the highest and this supposedly using the same formula. That is an undisclosed, hidden cost to the consumer.
Initially, we were criticized by the Canadian Bankers Association for not going to their head office to obtain the information we required. Mr. Chairman, that misses the whole point. We deliberately put ourselves in the position of the consumer. The consumer walks into a neighbourhood branch, not a head office in Toronto.
Our position is that the right to prepay should be legislated and that a standardized method for calculating the prepayment penalty should also be legislated. Initially, our members proposed extending to all mortgages the penalty of three months' interest which already applies under some National Housing Act mortgages. Discussion with the Canadian Bankers Association a year ago convinced us that its members would not accept such a penalty on the grounds that the compensation would be inadequate. However, the CBA did indicate that it could support the interest rate differential. At that point, we set out developing a proposal that would be fair to both the borrower and the lender.
As our survey shows, there are many different ways of calculating the interest rate differential. We believe this may be the major point of contention. Our research demonstrates that one method of calculation is fair to both lenders and borrowers; it the interest rate differential determined by using the net present value calculation based on a payment stream where the borrower is able to take advantage of all repayment options provided by the lender. These are typically in the range of 10 per cent to 20 per cent in the third year. Under this IRD -- and I emphasize this -- the financial institution is not worse off than it would have been if the mortgage had remained in force. I would also emphasize that our proposal does not reward speculators.
Mr. Chairman, when the Senate Banking Committee aired this subject briefly in the summer, the suggestion was made that the only time anyone would want to prepay a mortgage would be when interest rates are dropping. This is, indeed, a common reason for prepaying. The consumer sees that market forces are working in his or her favour and therefore wants to refinance. However, there are several other reasons for prepayment and they apply regardless of interest rate calculations. They include debt, marital breakdown, job loss and job relocation. I suggest that public policy is bad policy if it ignores these common realities of life in Canada in the 1990s.
Nor, Mr. Chairman, are we talking about micromanaging financial institutions. I said at the outset that the marketplace is working well. There are all kinds of mortgage products on the market, but the market is public. Terms and conditions and incentives are public. The consumer can see them and make judgments by themselves. Financial institutions offer a wide variety of prepayment options and incentives to attract new mortgage customers. They do not offer prepayment rights or focus on prepayment penalties to consumers as part of their competitive environment.
At the time of negotiating their mortgages, consumers intend in good faith to keep it for the full term, obviously. Prior to signing, the average consumer will not ask too many questions as to how he may break the contract; but circumstances change and, sometimes, contracts must be broken. Our formula provides full and fair compensation to the lender. Why should lenders exact a penalty significantly greater than if the contract remained in force? Prepaying a mortgage is not a competitive issue; it is a fairness issue.
Under these conditions, lenders can hardly claim that a standardized method of calculating prepayment penalties is interfering with their competitive environment; and government can hardly claim that, in the interests of public policy, it must leave consumers at the mercy of the lenders.
We are not talking about imposing a new regulatory regime. We are talking about reforming an existing one, Mr. Chairman, one we believe to be inadequate at this time, one that provides a prepayment penalty for mortgages over five years but none for mortgages of five years or less.
We urge the committee to support amendment to the Interest Act in this Parliament to give Canadians a right to prepay a mortgage. We also ask to you to support a standardized approach to calculating penalties. The right to prepay without the mechanism to prepay is basically no right at all.
Mr. Chairman, I have deliberately spent my time on these twin issues which we consider most important. Our members also produced compelling arguments for two other amendments. One would release an original borrower from a personal covenant once the lender has approved a subsequent assumer of a mortgage. For example, if you sold your house to me and I assumed your mortgage, then the current scenario would still hold you accountable if I defaulted on payments.
Another amendment would provide for uniform annual compounding of interest rates. Consumers are sometimes confused by being quoted rates without being told that they are compounded semi-annually. For us, this is mainly an issue of disclosure and plain language.
Mr. Chairman, we have previously submitted suggestions for improving disclosure requirements on mortgage documents by the use of plain and concise language which can be reasonably understood. We are pleased to see in the discussion paper that the government also recognizes the need for greater clarity. We urge the committee to support revisions to all appropriate statutes to achieve these changes.
The Chairman: In the white paper on page 18, there is a section on prepayment of mortgages which says, essentially, that the government is prepared to amend the Interest Act and also to clarify the way in which interest is calculated. I presume on the basis of what you have just said that you are in favour of the policy as stated in the white paper. Is that correct?
Mr. Beauchamp: I do not have the policy in my head at the moment. However, I understand the direction is the same as what we have outlined to you.
The Chairman: It certainly sounded exactly like it. I wanted to be sure that I was not missing something.
Mr. Beauchamp: The emphasis is not only that the prepayment right should be legislated but that a formula should be in place to allow the right to be exercised. Otherwise, I do not believe that the right itself will work. That is the emphasis. That is not found on page 18.
The Chairman: In your discussions with the CBA and the government, is it your sense that you are coming close to a consensus on both those issues?
Mr. Beauchamp: We have spoken, as I said, with the Canadian Bankers Association. We have proposed the IRD formula based on the net present value. They had been favourable to consideration of the IRD approach. They have not pronounced themselves on the net present value formula which we have submitted to them, and we are hoping that they will be supportive of that part of it. They were supportive of the notion of an IRD.
The Chairman: That reflects your discussions with the bankers association. What about your discussions with the government?
Mr. Beauchamp: When we met with the Finance Committee just a few days ago, they were happy with the general notions which we advanced, including the suggested formula. We seem to have wide support.
The Chairman: Have you talked to officials in the Department of Finance?
Mr. Beauchamp: Yes, we have. We have a whole litany of individuals, if you care to have the list.
The Chairman: I was simply curious about their reaction.
Mr. Beauchamp: We are receiving good support from not only consumers groups and MPs, but all kinds of other organizations, including the Canadian Consumers Association.
Senator Meighen: Mr. Beauchamp, it seems to me, and correct me if I am wrong, that it is very important to have full and complete and understandable disclosure. If the banks and the other financial institutions do not come up with a satisfactory formula for prepayment -- yours or another one -- is there not some danger that we will end up in our marketplace with only a one-year variable rate mortgage, period?
Mr. Beauchamp: We are trying to change the present penalty system. We recognize that the mortgage business is very competitive already. We are talking now about moneys in addition to those included in the contract between a lender and a borrower. We are concerned about such varied and undisclosed penalties. We are simply looking for disclosure. We are looking for legislated disclosure because we have seen a wide range of answers given to consumers when they go to pre-pay under the circumstances we have described.
Senator Meighen: If I could wave a magic wand now and legislate adequate and full disclosure, would much of the problem be solved?
Mr. Beauchamp: We do not think so. We think the right to pre-pay and the mechanism should be defined in legislation. That is the crux of our suggestion.
We have also recommended that all terms of a mortgage should be written in plain language and should be easily understandable. We go beyond that.
Senator Meighen: Do you not think that the competitive marketplace is adequate to ensure that some if not all of the players in it would offer the pre-payment ability? You want to legislate it so that all must offer it and, if they offer it on different terms, those terms must be adequately and fairly disclosed.
Mr. Beauchamp: The evidence from our membership indicates that that is not happening. We feel that the solution submitted in 1976 and in 1984, which was not approved nor put into legislation, should now be considered very seriously. We say this in light of the support we have found for our proposition.
Senator Hervieux-Payette: The department is saying that they would like to have more than three months' interest if people want to make a loan for 10 years. Normally, we take a loan for 15, 20, or 25 years, but we renew the interest rate at intervals, every six months, every year, every two or three or five years.
Would your three months would be the maximum? You say the three-month penalty of the National Housing Act should be retained. It should be retained for what length of time, five years?
Mr. Beauchamp: It is confusing because there are two pieces of legislation which address this. We are concentrating here on the Interest Act. The Interest Act provides for a penalty of three months after a five-year term. The amortization is irrelevant at this particular stage. We are not concerned with the after-five-year position of the Interest Act. We are concerned with what happens before five years.
You are quite right that the NHA allows for pre-payment and the three month penalty after three years.
We are concerned with the consumers' position on all mortgages under five years that are not under NHA, and we would like to see a legislated right to pre-pay. In fact, most mortgages today are under five years, and that is why we are concentrating our comments in that particular area. We would like the consumer to have that right to pre-pay on those mortgages under five years.
Senator Hervieux-Payette: You would like the actual cost revealed, and it would not be sufficient to simply say it is a three-month penalty. With any penalty or payment for compensation for stopping in the middle of an agreement, they could provide different payments to the bank if they want to renegotiate for another term or for another length of time.
Mr. Beauchamp: We had suggested a three-month penalty. When we spoke with Canadian Bankers Association that was not quite acceptable. That is when we went to work and looked at different formulas. We found the IRD based on net present value to be the best and the fairest formula that could be put in at the moment. This is why we have gone that particular direction.
Senator Hervieux-Payette: This would not be mandatory. When you say it should be retained, if they do not want the three months, it could be up to three months, but not necessarily three months.
Mr. Beauchamp: The three-month penalty was not acceptable to the Canadian Bankers Association, and it is at that time that we offered to find a solution which would be seen as fair and equitable to the Canadian Bankers Association and lenders in Canada as well as to the consumer.
At that point, we identified the interest rate differential based on the net present value as being a possible common formula to develop a legislated right-to-pre-pay mechanism.
The Chairman: Thank you. Your brief has a number of technical issues which were helpful to us.
Senators, our last witnesses this morning are from Life Underwriters Association of Canada.
Mr. Couillard, I notice the first half of your brief deals with issues which are not really addressed in the white paper, powers issues and issues related to the terms of reference of the task force and the payments system. I would ask that you leave those aside and focus on the last half of your paper dealing with changes which need to be made or are forecast to be made in the upcoming legislation.
Mr. Hal D. Couillard, Past Chair, Life Underwriters Association of Canada: On behalf of LUAC, I applaud this committee for making this effort on behalf of Canadians.
I am the immediate past chair of the Life Underwriters Association of Canada by one day. I reside in Calgary. I have been a practitioner for about 22 years.
With me are Dave Thibaudeau, president, and Bill Babcock, vice-president of public affairs.
For the past 90 years, LUAC has been the national professional association of the life insurance agents, brokers and financial planners in Canada. We are a voluntary association with more than 17,500 members coast to coast. Our members are primary distributors of life and health insurance and annuity contracts as well as pension plans, RRSPs, registered retirement income funds and investment funds administered by life insurance companies and mutual fund companies.
Our members increasingly serve the Canadian public by providing solutions to financial needs that use products other than insurance. As an association of market intermediaries, LUAC's membership and services have changed over time, adjusting to new market realities and, in many cases, anticipating those changes.
LUAC provides an extensive training and professional development program to its members and other providers of financial services, and we truly administer a very high code of ethics which is binding on its members. We acquire an intimate knowledge of the economic needs and circumstances of our clients in all social and income groups across Canada. Our association is committed to ensuring that the Canadian consumer has continued access to a wide choice of insurance and other financial products and services in a very competitive marketplace.
LUAC was an active participant in the consultations that led up to the financial institutions legislative reforms in 1992. We have continued to play an active role in subsequent developments both at the federal level and also as the provinces have updated their legislative frameworks for regulation of financial services in their respective provinces.
As a matter of fact, Dave Thibaudeau was just in Edmonton last Thursday working with the Alberta people.
We have come here today to provide LUAC's views on the latest step in this decade-long process of the government's white paper on the 1997 review of the financial sector legislation which was released on June 19.
We submitted our formal response to the white paper to the Secretary of State for Financial Institutions, and I have provided copies for you.
I will focus today on two issues from our written brief, while respecting your request, Senator Kirby. These issues are closest to my activities and those of my fellow members in the areas that we know best, that is, serving the consumers of life insurance and related financial products. The two issues specifically are the privacy safeguards for the consumer of financial services and the tied selling and cross-selling of products by all Canadian financial institutions.
With regard to privacy, our members are accustomed to receiving highly confidential, personal information about financial, medical and family matters. We acquire this information to advise our clients properly and to enable insurers to assess individual risk and to administer claims as they arise.
We are reminded every working day that our clients value their privacy and expect that that information which they disclose to us will be treated fairly and confidentially.
I mentioned earlier that LUAC has a high standard and code of ethics. Our members must adhere to our code of ethics as a condition of membership. The first article of the code of ethics requires a member to place the interests of a client or prospective client above his or her own. The second article concerns confidential information. It requires a member to respect the confidential character of all information regarding personal and business affairs received in the course of providing or attempting to provide financial services. Our members take this requirement very seriously.
More generally, the recent explosive growth in information technology and concerns about the power of large, impersonal institutions, has led to the widely held belief that there is a need to upgrade the protection of personal information.
The government has responded with two proposals for the protection of personal information. One of those proposals appears in the white paper which announced regulations that will apply specifically to federal financial institutions. The other, somewhat earlier, following the recommendations of the Information Highway Advisory Council and the Minister of Industry, announced the development of generally applicable legislation to protect personal information.
We trust at LUAC that the final product will not result in overlapping legislation. This is important. The fact is this: If you can see my chequing account and my Interac payment records and my credit card statement, you can profile me and detail me and target me for other products. That information lets you know what I might be ready to buy even before I know I am ready to buy.
Let me give you an example. The Vancouver Province newspaper reported last May on a $15 million software program used by the Royal Bank of Canada to track all credit card and Interac purchases made by its 9 million customers. The information goes into a personal profile on every customer; it is constantly upgraded. There, it is matched with information taken from records of the customer's bank accounts, loans, credit cards, investments, and credit applications. The system is used to identify prospects who will be susceptible to focus promotions of specific bank products.
So a fundamental principle of consumer privacy is the need to obtain an individual's free and informed consent before personal information may be used for a different reason other than the reason for which the individual gave it to that institution in the first place. The white paper confirms that a consumer's consent is key before any information is used for a new purpose or is disclosed to outside parties.
It seems that some institutions are prepared to shift their obligation to the consumer by so-called negative options to obtain consent. Again, I would like to give this committee an example.
About three weeks ago, one of our staff people at LUAC asked the CIBC Insurance for a quote on automobile insurance. When he received the quote, attached to it was an announcement that his personal information had gone into a client file where, unless he objected, it could be used to sell him other products, insurance products and financial products of other companies in the CIBC group. Without any justification, the insurer assumed consent and left it to the consumer to tell them otherwise.
It also appears that some institutions will use questionable means to obtain consent. I have another real-life example. In July, a staff member of LUAC received a letter from the Bank of Montreal, mailed to all holders of the Gold Mastercard. On its face, the letter offers the customer the opportunity to reduce credit card interest charges to 10.9 per cent. That is still pretty high given that bank prime is hovering below 6 per cent but presumably the new rate would be lower than the previous rate.
The offered rate is mentioned no less than 13 times in this piece, and that is the whole thrust of the letter, apart from a passing comment that the annual fee for the card will increase from $60 to $95, a roughly 60-per-cent increase. The letter describes that the annual fee "rises slightly." The letter has a tear-off authorization form at the bottom. The cardholder is asked to sign this "to activate your new low-rate card."
It is puzzling that the issuer of a bank credit card can adjust the interest rate or the fee charged to a cardholder as its cost of doing business changes. There is no requirement for the cardholder to sign an authorization for an interest-rate reduction. There is also no need for a cardholder to sign an authorization to increase the fee. You either pay the fee increase or you do not.
The only result obtained from the cardholder's signature on this self-described "Gold MasterCard Low Interest Rate Acceptance Form" is an acceptance by the card holder of the terms and conditions printed on the back of the tear-off form. Here it becomes kind of interesting. The terms and conditions are on a separate page from the signature in small print, even smaller than that used for trademark notices and for other legalese to be found at the bottom of the letter. The comments concern the bank's use of the cardholder information.
Ladies and gentlemen, this is a real-life situation. We can supply a copy of the form if you wish. The heart of these terms and conditions is to authorize the bank to:
... use the information in my MasterCard account to determine which product or services may be of interest to me.
It goes on to state:
... provide me with information and offers from the bank, or anyone else, that the bank believes may be of interest to me.
These terms and conditions occupy a very small part of the letter and relate to nothing else on it. A customer who signs this form will do so thinking that his or her signature is needed to obtain the credit card rate reduction which is being held out no less than 13 times on the other side. In reality, when the bank receives that signed form, it will obtain the customer's unrestricted consent to scrutinize his or her credit purchases and any personal information on file for the purpose of promoting undisclosed third parties and their products. This hardly demonstrates a scrupulous respect for consumers' rights to privacy.
When the government issues its promised privacy regulation, LUAC hopes it will be drafted to prevent this kind of practice. However, so long as there is money to be made from customer information, there will be an incentive to bend the rules.
LUAC looks forward to participating in future development of regulation to protect consumer privacy. I also wish to impress on you right now that in the business which our members know best, the retailing of insurance, the insurance business regulations that apply to banks and federal trust companies have provided very valuable safeguards for consumers' privacy since 1992.
The prohibition in the insurance business regulations against a federal deposit-taking institution passing consumer information to an insurance company, agent or broker prevents exactly this kind of marketing practice illustrated in this MasterCard letter.
That is why LUAC's brief in response to the white paper recommends that the insurance business regulations be maintained and enforced and that the parallel credit information regulations under the Insurance Companies Act be proclaimed in force at the earliest possible opportunity as the foundation for any future regulations that are adopted to protect privacy of customer information acquired by any federal financial institution, including life insurance companies.
I would like to turn to the second area of recommendation which concerns the need to protect the consumer of financial services from coercion. The white paper observes that concerns have been raised regarding the special nature of the relationship between financial institutions and their customers which can render the customers vulnerable to coercion. It also states there may be insufficient safeguards in market forces and in the Competition Act.
We categorically agree with those statements. The special relationship which is most likely to make consumers vulnerable to coercion is the relationship between someone who needs to borrow money and an institution that can lend it. That could be an insurance company, a bank or a trust company. We are not singling out any particular sector.
Coercion can take many forms. One of my predecessors in the chairmanship of LUAC has a client in the Vancouver area named Richard Hancock. We phoned Richard and asked him if it would be acceptable to document his situation when we appeared here. He was more than happy to comply.
Mr. Hancock had pledged some stock to the Royal Trust as security for a loan. About a year ago, he decided to sell the stock to retire the loan. Royal Trust insisted that he use Action Direct, a stockbroker in the Royal Bank group, to sell the stock. He wanted to use his own stockbroker but Royal Trust categorically refused. Mr. Hancock believes that if he had used his own stockbroker, he would have avoided delays in the trade caused by inexperienced staff at Royal Trust. Those delays cost him $625.
That may not be a huge amount of money, but let me go on. Royal Trust refused to make up his loss. Mr. Hancock complained to the provincial regulatory body that Royal Trust had subjected him to tied selling and failed to disclose the corporate relationship between Royal Trust and the stockbroker as required by B.C. legislation.
After the regulator questioned Royal Trust about the complaint, Royal Trust offered to pay the $625 and circulated a memo to advise its staff that it is not Royal Trust policy to require customers to use any particular stockbroker.
Mr. Hancock was reimbursed for his loss because he was persistent and comfortable in dealing with regulators and taking on the officials of a large institution. Most customers would suffer this loss in silence. This story illustrates that front-line staff in a large lending institution almost instinctively directed a trade to a corporate affiliate regardless of the wishes of the client and refused his suggested alternatives which would have protected the legitimate interests of the lender.
In dealing with a lending institution, it is obvious that the more you need credit approval, the more vulnerable you become. It is less obvious that individuals who are most vulnerable are consumers who need relatively small loans to solve the problems that keep them awake at nights. It is the small loans to which we would like to pay attention because a small borrower always needs a lending institution a lot more than the lender needs them. After all, to a lender, a small loan is a small asset that can have the same fixed cost to administer as a loan that has two or three more zeros to the left of the decimal point.
When a lending institution tells you that in today's market, coercion is not an issue because the lenders are competing for the borrower's business, think about the Canadians for whom the lenders are not competing -- hard-working families who rely on two incomes until one breadwinner loses a job, or small-business owners in a town where the big factory has just shut down. In those situations, the lenders do not even need to know how to spell "coercion." A word in the ear of a credit applicant that she really should have more insurance to cover her loan is all it takes to close the sale or to get consent to send her file over to a lender's insurance affiliate.
That is why our brief also recommends that the insurance business regulations be maintained and enforced and that the credit information regulations be proclaimed in force at the earliest possible opportunity as a foundation for any additional safeguards against coercive tied selling enacted under the Competition Act or similar legislation.
In sum, we agree with the assessment in the white paper that the legislative framework governing financial institutions that was established in 1992 is generally working well and should remain largely intact. We see the white paper's proposal for incremental change as the correct approach.
Looking to upcoming developments, LUAC understands that a soon-to-be-appointed task force on the future of the Canadian financial services sector will examine the whole structure of the financial services sector and consider changes to the framework to ensure Canada's competitiveness into the 21st century.
LUAC wishes to go on record as supporting the government's decision to establish the task force. We would encourage this committee to use its influence to ensure that the task force consults widely with Canadians, especially consumers, keeping in mind the ever-growing concentration of bank power in the financial services sector in Canada. Most importantly, however, we would urge this committee to advance, as quickly as possible, the introduction of legislative amendments to meet the March 31, 1997 deadline. We would be pleased to offer our views and to appear witnesses again when the draft legislation is before you.
Thank you for taking the time to go through this tedious process. We are open for any questions.
The Chairman: I have a technical question. We discussed with you at least two years ago the credit information regulations which have not yet been proclaimed. They are essentially the privacy regulations related to the Insurance Companies Act as opposed to being related to the other act.
Since I had not heard from anyone for a year and a half, I assumed they had been proclaimed. Does anyone know what the hold-up is?
Mr. Couillard: No.
The Chairman: When we discussed them with you some years ago, a clear draft had been developed. It was my understanding they were about to be proclaimed. What has happened? Do you know?
Mr. Couillard: We do not know what the hold-up is. We were before the House of Commons finance committee last week. We urged that committee, as we are urging you.
We are not here representing insurance companies, as you know. There have been instances with two major insurers where we saw a violation of this kind of information. The information was not being handled in a proper way. We went to those companies directly and separately, took them to task, and they reversed the practice.
The Chairman: Those were two instances that would have been outlawed had the regulations been proclaimed.
Mr. Couillard: Yes.
The Chairman: They would have violated the unproclaimed set of regulations which we discussed with you.
Mr. Couillard: They are happy. They are in favour, as are we, of protecting the consumer's right to privacy.
The Chairman: Do you have any insights on what the holdup is?
Mr. William T. Babcock, Vice-President, Public Affairs, Life Underwriters Association of Canada: We have none whatsoever.
Senator Meighen: Your presentation was extremely clear, concise and forthright. There is always this question of the efficiency of legislating morality and good practice. Perhaps we do need codes of conduct and legislation.
The Office of the Privacy Commissioner has offered the services of his office to act as a monitor or a court of appeal or ombudsman. I do not know whether you have any thoughts on that. Might that be helpful?
Mr. Couillard: We met with Commissioner Phillips about six months ago. We had a very fruitful working meeting with him. The LUAC was involved in all the discussions leading up to the CSA standards. We endorsed that. We support self-regulation and self-policing.
We do have an issue with the area of consent. How do we handle that? We would be happy to put those views forward with the task force and to work towards ensuring that consent is handled properly.
Senator Meighen: Your industry is largely self-regulated, is it not?
Mr. Couillard: Yes.
Senator Meighen: It sounds also as if your organization has been acting as a sort of an ombudsman in the case of the gentleman who dealt with Royal Trust and the other case you mentioned of the two life companies.
Mr. Couillard: If I was your financial planner, I would receive information from you about your dreams and your goals. I would help you to steer in the direction you chose and to reach your goals. However, I need to respect the information which I gathered in that process and to treat it very sensitively. Otherwise you will not keep me.
Senator Meighen: That is one sanction and not a bad sanction.
Mr. Couillard: That is a great sanction, yes.
Senator Meighen: Other than that, if you do not treat that information properly, what can I do to you?
Mr. Couillard: You can fire me. That is probably the biggest penalty.
Senator Meighen: I could also do that to a bank, could I not?
Mr. Couillard: Yes, you could, when the violation has already occurred. That brings us back to insurance business regulations or credit information regulations. Those go a long way to helping safeguard abuses right off the bat. That is why we endorse them. We want the IBRs to stay in effect because they are working well. We would encourage the proclamation of credit information regulations as soon as possible because they will go a long way to protecting you and I as everyday consumers.
Senator Meighen: Do you think that the abuses are becoming more numerous, or do you think it is just part of the scene which always existed and always will, and that the sooner we will get some sort of regulations in there, the better off will be those victims of abuses?
Mr. Couillard: Again, the IBRs and the CIRs will go a long way to protecting consumers.
As a practitioner, do I think abuses are increasing out there? I would say yes. The sooner we can keep these things in place without relaxing the rules, the better.
Senator Meighen: Do you have a view as to why it is increasing?
Mr. Couillard: There is money behind it. Any time money is behind consumer information or confidential information, rules will be bent.
Senator Meighen: That has always been the case, has it not?
Mr. Couillard: Yes, just to make a profit.
We are really advocates of protecting the consumer's right to privacy.
Senator Meighen: When you say money is behind it, do you mean that there is more intense competition to turn a profit?
Mr. Couillard: Profit is a driving factor with any financial institution, yes.
Senator Meighen: You are saying there are more abuses now, so I could argue that there is more competition. Yet, on the other side of the fence, you are telling me there is less competition.
I am not trying to trap you.
Mr. Couillard: I do not feel trapped. I am just trying to figure out which way this is going.
Senator Meighen: On the one hand, you say there is less competition and a concentration in the banks.
Mr. Couillard: I did not mean that.
Senator Meighen: Did I misunderstand you?
Mr. Couillard: The concentration issue is where there is a lot of concentration of financial power. In our industry, we have had 140 federally registered life insurance companies operating for over 100 years. The consumers have benefited. They have been the recipients of very strong competition. Our pricing has been very much driven by consumers' rights to have very competitive products and very competitive performance of those products. In our industry, in general, there is a lot of competition. It is not concentrating. However, when we see the concentration of power in the financial services sector, most assuredly the top five banks really are concentrating that financial power. We believe that is an overarching issue that the task force should and likely will address.
Senator Meighen: Without putting words in your mouth, do you believe that that concentration is causing increased problems in the areas of privacy and consent?
Mr. Couillard: Again, it is that relationship between a lender and a consumer who really needs that loan. That is the very dangerous one. That is where the consumer needs to be protected. Whether a bank, a trust company or a life insurance company is doing the lending, that is a very sensitive situation.
Senator Hervieux-Payette: With the Internet, this will increase again. I will be able to buy almost everything that can be produced on earth and make a cash transfer through my bank account. When I want to buy something, I would like at least to have a chance to do the shopping myself, not to have the shopping done for me.
To get around the issue of tied selling, I have my credit card with one bank and my bank account in another bank. Of course, the ordinary consumer may not think that is a good idea.
Mr. Couillard: Unless those banks merge.
Senator Hervieux-Payette: If they continue to merge, we may be left with only one.
I think we need some practical solutions coming from people such as yourself.
I come from the telecommunications sector. We hear various parties say that they will not use information or sell it to another organization. I am uncomfortable that a list of names can still be sold. When I sign, I do not know if 200 organizations will receive my name and then fill my mailbox full of garbage. If I am environmentally aware, I will feel strongly about the fact that millions of trees will die due to my signature on that piece of paper.
The Internet is making the marketplace more available to consumers and to the younger generation in particular. We must be careful. Normally, we would not choose to impose more and more regulations. It is rare that the private sector would ask us for more regulations. However, in this case, as more means are developed to penetrate each home, regulation is probably a good thing.
Your remarks seem contrary to the usual understanding of the private sector that government should not stick its nose into our business. You seem to be saying that if government does not interfere, flagrant abuses will occur and the people will not be well served.
Mr. Couillard: No; that is right.
Senator Hervieux-Payette: We must look toward the year 2000. We may change laws covering the next five years, but this technology-oriented world is moving at an extremely fast speed.
Mr. Couillard: We agree. We met with the House of Commons finance committee last week and with the Honourable Doug Peters about six months ago. We are concerned, as an association, about the effects of the Internet. An offshore company can start up and, using the Internet, market its products to Canadians. When you put your personal information into that system, you do not know where it will go. How do we regulate the practices of a life insurance company which does not reside in Canada but markets itself on the Internet? How do we monitor licensing activities, standards of education, ethics and practice and reserve requirements? That is a huge issue and it is definitely one that, in this explosive world of technology, is a concern to LUAC as well.
The Chairman: Thank you, gentlemen. We will try to find out why the regulations have not been proclaimed and let you know.
I assume you people will be part of the discussions on the new demutualization regulations. From your point of view, as long as policyholders are protected, the actual corporate structure is not of critical concern to you? I assume your concern is for the protection of existing policyholders' rights within a mutual company, as opposed to concern for the design of a demutualized company superstructure. Is that correct?
Mr. Couillard: We are satisfied as long as policyholders are first-line-protected policyholders.
The Chairman: In other words, you feel they are super premium in terms of the ranking order.
Mr. Couillard: They should be in the number-one position and should not be dethroned.
The Chairman: The other technical details are not of much concern?
Mr. Couillard: I do not want to say that yet.
Mr. Babcock: The devil is in the details.
Mr. Couillard: We would be interested in being part of that process.
The Chairman: That will be a fairly rapidly evolving field over the next few years.
The committee adjourned until 2 p.m.