Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 29 - Evidence - October 6, 1998 (p.m.)
OTTAWA, Tuesday, October 6, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 1:00 p.m. to examine the state of the financial system in Canada.
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Senators, our first witnesses this afternoon are a panel of three representatives from the mutual fund industry. We have Mr. Blake Goldring, president and Chief Operating Officer of AGF Management; Mr. Jim Hunter, president of Mackenzie Financial; and Mr. Bill Harker, Senior Vice-President of Trimark Financial.
Mr. Blake C. Goldring, President and Chief Operating Officer, AGF Management Limited: Senators, we appreciate the opportunity to make a presentation before you this afternoon.
Before we get into the substance of our presentation, I wish to introduce our group to you. Our companies, Mackenzie, Trimark and AGF, are three of Canada's largest independent mutual fund companies. Together we are responsible for managing assets of Canadian investors exceeding $67 billion. We do this through administration of over 5 million individual client accounts and we sell our products through a large network of financial advisors from coast to coast. In short, we may do much of our business on Bay Street, but we feel we truly represent Main Street.
The growth of our industry has been absolutely remarkable. Canadian consumers have continued to increase their levels of investment in mutual funds, demonstrating that they are very comfortable with this product. For example, in 1987, our industry had net assets under administration of some $20 billion. At the end of last year, overall industry assets exceeded $322 billion. Not only had value of assets increased incredibly, in the same period of time, the number of individual client accounts increased from 2.5 million to over 33 million individual accounts.
You might be wondering how that is possible with the Canadian population being what it is. However, it is common for an individual to have several individual accounts.
These statistics were provided through the Investment Funds Institute of Canada and they cover the 10-year period from December 31, 1987, to December 31, 1997. We are here today to talk to you about the importance of having money market mutual funds and why we feel that these funds deserve direct access to the Canadian payments system, and why we feel that this system includes both the Canadian Payments Association and the Interac Association on a cost-effective basis.
[Translation]
We appear today as a follow-up to our presentation to the MacKay working group. We want to inform you of our situation vis-à-vis the Canadian payments system.
We believe that allowing the money market mutual funds to join the Canadian Payments Association and Interac will result in more accessible and convenient financial services for the consumer.
[English]
Our companies joined forces to make representations to the MacKay task force on this subject because we believe that our industry has grown and matured to the point where we can safely and competitively enter the payments system with our money market mutual funds. The Canadian consumer deserves more choice when evaluating how to get the best return on their investments. At the same time, they want immediate and convenient access to that money. In our view, allowing customers direct access to the money in their money market mutual funds, without the need to make phone calls, bank transfers, dealing with another party, et cetera, not only provides a competitive alternative to the consumer, but it also allows a more efficient alternative. This is one of the reasons why we feel that membership in both the Canadian Payments Association and Interac goes hand in hand.
At least one of the big banks also sees this as an attractive alternative for their customers. Just two weeks ago, the Royal Bank announced a new type of chequing account; full chequing and Interac privileges with interest rates linked to money market mutual fund rates. In announcing this new account option, a bank spokesperson said:
Many people have funds accumulating in separate savings and chequing accounts and in short-term investment vehicles, such as money market, T-bills and short-term GICs. Rate Link, which is the name of this new product, replaces the need to transfer funds between all of these and lets them save, spend and earn high rates of interest all in one place. It simplifies their cash management so they can earn more while working less.
This example, Mr. Chairman, leads us to the key themes of our submission to the MacKay task force, which were: one, to provide greater consumer access to their money and make available to them more investment choices in the marketplace; and two, produce a marketplace environment that is more competitive with equal access for all participants. Our submission made eight recommendations, all of which fell within the scope of these two key themes.
I will now call upon my colleague, Jim Hunter, of Mackenzie Financial, to speak to the report of the task force itself.
Mr. Jim Hunter, President, Mackenzie Financial Corporation: Thank you for the opportunity to speak to you this afternoon. I will be brief, because we feel a question period will allow us to respond more directly to your respective interests.
We obviously were extremely pleased by the endorsement of our submission by the MacKay task force. In our principal objective, the report was clear. Money market mutual funds must be given full access to the Canadian Payments System. My colleague, Mr. Harker, will elaborate on the conservative security attributes of money market mutual funds, which qualify them for this access.
On a secondary but important principle of fair play, tied selling was also specifically addressed in the task force report. The elimination of tied selling practices will give approximately 50,000 life agents, investment brokers, dealers, and financial planners who sell investment products a fairer competitive environment in the towns and cities in which they operate in this country. The abuse of tying the replacement of an independently selected mutual or segregated fund with a bank's investment product to a bank loan application should result in a clearly defined regulatory action.
We are anxious to work with the government on these issues, and swift movement is absolutely crucial to our industry. As Mr. Goldring illustrated, the banks are established in the money market mutual niche already. Accordingly, a further delay in granting access to the payment system to our money market mutual funds virtually locks us out of this business.
In this regard, we have one final issue with which the MacKay report dealt obliquely. Although the broader definition of the payments systems includes both the CPA and Interac, the task force recommendation does not specifically deal with Interac membership for our money market mutual funds or other money market mutual funds. This is a crucial element to providing our customers convenience and ease of access to their accounts.
Access to Interac is critical. We need transaction-based entry fees into the Interac system that are level; we do not want to be blocked at the door by high fees that are different for different members. We want deposits accepted by Interac automated tellers that are not propriety to the institution which owns the machine, and the ability to utilize our own debit and credit the cards.
The services we would like to provide are available from participants in our industry in the United States. As a result, the money market business in the United States is approximately 40 times as large as the attendant Canadian money market business. More important, the business is not dominated by one financial service segment as it is in Canada. In the U.S., mutual funds and life companies and broker dealers are big players in the money market business. That is solely as a result of a more competitive environment for financial services in that market.
Opening up competition for money market fund services will have important positive liquidity ramifications for government securities, as well.
Without addressing Interac as well as the Canadian payments system, consumers will not be able to have direct access to their funds, and membership in the CPA will not provide the benefits intended by our submission and the MacKay task force.
We need full and equal membership, without any bank, other than the Bank of Canada, guarding the gate, just as the task force recommends, in order to provide the customers we serve with the same secure and convenient access to their funds as bank customers currently enjoy.
Mr. William C. Harker, Senior Vice-President, Trimark Financial Corporation: It falls to me to conclude our presentation by speaking on a subject that was raised with us when we appeared before the MacKay task force. It was hinted at in their final report and has certainly been a concern raised during meetings with officials in years gone by. The subject is the potential risks to the stability of the payments system by allowing us in.
Safety in the payments system means that participants have the incentives and capacity to identify and manage the risks to which they are exposed. It means that the system is governed by a comprehensive and transparent regulatory framework and is robust in the face of adverse shocks. In short, the stability of the system is really based on the stability of the participants.
I should like to take a few moments to summarize our view of the stability of our industry by making the following points.
The ability to process a debit against a money market mutual fund depends on the fund's assets and liquidity, not on the solvency of its investment manager, or its distributor, its custodian or any dealer.
The assets of a money market mutual fund are segregated and held by a qualified custodian separate from the assets of the investment manager, distributor, or dealer. They are therefore protected from any potential difficulties that an investment manager, distributor, or dealer might have.
In turn, the custodian is a regulated financial institution, typically a very large bank or trust company. The custodian keeps the mutual fund assets segregated from its own assets and liabilities; therefore, the fund assets are kept protected from potential difficulties of the custodian as well.
The investment guidelines for a money market mutual fund ensure low market volatility and relatively high asset quality. Most money market fund investments are concentrated significantly in government guaranteed securities with short-term maturities.
Money market fund units, when presented for redemption, are valued after taking into account all realized losses, accrued interest, and other liabilities. In the event of a material unrealized loss, the unit value would also be adjusted. Therefore, by definition, there are always sufficient assets in the fund to redeem all unit holders, and the highly liquid nature of the investments in a money market fund ensure sufficient cash can be realized to cover daily redemptions.
Financial statements for a mutual fund, including statements of changes in net assets and of the fund's portfolio, must be prepared and filed with the securities regulators on a semi-annual basis and audited on an annual basis.
Money market mutual funds have the means to meet daily demand redemptions by maintaining a portion of the fund's assets in cash, by borrowing, or by selling assets.
The activities of the investment manager are regulated through various means, but principally through National Policy Statement No. 39, or NP 39.
The regulatory focus of a mutual fund is on restrictions and practices designed to ensure fund investments are diversified and liquid in order that the fund can fulfil its role as a pooled investment vehicle redeemable on demand.
For these reasons, if there is failure of a mutual fund management company, there should be little or no impact on the investors in that company's mutual funds.
A Canadian money market mutual fund could therefore meet all, or substantially all, of the demands by any number of unit holders to redeem units within 24 hours. As you know, that contrasts with the ability of a traditional deposit-taking institution to independently satisfy the unlikely demand by all its depositors to withdraw funds. Beyond CDIC coverage, the depositor must rely on the creditworthiness of the institution.
I believe these points provide some food for thought. While I understand the basis of concern expressed in some quarters, I believe that this issue can be looked at in another way. On the basis of what I have outlined, what additional stability will we bring to the Canadian Payments Association and the payment system in general?
Again, I thank you for the time you have given us. I hope we have not gone beyond our allowable time. We certainly look forward to the discussion that will now take place.
Senator Tkachuk: With respect to the use of the payments system and the customers' use of the payments system, would you be extending credit to the people who own money market funds? For instance, I think of Canada Savings Bonds or treasury bills and things like that. Is that the way it would work? How would it work for the consumer? Take us through a practical application of how consumers will be able to benefit in respect of access to capital.
Mr. Hunter: There is no credit extended. Money market mutual funds are settled on the same basis as the overnight clearing in the bank system. Effectively, someone processes a cheque or a debit against that account. We would clear it that night against the unit value. Money market funds have essentially the same clearing as the bank system. They are cleared on T plus 1.
Senator Tkachuk: You mentioned credit cards and debit cards.
Mr. Hunter: Credit cards have access to the Interac system, as you are probably aware. Those particular types of transactions would be very similar to the banking transactions. If we offered them, we would need to extend credit, and that probably would be through our trust organizations.
Senator Tkachuk: You would be extending credit through credit cards. On the debit side, I would punch out an amount that I would like to have, for example, $200 or $300. You have a particular piece of security there related to that cash value in that account. What happens then? Do you sell the security to process the $300 or do you extend credit for $300 until you sell the security? Some will have terms of six months or three months. Does there have to be cash already in there?
Mr. Harker: The short answer to your question is, "No." The mutual funds that we are talking about will not extend credit to the clients. We will create access to the clients' accounts, which already exist. When they take the funds from their account, in most cases we will use the cash that is already in the mutual fund to redeem the units. In the event that the client asks for a large amount, we may need to sell some of the securities which are, say, 80 days, 90 days or 100 days average maturity, to realize the cash. In the normal course of events, however, there is no need to sell assets in order to meet the demands of the client through the debit card.
Senator Tkachuk: Do you see this going further? In other words, people putting cash into an account and using that as either an account for business or an account for personal use, or is this just to help them facilitate access to the extra cash they may need from time to time?
Mr. Goldring: We would like to establish a relationship with the financial advisors with whom we work across the country and their clients without the need to use another financial institution. Today, clients have to open a bank account in order to deal with us. We are looking to have a level playing field so that we can deal directly through our financial advisors and their customers.
Mr. Hunter: In the U.S. model, you do not have to deal with a bank to get all the types of banking service a normal individual in a community might need. You can get deposits, credit cards and cards from, say, Merrill-Lynch.
Senator Tkachuk: On page 6 of your brief you referred to "opening up the competition for money market fund services, which will have important positive liquidity ramifications for government securities as well." Could you explain that a bit further?
Mr. Hunter: Yes. By opening this business up, we believe it will expand the deposit base and you will put more buyers of government treasury securities into the marketplace. You will not be down to three or six banks. You will have Mr. Goldring's firm, Trimark, ourselves and some of the brokerage firms, who will also be big players in the money market business. Consequently, there will be more buyers of government treasury securities. It will be a more liquid market.
Senator Tkachuk: If you are accepted into the payment system and the recommendations of the task force are implemented, what will happen to your industry in five years time? Will you become part of the banking industry? How do you people see it? Why do you want this and why do you think that five years from now it will be a good thing for you, for Canada and for consumers?
Mr. Harker: Five years from now, you will see a thriving mutual fund industry offering a variety of product services attached to their existing accounts. We are talking about allowing clients to get at their funds in money market mutual funds from various places in the country without any competitive disadvantage. If we have that level playing field, we believe that we will be able to compete successfully and grow proportionately. We are not looking to become banks; we are looking to add services to our mutual fund business in order to satisfy our clients' needs.
Senator Tkachuk: Will your deposits be insured?
Mr. Harker: No. They are not deposits, they are units which are portions of a mutual fund.
Senator Tkachuk: But they will be treated as if someone had cash in the bank?
Mr. Harker: Yes.
Senator Tkachuk: I do not have to know what the vehicle is, I just know that I make a deposit. Whatever you do with it, I know that I have this much money and I use it like a bank account.
Mr. Hunter: Basically, we buy treasury bills and put them in the fund. When someone wants to access his cash, we redeem the treasury bills or use the cash flow to satisfy his demand for liquidity.
Senator Tkachuk: Do you expect to be charging for this service like the banks do? That is to say, will a fee be charged every time a transaction is made?
Mr. Hunter: Yes. There are fees on each of these accounts, and those are disclosed as appropriate under securities legislation. The investor receives a document stating the fees that will be payable long before he enters into any contract.
Senator Tkachuk: There will be fees for each transaction?
Mr. Hunter: I am not sure that is the case. Generally speaking, there are not transaction fees on mutual funds. The administration fee on the account covers all transactions.
Senator Tkachuk: That is like the bank used to do.
The Chairman: I wish to go back to your answer to the previous question to be sure I am clear on the process.
As Senator Tkachuk said, people give you money and you buy units. However, from the point of view of the consumer, it is cash that is there and it can be withdrawn. You then sell a security and put the money back into the account. Essentially, that is the process.
Presumably, the money that you withdraw will not be replaced on the same day that the asset is sold in order to put the money back into the account. Given the volatility of the market, is a risk element introduced by virtue of the fact that the cash deposit must come out of the account on one day and the asset that must be sold in order to replace that cash is sold the next day? To what extent does that volatility issue affect the stability of the system?
Mr. Harker: It does not affect it at all because we do not invest all of the money in T-bills or related securities. We invest a portion, saving about 10 per cent for this eventuality, which is in cash. We do not have to sell anything for the first 10 per cent of the redemption.
The Chairman: You are saying that, in a sense, the cash exists to pay a typical withdrawal.
Mr. Harker: That is right. However, if more than 10 per cent is redeemed on a given day, we have the right to borrow to cover redemptions up to 5 per cent of the money market mutual fund.
The Chairman: Borrow from whom?
Mr. Harker: From whomever we would like.
The Chairman: So you have a line of credit with someone?
Mr. Harker: Yes.
Senator Tkachuk: Can you see a time when you will ask for deposit insurance? Once you acquire the right to make transactions in an account and start offering the transaction service and investment accounts for customers, is the next step not to want to be able to take deposits that would be deposit insured and to provide more banking services?
Mr. Hunter: The investments in the account are basically government guaranteed investments. The only insurance you might need is transaction-based fraud insurance. That will not cause a major financial institution to fail. These are basically government guaranteed securities. By the nature of the securities in the account and the custody arrangements, you have a government guarantee but you do not have the insurance requirement.
Senator Tkachuk: Would the next step for your industry be to start taking deposits and being part of a group that insures the deposits up to a $60,000 limit?
Mr. Harker: It is very difficult to forecast the future. Our hope is that we would not ask for that and not need it. In a practical business sense, there is no need for insurance because you have the assets right there. That is our position at this point. It is hard to tell what the future holds.
Senator Tkachuk: A mutual fund company can never go broke?
Mr. Harker: A mutual fund can never go broke.
Mr. Hunter: That is to say, unless there is major fraud involved. It is not a mutual fund company that is at issue; it is the individual funds which are governed by strict investment definitions.
Senator Joyal: I would like to address my question to Mr. Hunter, and it relates to your statement at the bottom of page 5 and the top of page 6, in relation to the competition in the U.S., where you say that the services you would like to provide are available from participants in your industry in the U.S.
We have been told by representative of the banks that one of the key factors for their plea for major changes is the invasion of the Canadian market by the American mutual fund companies. Of course, Fidelity is always the example that is put forward. I am surprised that I did not find in your brief any kind of allusion to your competitors, and to the fact that, as we are told, the Canadian market, in terms of mutual funds in the forthcoming years, will face much more severe competition than it has faced in past years. You have had the capacity to report spectacular growth for the last 10 years. I would have expected that you would have come to us to ask for some protective measures because the rules of the game have totally changed over the last 10 years and you face competition worldwide. I do not hear from you or read from you anything in that regard. Am I wrong?
Mr. Hunter: No.
Senator Joyal: What makes you so optimistic about the future, while some other key players in the market fear foreign competition?
Mr. Hunter: There are two things I would mention. Blake and AGF and Trimark and MacKenzie have always had foreign competition. Templeton, which may be as big as, and is certainly as formidable a competitor as, Fidelity, has been in this country competing with us for 10 to 15 years, so we have always faced big competition. We also face it from our banking counterparts in Canada. We do not view this as an international issue. We view this more as bringing our paradigm up to date with what is happening in the world so that we can compete.
What we are really saying is that we just want access so that, if we are competitive and serve our consumers well, serve all the agents who sell our products well across Canada, we will have a chance in this particular market-place as well.
The electronic movement of cash will be a critical service to the end investor, whether he is in Quebec City or in Victoria. We want to be able to move that cash effectively and efficiently and on an overnight basis for the investors as they make calls on it.
Mr. Goldring: Perhaps we do not sound alarmist because we have total confidence, as Mr. Hunter said. We have faced foreign competition before. We also have a strategy to deal with it. All we are asking for is a level playing field. We would leave two key messages with you. The first is that we need a level playing field. That means that we have to be able to have access to the payments system, as well as to Interac, without having to pay the amortized cost to build up the system. In other words, we need to be treated equally.
Our second key message relates to timeliness. We require these changes to be made as quickly as possible. I reiterate the example that I read you, and I have here the press release from the Royal Bank. It is no coincidence perhaps, but they are where we have to go if we want to allow adequate competition and sufficient alternative product for Canadian investors.
Those are the two key messages. We need action quickly; and we need to be allowed in on a very cost-effective basis. We are looking for a fairly fundamental change in policy, not fine-tuning of the rules.
The Chairman: I thought I heard you say -- and I suspected that was the case by what was not in your opening statement -- you want, effectively, free access to the Interac network, in the sense that you are quite happy to pay a transaction fee in the future, but you want to pay none of the costs that have been invested in building up the network. Did I understand what you said?
Mr. Hunter: We will pay, in that transaction fee, the same embedded cost of building up that network as the banks pay. We do not want to pay a surcharge or a big entry fee.
The Chairman: You want to pay the same future transaction costs that all the other players pay?
Mr. Hunter: To maintain the system and keep it current.
The Chairman: Despite the fact that other people have invested a significant amount of time, effort and, particularly, money to build that up, you would like to get a free ride on that? Do I understand that correctly?
Mr. Goldring: If you want a world of competition, which we certainly believe in, we believe that it has to be fair to big players and little players. That would create an effective barrier preventing many mutual fund companies from being able to come into that area.
The Chairman: I think you have answered my question with the answer that you do want the free ride.
Mr. Goldring: I would not phrase it like that.
The Chairman: We need not argue semantics. I have a crystal clear understanding of your position. I am surprised you want a completely free ride, that you would not want to pay anything.
Senator Joyal: I do not want to start a discussion with the chair but you were barred from being a member of it. The chair cannot have it both ways. You are barred from being a member and then you are being accused of just wanting to enjoy the benefit. There is some qualification to that statement, Mr. Chairman.
I want to come back again to your answers to my question because it is very important for us to evaluate the condition of the market in the forthcoming years. Even though no one has a crystal ball, we can all appreciate that, if you had appeared six months ago, the prevailing economic conditions would have been certainly different from what they are today and might be tomorrow.
Your reasoning seems to be the following: Put us on the same footing as our competitors from the U.S. here in Canada and we will be able to beat them on our ground. Is that fair?
Mr. Hunter: Yes. Whether we will be able to beat them or not, as long as we are treated fairly, we will walk away from this table happy because we think we can compete. We certainly compete in a big block of our business, the equity mutual fund business. We are very competitive there, but the money market side is dominated by Canadian banks, and Canadian banks dominate the market for government securities as well, somewhat as a result of that business.
Senator Di Nino: It is interesting that you call yourselves "small players". Assets under administration in 1997 were $322 billion. That is not chicken feed in anyone's definition. We should congratulate you, as a matter of fact. You have done extremely well, particularly with the tremendous growth in the last 10 years or so, but do not refer to yourselves as "small players" because we may think differently of you.
I should like a point of clarification. I know you have said it but I think it is important that we emphasize it: The access that you are looking for to the Canadian payments system and Interac is for the money market mutual funds only.
Mr. Goldring: Yes.
Senator Di Nino: You are not asking for access, through that system and through the Interac, for the other products that you sell, is that correct?
Mr. Goldring: That is correct.
Senator Di Nino: In effect, if I understand it correctly, that would give you the ability to accept deposits, if I can use that term, like a quasi bank, which would allow your clients or customers who do not need, say, a line of credit, to deal with you exclusively as opposed to dealing with another financial institution?
Mr. Goldring: That is correct.
Senator Di Nino: But you do not want, from what I understand, the restrictions or the other aspects of regulatory or legal requirements of other financial institutions, is that correct?
Mr. Goldring: That is correct. In fact, all three of our organizations have trust companies, so we are all regulated.
Senator Di Nino: I was going to get to that.
Mr. Goldring: So far then, yes.
Senator Di Nino: I would suggest that you are, perhaps, seeking some special privilege here.
Mr. Hunter: I would say no. The issue is that we are regulated as mutual fund dealers and investment managers. We do not see a way around the cross-regulation of all the different financial institutions we would have within our umbrella of companies.
Senator Di Nino: You are asking us to accept your recommendation that the system be opened up to you for a group of Canadians -- the upper 10 per cent, 15 per cent or 20 per cent -- who would have cash on hand, without the necessity of having to serve the other 15 per cent or 20 per cent of the market served by the deposit-taking institutions under the banks, trust companies and credit unions. They serve this market at a loss sometimes.
Mr. Goldring: The mutual fund product is the most democratic investment vehicle ever invented. I can say that without any qualification. We serve millions of small Canadian investors across the country. Our average account is in the thousands of dollars, not in the millions of dollars.
Senator Di Nino: As long as he or she has cash.
Mr. Hunter: You can open a mutual fund account at Mackenzie with $50, and we have over 75,000 monthly deposits that would be under $100 a month. It is a very democratic product. It is just like going to a bank or Canada Trust with your child's deposits. We will open an account for your child.
Senator Di Nino: Each of you has a trust company. You are providing, in effect, an additional service to the community at large and clients who would like to deal with you on services other than specifically mutual funds. Am I correct?
Mr. Goldring: Yes.
Senator Di Nino: Do you all have branches of trust companies?
Mr. Harker: No. Only Trimark has branches.
Senator Di Nino: Trimark has branches, and the others just have one head office. You accept GICs and you are trustees for pension funds and RRSPs, et cetera. You compete with the banks and other trust companies in that area.
Mr. Hunter: I cannot speak for the others, but the principal reason for us to have trust companies is the trusteeship of RRSPs. That is a major business for us. We cannot give it away to the banks.
Senator Di Nino: I agree with that, by the way.
What is stopping you in the near future or long-term future from starting your own bank?
Mr. Hunter: Nothing.
Senator Di Nino: Thank you for that.
Mr. Harker: There is nothing, that is right. We own trust company subsidiaries now, but we were forced to, in a sense, in order to get partial access to the payments system. That was a key factor in Trimark's purchase of its subsidiary.
What we are talking about here is the appropriate regulation for this kind of a business, for money market mutual funds. That is the key question, I think.
Senator Di Nino: On page 6 of your presentation, you talk about needing full and equal membership without any bank, other than the Bank of Canada, guarding the gate to the CPA system. Can you elaborate on that? I am not sure I understand.
Mr. Hunter: Through the CPA, you have to clear. We do not want to clear.
Senator Di Nino: You want to be a direct clearer.
Mr. Hunter: Yes. If you are an indirect clearer, there is someone between you and the system. That player is a major competitor. We do not think that is fair.
Senator Di Nino: You would like to be a direct clearer.
Mr. Hunter: Absolutely. We want to control our own destiny, not have a bank or someone else between us.
Senator Di Nino: A question was raised regarding the independence or lack of independence of the board of the Canadian payments system. Are there any comments you should like to make in that regard?
The Chairman: I believe Mr. Harker is on the board.
Mr. Harker: I am on the board of the Canadian Payments Association as part of the trust company with which I am associated.
Should we decide that mutual funds or any other major category of new participants in the payments system be allowed in, as it were, we believe they should be represented on the board of the payments association. That is important.
Senator Kolber: Do you perceive the potential merger of two large banks as a significant threat to the mutual fund business? It has been postulated that if the Royal Bank and the Bank of Montreal got together, their combined income from mutual funds would be $400 million. I do not know if that is accurate. I heard that if they really wanted to get serious about it, they could cut their costs significantly without really harming their overall enterprise, and slowly cannibalize the Canadian mutual fund business. Do you put any credence in that?
Mr. Goldring: We have had to go against the major groups. It would not matter if you added two or three together. They would just be that much bigger. We are used to taking on larger competition. We pride ourselves on being able to go nose to nose against them because it comes down, ultimately, to service.
We are thankful that you have been listening closely to our message today. If we get these changes through, we will be able to compete on a level playing field. Simply having more dollars in the kitty to spend on marketing will not win the consumer.
Senator Kolber: Are you not fee sensitive?
Mr. Goldring: Certainly we are fee sensitive. All of our firms look at that very closely. I personally spend a lot of time trying to get the management expense ratio that consumers pay down as low as possible. That is a challenge. I cannot comment on what strategies the banks may or may not pursue in the future.
Senator Kolber: Is the answer that there is no threat?
Mr. Goldring: It is definitely a challenge, one we would have to look at very hard.
Mr. Hunter: If you cross out money market mutual funds from the bank mutual fund business, they would be smaller than each of the players at this table. It is the money market mutual fund business that makes the Royal Bank bigger than us.
Coming back to the fee issue, the buyers of mutual funds want good performance on equity products. They probably play off debt products against bank deposits. I suggest that a debt-based mutual fund has outperformed a term GIC over the last few years.
The last area is service. That is really where we want to concentrate on, and this access to the payments system will allow us to enhance our services.
Senator Callbeck: If the recommendations of this task force are implemented, do you see yourselves down the road getting into any other areas of the financial services industry, whether it be selling insurance or setting up a bank?
Mr. Goldring: We have banded together on this very important issue. We all believe in bringing value to the individual customers across the country. If we can add value to the chain of investments, we will do so. It is difficult to go beyond that at this point.
Mr. Hunter: I would suggest that my honourable colleagues have quite sophisticated businesses. They are in the mortgage business and the GIC business, but in minor ways. If we can give our investors and dealers better electronic access to those products, we can expand those lines of business.
Mr. Harker: We each sell our products through an independent financial advisor. There are many thousands of them out there. I am sure that many of those advisors are telling my colleagues that they wish to provide more services to their clients, and they want us to manufacture those services for them. If we can figure out a way to do it cost effectively, we will probably be there.
One of the ways of making it more cost effective is to support these recommendations. Our membership in the CPA will reduce our costs overall. We will be able to be more effective and, perhaps, deliver more services to our advisors for their clients.
Senator Callbeck: I have a question on tied selling. I notice the only sentence you have in your brief states that you are pleased with the recommendations on tied selling. Does that mean you are satisfied with the recommendations and you feel that, if they are implemented, that will be the end of tied selling?
Mr. Goldring: It was one of our key recommendations of the eight that we made before the MacKay task force. We were delighted to see it advocated that Parliament pass the rule prohibiting tied selling. Frankly, it will require real vigilance. I know I can speak for my colleagues when I say that we do hear about these situations; and there will be many watchdogs to look after the interests of the small investors.
Mr. Hunter: It is tremendously important for the financial planner or the life insurance agent on Main Street. He is the one who faces the local bank manager who has more weapons in his quiver than our salesperson. Tied selling is very important to our distribution sales force, and more important than it is to us as individual companies.
Senator Callbeck: Are you satisfied with the recommendations, then?
Mr. Hunter: Yes, and the response.
The Chairman: Your attitude vis-à-vis the tied-selling issue and your competitive position vis-à-vis the banks is totally different from the first presentation we had last night from the Insurance Bureau of Canada. Your attitude seems to be that, provided there is a good regulatory scheme in place to deal with the tied-selling issue, and provided you have access to the payments system and Interac, they are tough competitors, but you are prepared to take them on. Given what you view as the service quality of your sales force, you will, in fact, be able to beat them. That is a position I totally understand.
Can you help us to understand the level of paranoia that seems to exist elsewhere in the financial services sector? Last night, we were painted pictures of 20 per cent of all the employees in the business being laid off, and thousands of agents and brokers disappearing. Yet, the basic process is the same as the process you are talking about, namely, the banks would enter and provide competition in what is very much a service-related business.
Can you help us understand why you are quite confident of being able to perform well in that environment and other people are terrified of it?
Mr. Harker: I do not think we can comment on how other people arrived at their position.
The Chairman: You have had experience in taking on the banks. It is troubling to us to see such radically different viewpoints on what is essentially the same business proposition.
Senator Tkachuk: You sell a product about which the customer can judge performance. If he looks at Trimark, Templeton, and others, he can say, "They are beating the Royal Bank and the Imperial Bank of Commerce mutual funds all to hell. I am going there." The banks are selling products that no one really wants. You do not want to die, nor do you want to have your house burn. That is my view of the situation, which is why there is concern on their part. You cannot measure the performance of a life insurance policy because you are dead.
Mr. Hunter: Life insurance is still a sophisticated sale, and there is a place for it in every family's planning. Many of our distributors are life agents, and I do not think that the banks will be able to roll right over a them. What a property casualty agent sells is more of a commodity. A life product involves a sophisticated sale. It is important to people's financial planning in terms of how many kids they have and where they are in their lives. I may be wrong about the casualty business, but I think that, at the lower end, with cars and houses, it is more of a commodity.
Senator Di Nino: It is also compulsory.
Mr. Goldring: We feel we can move as long as these changes are fairly timely. Obviously, the world is moving ahead of us. In that regard, I mention one product in my brief. Several other bank products have been launched, one specifically by the TD Bank. With some other products the longer the process goes we, the worse our competitive position will be.
Senator Oliver: You want your changes implemented right away.
Mr. Goldring: Yes, as fast as possible.
The Chairman: Gentlemen, thank you very much for coming. I should tell you before you leave that your basic proposition falls on reasonably receptive ears in the sense that this committee is on public record, in at least one report in the last couple of years, as being in favour of a dramatic opening up of the payments system to all financial services companies.
In the past, we have also looked at the Interac issue. Our instincts are to be very much where you are on that question.
Our next witness is Mr. William Loewen, who is President of TelPay, a Winnipeg-based company in the telephone bill payment system.
Mr. Loewen, rather than deal with the content of your brief to the task force, perhaps you would summarize the points in your letter? Having read both, your letter really says it all. We can then proceed to questions.
Mr. W.H. Loewen, President, TelPay: Mr. Chairman, I am making this presentation based on my 30 years of experience in competing with the five major banks. If it seems like a commercial, I apologize. All I can say is that I know many other entrepreneurs have had similar experiences but were not as fortunate as we were. I wish they could be here to support this presentation.
One analysis of the MacKay task force report states that the recommendations cover four broad themes which are enhancing competition; empowering consumers; Canadians' expectations in corporate conduct; and improving the regulatory framework. Unfortunately, from our point of view, very little has been included in the report that even recognizes our concerns, let alone deals with any of them. This is in spite of the fact that we have made and continue to make a significant contribution to most of these areas.
With regard to enhancing competition and competitiveness, for the past 30 years I have run two businesses that were direct competitors to the five major banks. First, I founded Comcheq Payroll Services, not knowing that the banks were going to be my competitors. While Comcheq was very successful, we suffered from constant disadvantages at never being allowed to position ourselves as a direct clearer.
Having started with $15,000 capital, we eventually rivalled the Royal Bank and the CIBC in size, and certainly exceeded all of them in efficiency. The regulatory situation eventually led us to decide to sell. Although we had a much higher offer from ADP, an American firm, we felt we should sell to a Canadian bank where we thought the trust account of over $100 million and our customer base would be in good hands.
Five years later, all the banks have sold their payroll services to one of two U.S. firms which now control over 90 per cent of the payroll service bureau business. A part of Comcheq that was not sold was TelPay. TelPay is an electronic bill payment service operating coast to coast. Input to this service is by telephone or computer. It is a service used by nearly 200 smaller financial institutions, mostly credit unions, but including three banks. Over 700 utility companies, credit and charge card companies and a variety of other organizations can be paid through this service.
After analyzing the impact of both these operations, I am positive that anyone would agree that we have greatly enhanced competition and competitiveness. In fact, they both achieved the position of sole competitor to the five major banks.
Comcheq's existence gave consumers, in this case, a business alternative. They could change their bank accounts without changing their payroll service. Customer mobility is a great deterrent to excessive pricing and something that the major banks abhor.
TelPay accomplishes the same thing for consumers but allows nearly 200 smaller financial institutions to provide telephone banking services efficiently.
Both Comcheq and TelPay have conducted themselves in very responsible ways with regard to Canadian expectations and corporate conduct, much more responsibly than the banks, we would say. We have won many awards for business accomplishments and community support. We have provided our customers with the most comprehensive confidentiality and privacy standards and have argued for their enforcement by law against the banks.
We have handled billions of dollars of customers' funds responsibly and safely, never having suffered a loss through all of the financial turmoil of the past 30 years.
In terms of improving the regulatory framework, we have failed. We have made many representations over the years but have rarely had an impact, even though we sincerely believe that what would help us would help many other businesses and individuals.
The task force also recommends managing change. We are certainly leaders in change, showing the way to the major banks, in fact, in bill payment services. With respect to technology and change, Comcheq and TelPay have been significant innovators.
We have certainly had an entrepreneurial culture. We would always agree that prudential regulation is important and have regulated ourselves most prudently.
There is a need for flexibility. We believe that this is a most important need through this period.
We seem to be in agreement with most of what the task force says, and in many ways we are already doing the things that it recommends. However, it has done nothing to relieve us from the oppressive reign of the Canadian Payments Association, which currently thwarts us in much of what we try to do.
There are recommendations to allow regulated bodies to join the CPA. Make no mistake, the CPA is and will be run by the major banks with the present situation. They have the votes, which are based on transaction volume. They pay the bills and they have the resources to participate in the endless meetings that take place to discuss changes they do not want to implement. They engage in public relations activities such as the so-called stakeholders advisory committee. They disbanded what amounted to a large value transfer system nearly 20 years ago and still have not been able to implement a new one. There is no representation in this body from those who actually pay for the cost of clearing, that is businesses and the consumers.
The problem with the CPA is fundamental. Its purpose is solely to regulate a system that affects every Canadian individual and business. However, the regulators are effectively the five major banks. It believes it is a law-making body but is answerable only to the direct clearers.
As it turns out, many people in Ottawa also seem to think that it is a law-making body. As such, it is probably the least democratic of all institutions imaginable. There must be fundamental change in the regulatory process if there is ever to be meaningful competition in financial services. We must be able to go before an independent board to plead our case for changes.
As innovators, it is important that we be able to get approval for changes quickly. We should not be asked to present our case to our competitors who will stall their decision until they have implemented our proposal. If there is to be a law-making body, surely it should not be the five major banks.
We would like to have implemented a decision that would permit independent processors to provide the public with online access to their bank accounts. This is an idea that would seem preposterous to the CPA. However, I believe there is a good argument that such a process would be acceptable if presented to an independent body. It does not deviate to any great degree from the present process where we have access to other people's accounts with their authority on an overnight basis.
In another vein, I disagree with the task force recommendation regarding foreign participation in the Canadian market. In the early 1980s, over 50 foreign banks were chartered in Canada. Their impact has been minimal.
Closer to home is the recommendation that Industry Canada consider developing a legal framework for electronic commerce from foreign service providers. What about the Canadian service providers? Why is that we constantly assume that Canadians cannot do the job?
My guess is that the major banks proposed this. They are in the process of making a deal with Microsoft and First Data Corporation of the United States. No doubt the CPA rules will accommodate that alliance. Already, many Canadian bill payment transactions are being processed in the U.S. Is that what we really want?
In due course, I expect that the Canadian banks will be foreign-owned just as many other industries are. One of our great natural resources is business opportunities. New opportunities arise as technology changes. Should these opportunities go to Canadians or to foreigners?
Another point I would like to raise is the constant barrage of comments about risk. What we propose does not involve risk to any system. We simply carry out customers' instructions, received in every bit as secure a manner as any bank. We would be glad to be regulated or subject to an appropriate kind of special audit. I am certain that we would stand up under any such examination.
More details of our past experience are included in our presentation to the task force which has been circulated. Unfortunately, I am here on rather short notice and have a fairly busy schedule. I will be glad to circulate these notes, but at the present time they are in handwritten form. I would be very happy to answer any questions.
Senator Meighen: Do I understand correctly that you would like to have the CPA remodelled along the lines of a regulatory authority such as the CRTC?
Later in your presentation you said that it was important to receive decisions quickly and to be able to move with some speed. I did not think that was a characteristic of the CRTC, but I stand to be corrected.
Mr. Loewen: I am not thoroughly familiar with the operations or effectiveness of the CRTC. However, I am sure you would find the CRTC an even less effective body if it were run by Ted Rogers or Izzy Asper.
I do not think Moffat Communications would appreciate that. Effectively, that is what we have with the Canadian Payments Association. It is run by a tight little group according to its own interests. Every now and then it throws out a carrot to keep people happy, but usually it is some time after that carrot is effective.
Senator Meighen: Are you suggesting that it might be better to have it run by non-industry players?
Mr. Loewen: Yes, they would have to be non-industry players and I am sure they would gain experience in what is required. Presumably a process could be set up whereby specialists could be consulted.
Senator Meighen: Assuming that your proposed world came to pass, would you have any comments with respect to who should have access to the payments system? I am thinking of the representations which were made to us by the previous witness, and which you may have heard. Other people have also asked for the CPA to be opened up. Would you support that?
Mr. Loewen: I would very much support that. There needs to be a certain number of groupings. With today's technology, perhaps you can have many hundreds of direct clearers. Certainly there should be a lot more than there are right now. A direct clearer that serves a particular industry would perhaps be a first step. Definitely, there should be many more direct clearers.
Senator Meighen: Can you help us with any other insight on the MacKay report and matters other than the payments system, with which this dealt principally?
Mr. Loewen: I must confess I have not read it all. From what I have read, almost all of it is excellent except that they did not go into the question of who will run the actual nuts and bolts of the whole industry; that is, how the money is moved around. That is the only area that I found seriously lacking. I also do not agree with the foreign part of it.
Senator Meighen: Do you mean foreign ownership?
Mr. Loewen: I refer to foreign ownership. I do not think we need foreign ownership in such a vital industry as this. I do not agree that we should look to foreigners to solve these problems, which we can solve for ourselves. I do not agree when they say we must go to foreigners for service providers. Microsoft is courting the banks right now and Microsoft has a plan to handle all the financial transactions of the world -- certainly all the bill payment transactions of the world. At least that is what we hear from them.
I think these opportunities should be left to Canadians. I am not saying that selfishly. I am way beyond my retirement plans. I would love to be out of this, but I have some employees and customers whom I would like to see succeed.
Senator Meighen: Can that be accomplished without regulation, which some people would view as being restrictive vis-à-vis foreigners?
Mr. Loewen: I do not see that my request is restrictive, if that is what you mean. We should proceed in a responsible way and just do what we think is right for the market-place. Right now we are planning to put forth something that will cause the Canadian Payments Association to jump all over us. We will probably go ahead with it anyway because someone else has asked us to do it. We have done it for a while and the banks are doing it for themselves. We will see what happens.
The fact is, many of the dictates of the Canadian Payments Association are not obeyed by the insurance companies and others. In a way it is a farce, but you never know what will happen to you. Contrary to their explicit promises of a number of years ago, they put a restriction on allowing payments to credit card companies on our service. They said telephone, hydro, water bills and so on are okay, but credit card payments are not. Why? It is because all those other bills are regular payments. Supposedly, our phone bills will be in similar amounts every month, but credit card payments will not.
We had to live with that for about five years. We finally got it changed so that we could go after the whole market-place instead of just a little bit of it. Meanwhile, they were starting to introduce the same service and, of course, they did not restrict themselves that way. There is a rule H6 in there that is just a joke as far as fairness is concerned. They govern themselves in one way for their bill payment operation. Rule H4 governs us in a totally different way for our business.
It is a strange organization. I do not know how they can have the gall to try to get away with such things. In part it is because some of the more serious things are ignored.
Senator Angus: In your brief, which was submitted in September of 1997, did you follow that up with a personal appearance to the task force?
Mr. Loewen: Yes, I did. I believe it was in December. They were in Winnipeg around December, I think.
Senator Angus: Is that when Mr. Baillie was still the chairman?
Mr. Loewen: No, it had just changed to Mr. MacKay. Mr. MacKay in fact was not at that meeting because he had just been named.
Senator Angus: It seems your principal criticism of the task force report is that it does not seem to deal much with the payments system.
My understanding may be wrong, but I would like to know your understanding. When this task force was set up and when its terms of reference were outlined, they took out the payments system basically and referred it to a special technical group directed by the Bank of Canada and people who had a better knowledge and understanding of that complex process. Is that true?
Mr. Loewen: I do not know about those details. I do know that the Bank of Canada and the Department of Finance, perhaps in June or July, produced a report about the payments system.
Senator Angus: Have you read that?
Mr. Loewen: I have scanned it. I find that it is not at all what I would like. It is one of the bases on which I say that there are people in Ottawa who think the Canadian Payments Association is a law-making body. Perhaps in effect it is, but I do not know why the banks should be making the laws of this country. I am not a lawyer but, effectively, their decisions become commercial practice, which is almost commercial law.
Senator Angus: I appreciate that. Your comments were directed both to the main MacKay task force report and the companion piece on the payments system.
Mr. Loewen: That is right.
Senator Angus: In terms of your own organization, I understand you were a pioneer in the electronic payment of bills.
Mr. Loewen: That is correct.
Senator Angus: Part of the business was sold off, but the bill-paying part, TelPay, is still going. Are you the president of it?
Mr. Loewen: Yes, I am.
Senator Angus: How many employees do you have, sir?
Mr. Loewen: We have about 30 employees.
Senator Angus: What kind of equipment do you have? I take it this is all done somehow with computers.
Mr. Loewen: Yes. We started developing this system. We were going to turn Comcheq into a bank and we felt that we had to have an electronic delivery system for pay cheques and so on. We developed that and had it all functioning very well.
In addition, we wished to give employees that were paid through Comcheq telephone access to their accounts. The process of developing it started in 1981 or 1982. We could not buy a voice response system so we built our own. We designed the entire system ourselves. We used some great technology from a company called Waterloo Microsystems, and had the entire system operating by 1985. That was possibly the first totally branchless banking system ever.
At any rate, the long process of trying to become a financial institution dragged us down. For multiple reasons we finally decided to sell, because there is just no beating the banks.
Senator Angus: You are still doing electronic bill paying.
Mr. Loewen: That is right.
Senator Angus: Have you upgraded your software?
Mr. Loewen: It is always being upgraded, and we still use that old Waterloo Microsystems system, which is still as efficient as any system available today. It is all micro-based and, of course, the micro-computers have been expanding in capacity, so that works fine. It is very much the same system that we started out with. We had many lessons to learn at first, but it is basically that system which is being expanded all the time.
Senator Angus: Your activities fall into the general category of electronic commerce?
Mr. Loewen: That is right.
Senator Angus: Are there other players in that field in Canada besides yourselves and the banks?
Mr. Loewen: There may be.
Senator Angus: Earlier you mentioned your competitors, and said that you would like to keep this activity in Canada. I am aware of a couple of businesses that are in your area. Consider Bell's development of an electronic commerce business that operates on a bill-paying basis. Bell recently merged MPACT Immedia Inc., which is in that same field of paying bills. Are you familiar with them?
Mr. Loewen: No, I am not. I know that Bell is involved in electronic commerce with EDI, but I do not know whether there is anyone else. There are always other things happening. I am not aware of anyone else actually processing the debit to the bank account.
A whole range of things is involved in electronic commerce, but we are effectively involved in moving funds from one bank account to another. If Bell is doing that, that is a surprise to me.
Senator Angus: As you understand it, you are the only ones doing what you do?
Mr. Loewen: That is right, we are the only significant provider. It is not an easy business to get into. We have a list of 700 companies to whom we can make payments, and making those arrangements is not a simple task.
Senator Angus: I expect you would like us to have that list increased and unshackled?
Mr. Loewen: We will increase the list ourselves. What we want is to stop feeling harassed by regulations. We are currently in the midst of a problem with the Canadian Payments Association and Revenue Canada. Revenue Canada took the position that only the five major banks could handle electronic remittances to Revenue Canada. That position was due to an agreement that the department had made with the Canadian Payments Association.
Revenue Canada understood that the agreement with the Canadian Payments Association prevented any other financial institution from making an agreement with us. I believe that it is quite beyond the mandate of the Canadian Payments Association to dictate the nature of any agreements its members make with us, so long as we are not impacting the clearing system. The CPA has already admitted that we are partly right and I am sure they will go the rest of the way. Meanwhile, we are in what is almost a dogfight with them, and a problem with Revenue Canada. It is very important for us to be able to make those payments.
Senator Angus: I appreciate that, sir.
Senator Joyal: Since you created Comcheq, are you aware whether the system that you have been putting together -- and that has been sold to CIBC -- has been improved substantially? Did they do R&D to make the system better, or did they make any fundamental changes in order to make it a different product than the one you sold them?
Mr. Loewen: They have not really done so. They have added some personnel systems, but essentially CIBC bought Comcheq because its own system was in deep trouble. Our payroll system had always run on mainframes, but we had been able to convert it to run on micro-computers. The main reason they bought us was because it would allow them to take this mammoth system off their mainframe and process it on micro-computers. While the same staff that I worked with at Comcheq is still there and handling the developments, the emphasis has been on converting existing systems rather than on working on new innovations.
Senator Joyal: You now operate the TelPay service. Is a similar kind of company or service system available in the U.S., and do you think it might one day compete with you for the same market?
Mr. Loewen: Yes. Checkfree is quite a large company in the United States. It operates very much like we do, although there are some differences. The company is coming into Canada, but I do not know whether it is coming in with bill payment in particular. The more significant development is the alliance between Microsoft and First Data Corporation in the United States. First Data has done bill payments and handled bank processing for many years in the United States. They are allying with those two, creating a company called MSFD, and they are causing worry for the Canadian banks right now. I understand some agreements may already be in place.
Senator Joyal: In the near future do you expect that there will be substantial differences of competition context or environments for your company, or services like yours, in Canada?
Mr. Loewen: That is right.
Senator Joyal: If the changes which you have asked for are not implemented, do you fear that your position could be jeopardized in a greater way than it would be if the status quo were maintained?
Mr. Loewen: We have been pretty persistent in the past and somehow things never work as well as they should. I would not say that we would go out of business. Quite frankly, something like the Revenue Canada situation, where we may not be able to offer a whole range of payees, is a bigger threat than a competitor is.
I am not worried about Microsoft an a competitor. I just believe it would be better for Canadians to have the opportunity to make a choice. The banks have a similar payee base to the one we have, and they are perfectly free to turn that payee base over to anyone. At present, it looks as though they will turn it over to Microsoft.
Senator Joyal: In other words, you are not concerned by the competition that you might get from abroad; you are more concerned about the rules prevailing here in Canada.
Mr. Loewen: That is my concern. I would like to see lots of competitors. In fact, I would like to be here representing an association, not an individual company.
Senator Kroft: I do not want to put words in your mouth, but if the regime governing this area and the rules were fair, would that be an enhancement of the competitive environment?
Mr. Loewen: Yes, it would.
Senator Kroft: That kind of environment would stimulate the introduction of new, innovative competition into the marketplace?
Mr. Loewen: The competition bureau would have ensure that it happened. Let us say that the banks decide that they want to farm out the bill payment process. If each individual bank had to farm it out to different organizations, you would have great competition. However, if you allow the banks to do what they have done in the payroll business -- that is, to farm it out to a limited number of players or maybe even one player -- then we will be that one other body. That might be good for us, but I do not know. If I were afraid of competition, I would not be competing with the banks.
Senator Kroft: Concerning the payroll issue, there have been two acquisitions by your company, Comcheq. The result is that today the entire payroll business is owned by one American company, is it not?
Mr. Loewen: No, it is owned by two American companies. It is the payroll service bureau business. Other people provide payroll systems for in-house operation.
The Chairman: Thank you very much, Mr. Loewen. If you could type your notes and send them to us, that would be terrific.
The last witness today is Mr. Graeme Rutledge. Mr. Rutledge, we are all familiar with the Canadian Institute of Chartered Accountant, having had extensive dealings with it on a number of other issues over the last years. We are delighted to hear you on this subject today, and not on joint and several liability. We have exhausted our patience and level of interest on that issue.
You have circulated a brief. Please touch upon the highlights of it, but we understand the central issue -- namely, the accounting standards change, which is found on pages 104 and 105 of the main volume of the task force report.
I also understand from your staff that you issued a press release today, the content of which appears to be covered at the top of page 4 of your statement.
Mr. Graeme K. Rutledge, Chairman, CICA Financial Institutions Reform Study Group, Canadian Institute of Chartered Accountants: I am a senior partner with Deloitte and Touche and Chairman of the CICA's Financial Institutions Reform Study Group. With me today are Ms Sylvia Smith, Director of Accounting Standards; and Ms Diana Hillier, Director of Auditing Standards. We have been invited to comment on the report of the Task Force on the Future of the Canadian Financial Services Sector.
The CICA fully supports the important initiative carried out by the task force. Over the course of the project, we have made representations to the task force and we have met with the task force and its staff on a number of occasions. My presentation today will concentrate on one of the matters addressed by the task force, namely, accounting for business combinations.
We want to inform the committee of the recently developed plans of the CICA's Accounting Standards Board for addressing accounting for business combinations in a timely manner. Before I do that, I should like to provide the committee with some important background and observations on the issues involved in this rather complex area.
Our presentation today will also briefly address certain issues relating to stakeholder information needs, corporate governance, and the regulation of financial institutions.
First, I will address accounting for business combinations. Recommendations 42 and 43 of the task force report address the impact of accounting principles on the competitiveness of financial institutions, especially in the area of accounting for business combinations. Essentially, the recommendations encourage the accounting standards board to be sensitive to changes in accounting principles that might negatively affect the international competitiveness of Canadian financial institutions, or which might impede the start up and growth of new financial institutions.
The Accounting Standards Board is the CICA body charged with the responsibility to set accounts standards in Canada. The board's basic mandate is to establish and improve standards of financial accounting and reporting. Several groups benefit from the work of the Accounting Standards Board, including users, preparers and auditors of finance statements. Indeed, the public at large benefits from quality financial information.
The effectiveness of finance reporting is judged based on the extent to which it enhances the accountability, transparency and comparability of all entities competing for capital in today's market. This sort of quality financial reporting contributes to the competitiveness of Canadian entities by helping stakeholders make their resource allocation decisions.
Now that we have talked about the basic mandate of the Accounting Standards Board, I will address the impact of globalization. The board recognizes that international capital markets are increasingly important to Canadian enterprises. In fact, much of the board's work in recent years has been aimed at eliminating or minimizing differences between Canadian and international accounting standards.
Since the U.S. is our biggest trading partner, minimizing differences between Canadian and U.S. standards, in particular, has an important focus. As important as harmonization is, the Canadian board must remain faithful to the goal of making changes to accounting standards which enhance the accountability and transparency of financial reporting. Conflicts between this goal and the desire to harmonize sometimes arise. This is the problem with accounting for business combinations.
The Accounting Standards Board is acutely aware of concerns over accounting for business combinations. There are several complex issues, and we would like to make a few observations in that regard. We offer these observations to illustrate some of the complexities and why there is no easy answer here.
In Canada, business combinations are accounted for using the purchase method, except in rare circumstances where an acquirer cannot be identified. In that case, pooling of interest would be used. Under the purchase method of accounting, the acquiring company is accountable for the price paid to make the acquisition. That is the market value of the transaction.
This accountability is lost under the pooling of interest method. The U.S. criteria for which business combinations are treated as poolings are very different. The result is that many U.S. acquisitions in which one party acquires another are recorded as poolings of interest in the United States, with little or no accountability for the value of the transaction.
The Accounting Standards Board believes that accountability to the stakeholders for the value of the transaction is very important. A number of CFOs of Canadian companies have come forth to support that view. The purchase versus pooling of interest question may sound very technical, but accounting to stakeholders is what is at issue.
The Financial Accounting Standards Board sets accounting standards in the United States, and it also recognizes that there are flaws in the U.S. approach to pooling. They have a project well under way to change the U.S. standard. We expect, based on close cooperation, that proposed changes will be issued for public comment in the U.S. in the second quarter of 1999.
The FASB is supported in this initiative by the Securities and Exchange Commission. Representatives from the SEC have indicated just how difficult the U.S. standard is to regulate. The former chief accountant of the SEC has gone on record referring to U.S. pooling standards as broken and in need of rethinking.
Recent developments in accounting for business combinations in the U.K. are also worth noting. The U.K. uses a similar approach to ours for determining those rare business combinations that will be accounted for as poolings of interest. This approach has not changed. However, the U.K. standard for accounting for goodwill and intangible assets was changed last year. The new standard in the U.K. requires that goodwill and intangibles be capitalized and amortized over their useful lives if determinable. This change eliminated what many in other jurisdictions were referring to as the U.K. advantage, since U.K. standards used to allow goodwill to be written off in the year of acquisition.
In addition, the new standard allows goodwill and intangibles to be amortized over a period of longer than 20 years or perhaps not at all, if the longer or indeterminate life can be justified. Goodwill and intangibles amortized over a period longer than 20 years, or not amortized at all, will be subject to annual impairment tests.
Another international development worth noting is the G4+1 initiative on business combinations. That is a working group on accounting standards from Canada, the United States, the U.K., Australia and New Zealand, and is joined by the International Accounting Standards Committee. The G4+1 is currently developing a position paper which is expected to be issued in December of 1998, and which will propose a single method of accounting for business combinations.
The goal of this initiative, which is being led by the FASB, is to develop internationally harmonized standards on the method to be used for accounting for business combinations. We believe the FASB leadership in the G4+1 project is a concrete sign of their commitment to changing accounting for business combinations. In addition, being part of an international effort should help with the adoption of change in the domestic market in each of the jurisdictions.
Despite all these international developments, the Accounting Standards Board is acutely aware of the issues in Canada as well as the varying views about what course of action would be best. Some believe we should wait for the U.S. standards to change. Others believe more immediate action is needed. In the interim, there are really two different ways to come at the problem: one, picking up U.S. pooling criteria; or two, making some changes to accounting for goodwill, especially amortization, so that reported earnings would come closer to reported earnings under pooling of interests.
Picking up U.S. pooling criteria might seem like the simplest and most direct way of harmonizing with U.S. GAAP on this issue, but this approach is not as simple as many would believe. Under U.S. GAAP, there are 12 detailed criteria that must be met to achieve pooling treatment. Meeting these criteria can severely restrict certain business activities, such as the ability to buy back shares -- both before and after the transaction -- and to dispose of assets for two years after the business combination.
Compared to the U.S., Canada has, in relative terms, more companies that are subsidiaries of other companies. It is also worth noting that the U.S. pooling criteria preclude the use of pooling of interests for a company that has been a subsidiary in the two years prior to the combination.
The Accounting Standards Board is committed to following a due process of consultation and analysis. A similar due process is followed by other standard setters and necessarily takes time. As part of the due process, we gather input from interested parties on the proposed change. These interested parties include Canadian companies and those that rely on financial statements, as well as regulators.
In the meantime, as an immediate remedy, we would like to point out that some Canadian companies are preparing two sets of financial statements, one under Canadian GAAP and one under U.S. GAAP. The disadvantage of such an approach is the potential for confusion. However, the distinct advantage is that it can offer some immediate relief to those who feel competitively disadvantaged compared to their U.S. counterparts.
The Accounting Standards Board continues to believe that the best remedy for the concerns surrounding accounting for business combinations is harmonized North American standards. To this end, the board is continuing with the project, concurrent with the FASB project. Exposure drafts from these concurrent projects, inviting comments on proposals for harmonized standards, are expected to be released in both countries in the first half of 1999.
The Accounting Standards Board recognizes the urgency of the issues related to the business combinations and has been actively monitoring the situation, with input from regulators and from the business community. The board has also participated in recent OSFI initiatives to examine possible interim solutions. At the Accounting Standards Board meeting of September 23, 1998, the board decided to take steps to maintain control of the timetable. It was agreed that, should the FASB be unable to issue an exposure draft this May of 1999, the Canadian Accounting Standards Board will issue its own exposure draft in May to address the concerns related to accounting for business combinations with a target of releasing final standards by the fall of 1999.
The Accounting Standards Board will be issuing an invitation to comment this fall on the G4+1 proposal for a harmonized method of business combinations. The board will also be developing an invitation to comment on accounting for goodwill. The input gathered through these two steps will facilitate the development of the exposure draft in May, 1999, and ultimately final standards.
The Accounting Standards Board has been in close contact with OSFI on this issue. We understand that the board's current plans have the support of OSFI, in that the OSFI has decided to follow the board's progress in addressing the issue and to hold in abeyance the possibility of using its accounting override to put in place an interim solution.
We would like to note our concern over the possibility of OSFI using its power to specify accounting principles for business combinations since such a solution would only apply to federally regulated financial institutions, thus creating imbalances in the Canadian marketplace. We have heard from a number of CFOs of Canadian enterprises expressing this same concern.
Let me turn to the information needs of stakeholders. The task force refers to transparency and disclosure of information for consumers. We would like to note, however, that the report does not seem to address how this transparency and disclosure might be achieved for other stakeholders, notably shareholders.
We believe there is a need for a comprehensive study of the information requirements of all stakeholders, and of how such requirements can most effectively be met.
Such a study should involve industry associations, consumer groups, regulators, and other interested parties. The study should consider what information should be provided, in what form, and how often. The CICA would be pleased to participate in such a study where its expertise is relevant.
Turning to corporate governance, we recognize that the task force report did not conduct a comprehensive study of corporate governance practices in regulated financial institutions because corporate governance issues will be considered as part of the process of reforming the Canada Business Corporations Act. However, we would like to note that the role played by depositors and non-participating policyholders in financial institutions gives rise to some unique governance issues. We question how the particular roles of depositors and policyholders will be addressed in the broader study of corporate governance taking place as part of the CBCA reforms. A more focused study might be needed to address the unique governance issues presented by depositors and policyholders.
Turning to regulation of financial institutions, we would like to note our support for the task force recommendations directed at addressing duplication and overlap between federal and provincial regulation. We also agree with the recommendations aimed at the streamlining of approvals. The task force also recommends that OSFI's statutory responsibility be expanded in certain areas. In response to these proposals, we would like to note that current thinking on governance and regulation seems to favour the development of principles around self-governance and accountability. We would caution that any changes in regulatory powers need to achieve an appropriate balance between self-governance and regulation.
That concludes my formal presentation. We will be pleased to answer your questions.
The Chairman: Are you aware that OSFI issued a press release following your press release today?
Mr. Rutledge: I was aware that they intended to, but I have not seen the release.
The Chairman: I will read you the one relevant paragraph in it because I think my colleagues ought to have this information in preparation for the ensuing discussion. This was released by OSFI at noon today. It reads:
In OSFI's view, it is crucial that Canadian federally regulated financial institutions (FRFI's) be given certainty that competitive accounting standards for business combinations will be available in the near future to permit businesses to plan their future actions. Accordingly, if it becomes clear that the CICA faces obstacles that make it unlikely that this objective will be achieved in a timely fashion, OSFI will be prepared to introduce changes to accounting standards used by FRFI's to reduce as far as possible the competitive disadvantage. This override would be effective for fiscal periods commencing on or after November 1, 1998, and would continue until such time as there is convergence between Canada and the United States in the accounting for business combinations.
This issue of the difference in accounting standards on business mergers and acquisitions has been around for several years. I have the very clear impression that the CICA has been dragged, very reluctantly, to the point where you made your decision on September 23 to proceed in the current direction. I say that, because I find it hard to believe it is coincidental that an issue that has been floating around the CICA for quite a while, and not moving anywhere, suddenly provoked action when two things occurred: One, MacKay put out a report which says you ought to make the change and, two, OSFI says that if you do not make the change, they will.
One therefore has the sense that you are very reluctant to be where you are and one can begin to wonder about that upon reading your submission and your press release, which talks about a target for a solution by the fall of 1999.
I do not understand the enormous reluctance that your profession appears to have had in coming to grips with an issue where there are suggestions there may be a different way of handling something from the way you have historically handled it. My instinct is that there is no absolute truth in accounting standards. Yet, that may have been a difficult concept for the association to come to grips with. Is that an unfair characterization?
Mr. Rutledge: First, I appreciate you reading that paragraph of the OSFI communication into the record. That is essentially what we understood OSFI would be saying. There has been close communication between the two groups, exchange of draft press releases, et cetera.
The Chairman: I asked the questions because I thought you had seen the press release.
Mr. Rutledge: That is fine. The main thrust of your question is why this is taking so long and whether we are being dragged reluctantly to the table.
I believe it is very fair to state that the Canadian Institute of Chartered Accountants has been very closely monitoring the situation for a number of years. It has been involved. The Canadian Institute of Chartered Accountants was among the first, together with the U.K. institute, to bring to the attention of the U.S. -- the FASB -- that the FASB is basically out of step with the rest of the commercial world in that sense.
As a result, they did agree that they would undertake a project which they would put high on their agenda, and that the Canadian CICA would participate in that project. The time frame of that project, when we started it, was reasonably short. Unfortunately, it seems to have constantly expanded.
The record will show that this subject has been on the agenda of the Accounting Standards Board many times over the last few years. At their September meeting, they basically decided that this had gone far enough, that they had to take control of the timetable. The Canadian Accounting Standards Board is on record as saying that if the timetable that has been agreed to with the FASB of May 1999 for an exposure draft is not attained, they will make their own.
In a way, it will be too bad if that happens because harmonization has been such an important goal between Canada and the United States. This could result in a situation where Canada will have to make a change on its own. The Americans will make a change later and we may or may not be in sync at that time.
The Chairman: You did not conclude your statement about where you are with the May draft. It seems to me that the OSFI statement indicates that there is a terminal date for this process, one way or the other. Is that correct?
Mr. Rutledge: The due process that the Canadian Institute of Chartered Accountant follows calls for a discussion paper and circulation within a community of knowledgeable people for initial input. Once the exposure draft is issued, that is basically the statement of intent. There may be some fine-tuning of it between that date and the release of the final standard, but the exposure draft is a very important step forward.
The Chairman: Is it your expectation that the final draft will be achieved prior to October 31 of 1999?
Mr. Rutledge: We have said the fall of 1999. The superintendent is saying October because that is the fiscal year end of our Canadian banks.
The Chairman: What are your expectations with respect to meeting that deadline?
Mr. Rutledge: I believe that the current timetable for the final meeting of the Accounting Standards Board is November.
Ms Sylvia Smith, Director, Accounting Standards, Canadian Institute of Chartered Accountants: We will definitely endeavour to meet that deadline. We are setting up a due process to enable us to do that.
The Chairman: OSFI has essentially said that if you do not meet the deadline, they will; is that correct?
Mr. Rutledge: That is correct.
Senator Angus: Senator Kirby has covered, I think, the essential issue here this afternoon. However, to put a finer point on it, there is clearly an impasse here. It was manifested for senators this morning when the CEO of Great-West Life had occasion to make some comments about the CICA on this issue. He did not mince his words. He wanted to make it very clear to us how impeded the industry feels by the disparate rules between Canada and the U.S., in particular. As the chairman points out, it is not something we just found out about yesterday. There is a substantial amount of frustration out there. The chairman put it well when he said you are diffident about this. You do not want to change it. You would rather keep the status quo and have the Americans adopt our system.
Mr. Rutledge: No. I should like to correct that, if I may.
Our view is not to keep the status quo here and have the Americans change. Our view is to work with the Americans and, together, bring in a new standard. Whether that will be a change from what we have or a change from what the Americans have, remains to be determined. The commitment was to harmonization between the two countries. We are committed to harmonization up to a certain point in the timetable, and then we break the timetable and go our own way.
Senator Angus: You do say that throughout your report. In an ideal world, we would need harmonization quickly. It is consistent with opening up competition to the maximum extent. On the other hand, the word "concern" appears even more often in your document. You are very troubled about not getting it right.
To what extent are safety and soundness aspects involved here? Clearly that is your concern, in terms of accounting for these combinations and the Canadian system. Could you perhaps highlight the main differences? I understood about the pooling.
Mr. Rutledge: If I understand your question, you are asking about the main differences between the Canadian standard and the existing U.S. standards. The main difference is that in the United States, a very large corporation acquiring a relatively small corporation is permitted to use pooling of interest accounting, provided the deal is structured so it is an exchange of shares between the two organizations, and 12 criteria are adhered to. Those 12 criteria are such that you stay together for two years prior to the acquisition and two years after the acquisition. You do not do anything indirectly that would otherwise be a cash consideration directly. You are not allowed to sell shares for two years. The parties receiving the shares -- the interest groups -- cannot dispose of their shares. They cannot turn around, sell the assets, and get cash that way.
Senator Angus: This is like the people who got Great-West shares for London Life. They would be prevented from negotiating those securities for this period of time. Is that a fair analogy?
Mr. Rutledge: If the parties are what we refer to as significant control groups. If the company is widely held, the answer would be different. However, if it is one interest group and another interest group, they must not dispose of their shares for that two-year period.
Senator Angus: Even if they go way down in value.
Mr. Rutledge: Even if they go down in value.
Senator Angus: What is the purpose of that? What is wrong with that? That is what they do in the States. Is that correct?
Mr. Rutledge: Yes.
Senator Angus: You do not like that.
Mr. Rutledge: The reason we do not like it is that if you were to do a cash transaction, you are free of all those restrictions. However, just because you use paper, which today is an alternate form of cash, these restrictions apply. The logic does not seem to be consistent there.
In the case of Great-West, I did say in my remarks to the committee that one of those 12 conditions is that you cannot be a subsidiary of another corporation. As you well know, Great-West is in fact a subsidiary of another corporation. Therefore, it would not be eligible to use U.S. pooling of interest rules even if the regulator were to bring in the U.S standard. If the regulator brings in U.S. Accounting Principles Board opinion No. 16, commonly known as APB-No. 16, then all the conditions that apply to it would prevent a corporation such as Great-West Life -- or another publicly traded corporation that is a subsidiary -- from availing itself of those. Some businessmen are only beginning to realize that many restrictions apply in the U.S. pooling situation.
In Canada, we restrict pooling of interest to those situations where two groups of approximately equal size come together and there is no clearly identified acquirer. They are basically bringing their businesses together.
Senator Angus: I understand you to be saying, "For heaven's sake, let's not throw the baby out with the bath water in the interests of harmonizationation". Those people who are complaining to us that the Canadian system, in our competitive environment, is prejudiced by the difference may not have it right. They may not fully understand it. In fact, we have a much better system here, and the emphasis should be to get the best of our system incorporated into the new, harmonized version.
Mr. Rutledge: We believe that. I did comment that the U.K. standard-setting body made a change one year ago. It is well aware of the U.S. standards and decided not to pick up the U.S. standards. In fact, it did have a system whereby it permitted the write-off of goodwill in the year of acquisition, which would get us back to the U.S. standard. We would have the identical situation afterwards. However, it decided that was not an appropriate standard and changed it last year. This is why we are involved in this very difficult area of harmonization, trying to get things right, and remain competitive here in Canada. It is a struggle.
The other point I wish to emphasize is I realize that this particular hearing deals with federally regulated financial institutions. The Canadian Institute of Chartered Accountants has a very wide mandate of standard setting for all entities that prepare financial statements in Canada.
Senator Angus: That is one of the beauties of federalism.
Mr. Rutledge: Federally incorporated companies under the CBCA are a case in point. They may not have a level playing field with others if the regulator needs to use his powers in this particular instance.
Senator Angus: What troubles us the most is that you are saying over and over that there is no consensus as to the resolution of the issue. You have indicated that some suggest we should simply pick up the U.S. system.
We have a problem. I am not sure what we are to understand from this, other than that you are urging us to be patient in terms of jumping on the MacKay recommendation in this regard.
Mr. Rutledge: To the extent it is possible, Mr. Chairman, I would ask you to urge the Canadian business community, the wide Canadian community, to make its views known. It would be very helpful to have the CEOs, the leaders of business, come forward and let the CICA know their views about different alternatives. That would be very helpful.
Senator Angus: On page 4 you set out the disclosure recommendations and more information. You point to some caveats there that are interesting. All things are not as simple as, perhaps, Mr. MacKay would like us to think they are. You mentioned that the report does not address how transparency and disclosure might be achieved for stakeholders other than the consumers, whoever they are. Who are these other stakeholders whom you had in mind? You mention industry associations and others.
Mr. Rutledge: I know that shareholders are also consumers. However, it is in their capacity as shareholders, deposit holders, or non-participating policyholders. You raise the issues of safety and soundness. In the long run, a business must be safe and sound if it is to succeed. I think businessmen make decisions every single day that involve the paying out of money in some form or another. You could say that that might not be in the interests of the depositor, but it may well be in the interest of a shareholder, if you are talking of a dividend. Obviously, you should not pay a dividend if the business will not be safe and sound thereafter. There are other transactions in the capital sense that need to be considered. It is the interests of these various groups.
Senator Angus: Are you familiar with the system which New Zealand recently brought in?
Mr. Rutledge: Yes, somewhat.
Senator Angus: It is partly to get away from a strictly rules-based supervisory system and let the market forces take over, but subject to very stepped-up disclosure on a quarterly basis. How does that hit you? Do they miss the boat there as well?
Mr. Rutledge: Our initial review of the situation there is positive. Again, it comes down to whether the public is able to understand the different measurements being provided on a quarterly basis.
Ms Smith: The principles of disclosure and transparency are certainly consistent with the objectives of the CICA and the Accounting Standards Board. We have not studied what New Zealand is doing in detail; but we would say that it is moving in the right direction. That is clearly an area that we think needs to be studied further. We would be supportive of that kind of move, which is consistent. However, we cannot comment on the details of the New Zealand system.
Senator Angus: We just issued a report the other day in which we make some comments on that issue. It would be interesting to know whether Mr. Rutledge and his colleagues think we have got anywhere near the mark.
Mr. Rutledge: We would be interested in looking at it.
Senator Kroft: I am left with the reality that while we have had a discussion of half an hour or so, the MacKay task force describes several meetings which they had. They appear to remain resolutely unconvinced. We are left with that fact. I am tempted to put to you this question: Why do you think you did not convince them?
Could you help us to understand? Was there a single sticking point that is not clear? They said, "We met again and again. We listened. We still feel we should get on with it."
Mr. Rutledge: The message I am taking from the MacKay task force is that while harmonization and globalization are desirable goals, protecting the competitiveness of Canadian industry has a higher priority right now. That is what I am taking from his recommendation. Even while we would like to have harmonized accounting, in the interim we may have to move. I think that is why the Accounting Standards Board now has an advanced timetable, a shortened due process.
Senator Di Nino: I am not sure that I am getting a great deal of comfort from this exchange today. I have not necessarily shared this with all my colleagues on a public basis, but I spent four decades in the financial services sector.
One of the issues that has always come up whenever a problem has arisen is the role that the external auditors, your members, have played in the events which have led up to problems -- which have created some serious difficulties for Canadians, certainly for Canada. I may even say some large institutions, and I will not mention any names but we can all guess.
What we hope to achieve from these types of discussions is to move the yardstick forward a little. When we address the issue, which is the future of financial institutions in Canada, we should be able to have some sense of comfort that we have moved that yardstick forward, at least as far as the public's dependence on external auditors being part of the solution to avoiding the problem is concerned. I am not getting that today. I am getting a feeling of discomfort -- something which I have had for a long time -- that there is some head banging going on here, and that perhaps something will fall through the cracks. When that happens, it is the public that gets hurt.
Am I seeing it right, or am I overreacting?
Ms Smith: Putting the auditors' role aside for a minute, what we were talking about first was information. This is useful information. There are a number of trade-offs when you look at how much information, and what, should be put out in the market place.
In the first place, with respect to business combinations, and forgetting about the U.S. standards for a moment, we have a standard that has been in place for a number of years. Basically, it is not perfect, but it does have enough information and disclosure to hold management accountable for the decisions they make and gives enough information to investors to make a decision as to whether that acquisition was a good one or not. That is one element.
When you bring in competition and the U.S. and comparability, there is a different standard in the U.S. In many cases, it provides less information. Thus, you have to say to yourself, "Should we be picking up that standard or not?" This is where the dilemma comes in. You want to harmonize because you want to give everyone the same accounting language, but you know if you do that by picking up a U.S. standard, you will have less information in the market-place place. There lies the controversy. This is why it is a sticking point and it is so difficult for us to move forward.
After looking at that, the board decided we need to have harmonized standards and we have to influence the Americans. The sceptics say, "The Americans will not move. You are a little flea and they are an elephant. How will it work?" This is the dilemma on which we have been working.
You mentioned your discomfort today. You are feeling that because we understand the trade-off between providing the information that you think is necessary in the market-place and then, at the end of the day, not disadvantaging organizations by giving too much or being offside with the biggest market-place in the world. That is the kind of discomfort you are experiencing. This is the balance we are trying to achieve by following the work program we have described to you today. I hope you understand that.
Senator Di Nino: Are you saying that the MacKay report may be giving away too much; it may be leaning more towards that balance than you, as the professionals in this field, would want to see?
Ms Smith: There is some concern that that is the case. The difficulty is, we recognize that harmonization is important. The way to have effective and efficient capital markets is to have a common language. We have been working towards that. That does not always mean picking up other people's standards, but rather trying to influence standard setters around the world to come to common standards that are the best standards.
The MacKay task force, while they see that, they are looking at the problem at the moment, and indicating that there is a difference that needs to be changed right away. It may be the context that they are concerned about. They may not see the full picture of what the board is trying to do in terms of harmonization.
Senator Di Nino: Do you include OSFI in this? They sent out a press release and said that if you do not do it by October 31, they will do it themselves. Are they also not seeing the whole picture? Why do we have this confrontational position being taken by OSFI?
Ms Smith: I am not sure it is confrontational. They are trying to spur us on to do it as effectively and as quickly as possible. I understand that from their perspective. They are looking at a point in time and a particular standard. I cannot answer for OSFI as to whether or not they are missing the picture too.
Mr. Rutledge: I understand the MacKay task force recommendation to say that the first choice for the CICA is to come up with a solution on a timely basis.
The second choice would be to have OSFI use its power under the Bank Act and the Insurance Act to dictate an accounting principle to be used in that particular instance. Clearly, the preferred solution is that CICA do it.
Senator Di Nino: Do we have a year to accomplish it?
Mr. Rutledge: We are saying it will take us a year.
Senator Di Nino: We should follow up on this. I am not satisfied. There is something here that is not making sense.
Senator Joyal: I should like to come back to page 4 of your brief where you refer to the Basle Committee on bank financing transparency.
One of the arguments that major banks and institutions have been putting forward to support consolidation of the sector is the capacity for the Canadian institution to have access to global markets or the capacity to enter new markets.
In view of the experience of the late 1980s -- banks making investments in fields such as real estate -- do you feel the obligation of major financial institutions to disclose information about their investments and activities abroad is enough to meet the objectives of the MacKay report concerning the protection of their shareholders and consumers generally?
Mr. Rutledge: That is a tough question to answer completely. Certainly, individual needs for information can differ significantly. However, what we are all driving for, as is the Basle report, is disclosure of information that enables the reader to assess exposure to risk. Combine that with the management of the organization discussing what your risk practices are, your policies on risk, and how the board of directors ensures that those policies are respected.
That is the best we can do at this point in time. Whether it is enough will remain to be seen. It would certainly be an improvement from where we are currently in the world, generally speaking.
Senator Joyal: Do you not think that if financial institutions have access to our level of capital, they will try to re-invest it somewhere else? Should we not pay greater attention to how the practice of accounting could be refined in order to provide for easier access to risk evaluation of the activities of those institutions abroad?
Globalization, as we have seen it in the last several months, carries not only benefits but also risks. As much as we can establish new rules to allow Canadian institutions to better compete internationally, we must develop a capacity or potential in Canada to evaluate the risks we are taking abroad too.
We must be as concerned about globalization as we are about ensuring competition. Otherwise, the whole system will not serve the interests of the country.
I have the impression that we still have some way to go before we achieve results from the efforts that we should be making.
Mr. Rutledge: We have made great strides in the information that is set forth in financial statements and in the notes to the financial statements. That information is very much along the lines of your wishes. Perhaps it is not going fast enough -- perhaps it is not in as much detail as you would like to have it -- but it is certainly moving in the direction that you are seeking.
One of the cases that I would mention and one that I think this committee is very interested in is the whole area of derivatives. We have come down with an initial accounting standard that requires disclosure of information on derivatives. Some people have said it is difficult to understand the process. This is a very difficult area to begin with. It is difficult to make simple.
We have not yet agreed on measurement standards with regard to derivatives. However, we have come down on the side of disclosing the process and disclosing information that sets forth risk. That is along the lines of what you are considering. When you talk about globalization, we must see more geographical information and a matrix and geographical line of business. We will see that.
Ms Smith: We do have a new accounting standard on segmented reporting which encourages more disclosure of information along the lines of business and geography. It is starting to move.
Senator Joyal: Are those not mentioned in the Basle committee report?
Mr. Rutledge: They meet some of the objectives of the Basle committee. The Basle committee is going further than that. The Basle committee is talking about internal performance measurements by management that are more than just financial.
Ms Smith: I should also add that this is not actually the purview of the Accounting Standards Board. Another committee has been set up by the CICA, because it is not really accounting related. However, there is a committee called the criteria of control committee which is working on the concept of risk -- what it is, how it can be managed, how directors are part of that process. It is also working on external reporting of risks that are key to enterprises -- not necessarily restricted to financial institutions but looking at all entities. It is doing research in that area. The work of that committee will get you closer to the concerns that you have raised.
Senator Stewart: Let me start by reading a sentence from your submission at page 2:
While there is consensus that current differences between Canadian and U.S. GAAP in the area of accounting for business combinations is of concern, there is currently no consensus as to how to resolve this concern.
I assume you are saying that the Americans seem to be unwilling to move. You, on the other hand, feel that you do not want to move down, to degrade your standards down to theirs.
Are the Americans simply being complacent because of the size of their economy? They feel reasonably secure with their own system. Or do they have reasons that they regard as good for not moving closer to your standards?
Mr. Rutledge: The Americans have said that they wish to revise their standard. They wish to change their standard. The FASB has said that it is flawed and it needs to be redone. They are redoing it. They have not yet reached the point where they are willing to publicly state the new direction, but they have said that by May of 1999, they will issue what they refer to as an exposure draft, which will basically be the draft of the new accounting standard.
When we say we believe there is no consensus as to how to resolve the concern, we are referring, in our submission, to the concern that exists within the Canadian business community that, one, the playing field should be levelled. There is no consensus as to how to level the playing field today; whether to pick up the American standard or to do something different right now.
Senator Stewart: You say that they say they are moving ahead to reform their standard. In the last sentence of your response, you imply that you do not believe that the changes that they seem to have in mind will go far enough to satisfy the higher standards, in your view, of your organization.
Mr. Rutledge: No, I think they may meet our expectations. My concern and that of the CICA's Accounting Standards Board is whether they will be able to carry it out within the time frame they have set.
Senator Stewart: You are being told by the authorities in Ottawa that regardless of what the Americans do, by a certain date, about a year from now, they will in effect make you adopt the current American standards, whatever they are at that time. Is that roughly what they are saying here? I suppose we will not know the answer until at least May.
Mr. Rutledge: OSFI is talking about the currently existing American standard, APB-No. 16.
Senator Stewart: However, that may not be the standard on the ultimatum date.
Ms Smith: I do not think OSFI is suggesting that we pick up the current American standard. They are suggesting that we make a change to even the playing field; in other words, do something to make the difference go away. That is not necessarily picking up the current American standard. It can be done in other ways.
Senator Stewart: Surely you are moving toward it?
Ms Smith: Dealing with goodwill in one way can take away the earnings impact. That is another way to deal with it. You do not actually have to pick up the U.S. standard but you can change accounting for goodwill so that the effect on earnings is the same.
The Chairman: I do not want to open a new subject but you may want to send us some information on this. In your corporate governance section, you observed that MacKay did not deal with this because it is being covered under the forthcoming amendments to the Canada Business Corporations Act.
When this committee issued a report on that about a year and a half ago, all the recommendations in there, we are told in our report, will be in the bill. You made a comment in your corporate governance section that intrigued me, and if you have any information, I would like to have it.
In the course of our discussions on corporate governance, we were not looking uniquely at financial institutions. We were looking at general Canadian corporations.
You suggested there might be some unique corporate governance issues related to depositors and deposit-taking institutions and non-participating policyholders of life insurance companies. I do not want to open that subject up now because it is large and it is not part of our current mandate. However, we would certainly like to have any information that you have on what you see as the corporate governance issue surrounding those two classes. We might well, in some future forum, come back and have you talk to us about it. I think many of us would find it interesting.
Senator Di Nino: One of the questions which should be raised, particularly when talking about depositors, is corporate governance -- the responsibility towards a shareholder versus the responsibility towards the depositor. If you cover that point, that would be useful to me, at least.
The Chairman: I listened to your response on what has caused the delay in resolving the accounting difference. One has a sense that this is a conflict between what the accounting profession would regard as "the right way to deal with the goodwill issue," among other things, and a broader kind of public interest issue, that of the importance of comparability with the U.S.
Perhaps one issue here is whether the corporate governance rules of the CICA ensure that there is a public interest element considered and not merely the interests of the profession. It seems to me that that is what has caused the current impasse. As I look at the opening up of other professions to the notion of independent directors, and other organizations like mutual funds, one wonders if that is not an area of corporate governance which your institute might want to examine in the future.
Ms Smith: When I look at it, I say our concern about the accounting is not just an interest of the profession. We are looking towards standards that increase accountability and transparency. I would say that is in the public interest.
The Chairman: I did not want to get into an argument with you but let me put it slightly differently. People outside the accounting profession might have a different view of what constitutes the public interest than people who are only in the profession. Every other institution in the country has opened up its governance structures to conflicting viewpoints and outside viewpoints. Perhaps if you had done that, we might not find ourselves in this current box.
You said the draft is due out in May. We will come back and pick up on Senator Di Nino's point. We will continue to keep the pressure on you to get the issue resolved by the end of October.
The committee adjourned.