Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 35 - Evidence
VANCOUVER, Thursday October 29, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:00 a.m. to discuss the present state of the financial system in Canada (Task Force on the Future of the Canadian Financial Services Sector).
Senator Michael Kirby (Deputy Chairman) in the Chair.
[English]
The Chairman: We are here for our second day of hearings in Vancouver on the MacKay report, the Report on the Task Force on the Future of Canadian Financial Services. This will be the last day of our hearings in the west, having spent a week in Eastern Canada, a week in western Canada and finishing off next week in Toronto and Ottawa.
Today, we will hear a number of significant witnesses from western Canada, from both Alberta and British Columbia, beginning with representatives of the Securities Commissions of Alberta and British Columbia. We will hear evidence from property and casualty insurance brokers. We will also hear from representatives of the Hongkong Bank and the Alberta Treasury Branch.
Our first witnesses this morning are the chairmen of the Alberta Securities Commission, Mr. Bill Hess; and the British Columbia Securities Commission, Mr. Doug Hyndman, accompanied by Ms Joyce Maykut.
Senator Tkachuk: There are two senators here this morning from British Columbia who are not on the Banking Committee. They must have been watching the proceedings. The two senators who have joined us, Senator Gerry St. Germain and Senator Pat Carney, will enliven the conversation. I wish to welcome you both, on behalf of the committee.
The Chairman: We are delighted to have you here Mr. Hyndman and Mr. Hess. Please proceed with your presentation.
Mr. Douglas Hyndman, Chairman, British Columbia Securities Commission: We have been working with our colleagues in other provinces to develop a joint proposal that responds in part to the MacKay report. My colleague, Bill Hess from Alberta, will make an opening statement and then both of us will be pleased to entertain questions.
Mr. William Hess, Chairman, Alberta Securities Commission: It is an honour to appear again before this committee. I am reminded that the last time I appeared before the Senate Banking Committee, I was questioned about two projects that were current at the time. One was the development of the electronic filing system by the securities regulators, the other was a proposal for a national securities commission. I am pleased to report that one of those projects is up and running and working very well; the other one seems to have died for lack of interest. However, since that time, securities regulation and regulators have been busy.
Perhaps honourable senators have heard about our increased efforts to bring about a more efficient and effective regulatory regime which has two components. One is the electronic filing that we talked about last time. The other is what we refer to as a mutual alliance system. Both are to achieve a similar goal, namely, to make the system for the users transparent and easily accessible. Our new system, which is in its first operation phases, has been dubbed by many in the press as "virtual national securities commission."
The vast improvements in the efficiency and harmonization of securities regulation is relevant to some of the recommendations in the MacKay report, and certain other related matters which are of extreme importance to Canadian consumers of financial products. Several recommendations in the report deal with consumer protection issues and improving the framework for regulation of the financial services sector in Canada.
The report also recognizes that there are areas of regulatory overlap and urges a rationalization. The CSA, which is the umbrella group of securities regulators in all the provinces and territories of Canada, believe that the task force report reinforces a need to fundamentally reassess how financial services regulation is done in Canada, looking at not only why regulation is done, but by whom.
The concerns of the current regulators are based on the old four-pillar system of financial services. The present institutional structures of regulators was focused and aligned with the way the pillars used to be. Deregulation, competition and innovation has blurred the boundaries between both products and services and the institutions, and it is for this reason that regulation must be reviewed at the same time.
The objective of maintaining the soundness of the financial system is met by prudential regulation by both the provincial and federal insurance deposit-taking regulators. However, we recognize that there is some duplication and overlap issues that must be addressed on the prudential side. Unfortunately -- and, this is our main point -- market regulation as it applies to financial products and services is more diverse. It is duplicative and often inconsistent, and we believe there is evidence of significant gaps in the regulatory system. The level of market regulation of products and services provided by deposit-taking institution regulators is materially less than the regulation of other financial products.
We believe that a regulatory structure must promote the soundness of the financial system, enhance market efficiency, while ensuring an appropriate level of investor protection. A regulatory system must be flexible. It must be applied consistently and fairly. This includes the principle that, to the extent that institutions perform similar functions or offer similar products, they should be regulated in similar ways. Regulation should be cost effective and it should make use of existing expertise, experience and resources. Finally, duplication that can be eliminated should be eliminated.
The CSA will be preparing and presenting a paper this fall that will present our collective views along the lines that were outlined today, namely, a view towards a more efficient regulatory structure that would be achieved by dividing responsibilities along the lines of the recent Australian model and separate prudential regulation and market regulation, but making them consistent across the board.
Market regulation for all financial service providers should be assumed by the provinces and territories. The market regulator would be responsible for all market contact, integrity of markets and consumer protection. Efficient and effective market regulation would be achieved by consolidating within each province or territory the existing regulators for market integrity and consumer protection, principally the securities and insurance regulators. The resulting provincial-based regulators would then coordinate and harmonize on the basis of the model that I outlined to you before, namely, the virtual national securities commission.
To the extent necessary, transfers of regulatory authority would have to take place between the different levels of government. This market regulatory organization would take a functional approach to regulation which would result in consistent regulation across product lines with flexibility to accommodate differences between products and to facilitate financial integration and innovation, and would promote commercial certainty to market participants and provide clarity to investors.
The benefits to Canadian consumers as a result of our proposal are obvious. There would be one market regulator to deal with matters of concern to consumers. There would be a common disclosure regime across products, which would make it easier for the consumer to do comparative shopping. It would also provide a level playing field between institutions that would increase competition, which would be of benefit to the consumers.
The Chairman: Thank you, Mr. Hess. You have given us a lot of room for questions.
Senator Meighen: Could you bring me up to date on the progress that has been made across the country, particularly in your jurisdictions, with respect to electronic filing?
Mr. Hess: There has been in place for a number of years now a Windows based system called SEDAR. At this point in time, it provides for the electronic filing of prospectuses and some continuous disclosure documents. It means that there are no longer the multiple packages of documents flying around the country when there is a prospectus filing. A service provider, usually a law firm, would do the filing through the electronic system. Obviously, it is of benefit on the issuing of prospectuses, but it is also a public information access. If you type in SEDAR on your Internet access, it will bring up SEDAR and you can access any documentation. I use it myself sometimes when I am phoned and asked questions on companies. It increases transparency, it increases access and information to the public, and it facilitates financing. The SEDAR system will be extended to other types of filings.
Regulators are also looking at other areas to use electronics to improve the regulatory structure. We will be looking at insider filing and registration systems for brokers. Under the virtual national securities commission, we are looking at our own communications to make it work. In many respects, the virtual system is like branch offices of the same organization. The B.C. Commission will be clearing prospectuses and registering people living here on our behalf if they want to conduct business in Alberta. The bottom line is that we are using technology.
Senator Meighen: You say that you are looking at insider trading. That is an area of particular interest to us. Under the present rules, in some jurisdictions you do not have to file until the first 10 days of the month following the month in which the trade was carried out. That is a long time and it can be a long time away from the date of the trade, so the timeliness is gone. When you say that you are looking at it, is it chiefly a funding or a technical or a political, small "p" problem?
Mr. Hess:It is probably a funding issue. We are at the stage now where we are getting close to asking for and receiving proposals. It is funding not only in developing the system but also in figuring out how the system is will work and who will pay for it on an ongoing basis. SEDAR works on a user-fee basis. However, it is not as easy when you are dealing with an issue such as insiders, because insiders do not need to be part of the system. We must ensure that it works for everyone and that the information is available for everyone.
The issue you talked about, namely, different times for filing, is being addressed separately through legislation. We hope to go to the 10 days after the trade mode. I appreciate that people think this is a long time, but there are issues involved in that, too. If you are travelling, when does your broker execute the trade? When were you aware of the information? You might think that it can be instantaneous, but do not forget that we have T plus three settlement. You may phone your broker today, but the trade may actually take place at some other point in time. I do not suspect it will ever be instantaneous.
Senator Meighen: It occurred to me that if you had the obligation, you -- the person doing the trading, not the broker -- had the obligation to register those companies in which you were an insider. Consequently, any trade that took place in those companies would automatically trigger an insider report filing. On the surface, does that strike you as being a difficult thing to achieve?
Mr. Hess: Again, it is an issue of the timing. When does the trade take place? You may phone your broker today, but your actual trade may only take place this week.
Senator Meighen: Since it involves a company in which I am an insider, would it trigger the filing when that trade occurs?
Mr. Hess: Yes; I agree.
Mr. Hyndman: We have been exploring with the stock exchanges the possibility of building into the exchange trading and reporting systems the concept of what we call real-time declaration. Individuals who have accounts at brokerage firms would have to identify those for which they are insiders. When a trade is put through the system -- and most if not all the exchanges now have electronic trading systems -- the order would be marked as an insider order. When that is executed, it would be recorded in the system and the exchanges could report daily, or whatever, to the individuals who are doing the trading, at least the volume of trading on either side of the market by insiders. This would be very useful market information. It presents some technical complexities in doing that, but probably more important from the exchanges point of view, they are concerned about where that puts them vis-à-vis U.S. exchanges, which do not have that requirement at the moment. When there are a lot of companies interlisted on both exchanges, they are afraid of having trading volume diverted to the U.S. exchanges by insiders who would just as soon their trades were not declared on a daily basis. I think the exchanges are probably in favour in principle, but they would like to see us negotiate this with our friends south of the border, in particular, to try to have a North America-wide standard. That will take a little longer, perhaps.
Senator Kenny: You described the system that I was going to ask you about. Essentially, it would be to notify your broker that you are insider. When the trade is executed, the disclosure automatically takes place. That would seem to be a plus and an argument in favour of our exchanges, rather than a detriment. A lot of large institutions would like to have that information the day it happens and would be quite supportive of our exchanges if they had that feature, rather than it being a negative one and having people saying, "Because of early disclosure I will make this trade in New York or some place else." What you are telling us is that people really want to avoid disclosing or the exchanges are afraid that people will want to avoid disclosing.
Mr. Hyndman: That is their concern. They have more general concerns about competition for trading volume, for order flow between themselves and the U.S. exchanges. We owe it to them to at least explore that issue before pushing them into this.
Senator Meighen: You described the type of market regulation based on a functional approach that you are working towards. Is this something that we could look forward to in a matter of a few years or months or a decade? How much government action is required before you can put it into effect at the provincial level?
Mr. Hess: What we would need would probably involve the federal level as well. To make it clear, what we would be talking about is consumer protection regulation of all financial products. Let me use an example. We have a fairly sophisticated regulatory regime with respect to disclosure, conflicts of interest, qualifications of sales people and know-your-client rules in the mutual fund area. There is a pooled investment product which is regulated and regulation is increasing. We have seg funds which are sold by insurance companies, less regulated. We have GICs that are not traditional GICs, but the rate of return is linked to a stock index. That also is a pooled investment, and I would submit that it is totally unregulated. Maybe there is some disclosure about how the rate of return will be calculated, but that is it. There are little or no proficiency standards, no know-your-client standards. That is a similar function that needs to be regulated in a similar way. That is obvious. You can do it by having three different regulators performing the same function and having them get together and have this massive group of regulators, or you can streamline it, reduce duplication, eliminate duplication and eliminate the gaps that may appear between them by having it done by one regulator. It covers banks, which are federally regulated; insurance companies, which are provincially and federally regulated; and securities dealers, which are provincially regulated. It needs cooperation. How long would that take?
Senator Meighen: Well, I am an optimist. I think I will live to see it -- at least, I hope so.
Mr. Hess: Compared to a national securities commission, what we are talking about here is function, not structure. We are also talking about something that we believe is more likely to happen, and certainly more likely to achieve full participation by all the jurisdictions than other proposals which were just structural in nature. No one ever got around to talking about function.
Senator Meighen: Is Quebec involved in the CSA?
Mr. Hess: Yes. They are an active member and they are working with us and will be involved with us on the paper.
Senator Meighen: Thank you.
The Chairman: I have a supplementary question based on your last response. I want to be clear about what you are saying. Safety and soundness or prudential regulation of federally chartered financial institutions would continue to rest with the federal regulator; market regulation or regulation of securities type products would continue to rest at the provincial level. It is the consumer that I am puzzled about.
You seem to be suggesting that consumer protection would be exclusively a provincial responsibility or provincially regulated. Is that a legal constitutional argument -- and it seems to me that it might not work -- or is there some other reason for suggesting that regulation of consumer protection is something that the federal government should not be involved in?
Mr. Hess: We are not dealing with constitutional issues.
The Chairman: That is an enormous relief to someone with my background.
Mr. Hess: We are dealing with a practical issue here. We have the most sophisticated and the best funded -- at least in four provinces -- financial consumer protection regulators, which are the securities commissions.
We are suggesting that both levels of government should hire the best people and hire one entity to do the financial consumer regulation. On the prudential side, we think prudential regulation has less in the way of gaps. A good job is being done on prudential regulation by both the provinces and the federal government. If they want to combine entities -- that is, if the provinces want to follow the lead of some and move the prudential regulation into the federal domain -- that is fine. It may reduce duplication. However, we are saying that in the area within which there are the biggest gaps, there is only one body currently, namely, the securities commission, which regulates financial consumer products adequately. Hire them to do it; get rid of them; hire someone else to do it; or, alternatively, develop numerous agencies at both the federal and provincial level, but let us hear no more criticism of duplication of securities regulation if you are to pile on more duplication.
The Chairman: Perhaps I can try a concrete example to make sure I understand what you are saying. The MacKay report talks about a number of things. It talks about privacy, coercive tied selling. In some ways you can think of their appeal for plain language documents as an element of consumer regulation. Are you suggesting that those types of issues should be regulated by the existing security commission? That strikes me as out of their normal territory. Alternatively, if I buy your position that there should be a single regulator, should that single regulator then be a joint federal-provincial organization of some kind?
Mr. Hess: First, on the consumer protection issues of tied selling and privacy, we already regulate those sorts of things to a degree. Conflicts of interest and rules about conflicts of interest are a big part of what we do with respect to regulation of securities sales. We do have the expertise in that.
The Chairman: Remember that we are not talking just about security sales here. We are talking about the sales of other products that clearly do not fall into the securities arena.
Mr. Hess: That is right. All financial products should be regulated on a similar basis. That is how they have done the Australian model. It is done at one level of government because they all agreed to do it at one level of government.
The Chairman: I wanted to be absolutely clear that I understood.
Senator Austin: We were in the U.K. talking to the FSA at a time when the FSA was a brand new idea and the Blair government had just introduced a universal regulator. I am soliciting your comments with respect to the underlying decision of the Blair government, which was to have a regulator with an institutional overview. It will also have its functional capacities, because the existing regulatory system will continue, but there will be an overview process which will be composed of the heads of those various functional and supervisory systems. The old saw in the business is that functions do not fail, institutions do. Do you have a perspective of what is happening in the U.K. or a comment on whether that kind of system would work for them or, in a more cooperative way, for us?
Mr. Hyndman: It is too early to tell whether or not the FSA will work. It is just being organized. In the world, we are looking at two different models of structuring financial services regulation. One is the British model, with the unified regulator that looks at both the prudential side of regulation and the market regulation side; and the other is the Australian model, where they split the two between two separate organizations.
One of the arguments for splitting the two organizations is that there are incompatibilities between the two functions. Historically, we see that in Canada, where the motivations of a prudential regulator are to preserve the institution to ensure that the institution does not fail. That often leads them to conceal information in order to avoid a run on a deposit-taking institution, whereas securities regulators are historically interested in disclosure. This has happened in the past, where trust companies got into financial difficulty and OSFI, for example, did not want anyone to say anything about it. The securities regulators are saying, "What about the shareholders?" We must get some information out there so that the trading is done on an informed basis.
It raises interesting issues if the same regulator is responsible for both functions. How are those conflicting motivations reconciled? We will see in the U.K. how that works out over time. For a number of reasons, the Australian model is probably more suitable for the Canadian context. There are some advantages to splitting prudential and market regulation. The federal-provincial context in which we operate in Canada probably lends itself easily to a division between federal regulation of prudential matters and provincial regulation of market conduct because we have an existing structure of securities commissions. If you leave it at the provincial level, it avoids the whole issue of negotiating transfers of jurisdiction and having provinces opt out as we had in the discussions a few years ago at the federal securities commission. It builds on existing expertise and the advantages of having a regionally based structure that is desirable for market regulation where you want to be close to the people you are regulating and close to the consumers for whose benefit the regulation was put in place. That is why we are leaning to the Australian model as one that Canada should adopt.
Mr. Hess: That is an excellent question. You have flushed out another part of our proposal to which I did not refer in my opening remarks. From what I have said, I hope this is not characterized as the provincial securities commissions trying to grab more turf. We are looking to improve regulation, both on the market side and the prudential side.
Reference was made to institutions failing. You realize that is the prudential side. That is the concern of the prudential regulator. At the other extreme is the market regulator, who does not care about the institution failing but does not want the customer to get ripped off. There is that dynamic.
I agree with you that the pillars have collapsed. We read frequently about the mergers on the business components of the bank. The Royal Bank did it this week. We are concerned about that and we have proposals to improve prudential regulation. We need to let OSFI in to the securities dealers. They do not have that access now and they must get the information from us. That will be part of it, too, namely, the close cooperation between the market regulators and the securities regulators.
There will still be a securities investor protection component to the prudential regulation of securities dealers because of the continued existence of the Canadian investor protection and there will be a protection fund for the new mutual fund, the SRO. There will still be an interest there. We will be letting OSFI into the bank-owned securities dealers because there is that concern. That is one of the regulatory gaps that we are concerned about.
Senator Austin: Both answers delight me because you were both referring to gaps in the supervisory system. I have thought for a long time that the attempts to throw all of this into one jurisdiction or another would be un-Canadian. We have only one route to go in this country and that is cooperation and integration among the various agencies. That requires people on the line to find the way. It will not come by dicta from on top, it will come by day-to-day working relationships, identifying gaps and cooperatively coming together on them.
Mr. Hess: As Mr. Hyndman has stated, I believe the Australian model is a better model because it deals with the conflict at the regulatory level between market regulation and prudential regulation. Also, as you have said, it provides a Canadian solution.
Senator Oliver: My question is about the virtual national securities commission. For some time, this committee has been looking at ways and the problems of getting some kind of national body to regulate securities in Canada. Since 1960, there have been more than four royal commissions and task forces trying to find some solution. You are now talking about a virtual national securities commission.
As has been stated to Senator Meighen today, a problem in the past has been the conflict between federal and provincial jurisdictions. Also, inherent in this is a lack of sensitivity to provincial and other needs and other systems that have been built up. In this virtual national securities commission, is it your view that this will overcome some of these sensitivity problems and that we finally have something that will bridge these gaps?
Mr. Hyndman: We are already well down the road to doing that in the Canadian Securities Administrators. The term, "the virtual national securities commission" was coined out of discussion between us and the media over the last couple of years. There were discussions a few years ago about the possibility of creating what was called a Canadian Securities Commission, which provinces would participate in on an opt-in basis. It looked at the time that some provinces might go in and one or two or three of the larger ones might opt out. In our view, that would probably have represented a step back from where we were before, because it would have taken a system where we had the Canadian Securities Administrators, which was reasonably cooperative and introduced another level of government in regulating in some provinces and not other provinces. It probably would have made cooperation more, rather than less, complicated, partly as a result of those discussions and the concerns of the industry about cost of regulation and difficulty of operating across provincial boundaries.
We decided at the Canadian Securities Administrators to push a lot harder and faster on harmonizing our requirements and on streamlining the process of dealing with multiple securities commissions. We are in the process of introducing a number of systems under the rubric of what we call "mutual reliance," which operates on a system of home province regulation, whether it is by dealer or issuer. They would deal primarily with the securities regulator in their home province where the head office is located. The other jurisdictions would, by and large, rely on the review of regulation decision making by the home province regulator in allowing that market participant to deal in the other provinces.
For example, if an issuer in British Columbia wants to file a prospectus and sell across Canada, they file it through the SEDAR electronic filing system. One filing goes to all jurisdictions. British Columbia is the prime jurisdiction to review it. Our staff would review the prospectus. Others would have an opportunity to opt out if they thought there was something awry with the particular filing, but I do not think that has ever happened since the system started.
Normally, our staff would make the decision and grant a receipt to authorize the distribution by the company. It is then able to sell the offering of securities Canada-wide on that basis. We are introducing that in a number of areas, such as registration exemptions. That system provides the ability to access the whole Canadian market, along the lines of what has been done in Europe with the so-called single passport model. However, regulation on the ground is retained for local participants who only want to deal with one securities commission and they have one close to hand with which they can deal. Investors who want to make complaints and circumstances where investigations arise are normally very local and require local knowledge and on-the-ground regulation. Our system maintains the ability to do that. That gives us the balance that is needed in securities regulation not only between being able to regulate at a national level but also being there on the ground at the local and regional level.
Senator Oliver: Your system requires goodwill and mutual reliance on one another. Have cracks started to appear in any of this yet? What problems do you see in the continued evolution of this new virtual system in the future? Do you think that it can ever become a real reality?
Mr. Hyndman: It is becoming a real reality. When you ask if cracks are appearing, I would say "Au contraire." All the movement over the last couple of years has been in the opposite direction as we have increasing interaction among commissions and among the staff of the commissions. Old jealousies and suspicions are breaking down. Later this month, we are having a training session for staff in a couple of functions from securities commissions across Canada. We are all getting together to ensure that we are applying similar standards so that we each understand how the other is coming at various issues. That will build confidence among staff. As security commission chairmen, we can agree that things will work, but that can be sabotaged at the staff level if the staff are not trusted in other jurisdictions. That level of trust has been increasing and we are doing things to raise it even higher so that there is much more interaction. As Mr. Hess stated earlier, it becomes more like branch offices of a single organization rather than a bunch of independent fiefdoms.
Mr. Hess: You referred to overcoming concerns. What we are working on accommodates concerns.
Perhaps I can make a couple of other points about the national securities commission. First, regardless of the benefits of a national securities commission, some people, particularly in the regions, perceive that there could be minuses and they do not want to take the risk. Second, we believe that what we are working on can accommodate most, if not all, of the perceived advantages of a national securities commission.
Finally, there never was a discussion about a national securities commission. Quebec was never at the table. You can speculate where our provinces would have ended up. If there is to be a national securities commission, fine, but let us not waste time talking about a partial national securities commission.
Senator Oliver: In terms of costliness and efficiency, do you think that the direction that you are taking now would probably be less costly and certainly equally as efficient if we could conceive of a national securities commission by bringing everyone to the table?
Mr. Hyndman: I suspect the current system as we envision it evolving will be less costly. You avoid the overhead superstructure that ultimately would be developed for a national agency. However, you must still have regional offices.
When this project was being discussed a few years ago, Mr. Hess and I put together a paper about how we thought you would have to structure a national securities commission. You would have to speculate about the costs, but if you consider how organizations normally develop, you would have a national organization with a number of offices. You can imagine a chief executive officer, a bunch of assistants and a bunch of staff serving them all up at a central office and supervising the people who work in the various regions. Here, we avoid that whole structure and get most of the benefits, if not all, at lower cost.
As Mr. Hess stated, it avoids the concerns of the regional participants -- certainly in Western Canada and in Quebec as well -- that do not want to see a federal securities commission take over because they are concerned about having to get on an airplane for four hours to talk to their regulator if they find that decisions are made centrally rather than in the region.
Senator Oliver: I am happy to hear about the development you have been making to date. It sounds quite encouraging.
Senator Austin: My view is that any system that people want to make work, will work. However, if not enough people want to make the system work, it will not work. In the U.S., the SEC works and it is at the top. It is the octopus with its tentacles all over the system and in regional offices.
I wish to ask you about one aspect of the MacKay report concerning the introduction of an idea. The MacKay report is focused on the consumer. That fact is repeated over and over again in their report. The idea is that OSFI should have a responsibility within its prudential framework to foster competition and that it should take competition into account as an additional factor in its function.
From your experience as regulators, can you give us your view as to whether or not that that aspect is easy to assimilate into a prudential regulatory framework?
The Chairman: The witnesses are trying to decide who will handle that question first.
Senator Austin: This is a personal view, not an institutional view.
Mr. Hess: After we take over all market regulation, we will move on to the competition people. Being a regulator always involves, being cognizant of the bigger picture. Obviously, we have a Competition Bureau and competition legislation. Obviously, that is where the focus should be concentrated.
When you regulate, what you do affects market behaviour. We always must take into consideration what we do. One thing that we must work on right now is alternate trading systems. A few years ago, regulators thought we could make traders go through the stock exchanges. Maybe that is not a fair way of categorizing how the OSC ended up many years ago. That is fine, but the trading just went around that system and went south. You must be cognizant of that. We must now do something to permit alternate trading systems or there will be continued erosion of trading and liquidity here. Have I avoided the question well enough?
A regulator must be cognizant of how that is built into the mandate. I am not an expert in prudential regulation, so I will leave it at that.
Senator Austin: Do I understand you to be saying, in effect, that the MacKay report is merely making explicit a factor that would be taken into account in any event? Is that what you are saying?
Mr. Hess: I believe so. Under our rule-making processes, we make public impact statements about what we perceive the impact of rules to be. All regulators should do the same thing so that there is public comment on it and the legislatures can make assessments of whether the regulators are performing their roles adequately for the bigger picture, which is your responsibility, not ours.
Senator Austin: It is hard to trace a responsibility for fostering innovation and competition in the context of prudential regulation. Around the table at OSFI, they may be asking about this item on our checklist, but when you are looking from outside it is hard to understand how that discussion would evolve.
With the prudential responsibility, would you set up a new department or a new department head whose responsibility is to focus on this new responsibility and to contribute that to the debate, or does everyone have the same responsibility horizontally for every item on the checklist? These are rhetorical questions. We are grappling with the recommendations.
I have a quick question which calls for a relatively quick answer. This is directed to you, Mr. Hess, but I would be happy to have Mr. Hyndman's views on it as well. At some point, the answer to the question will undoubtedly involve his views. This is about regulatory oversight in the Alberta Treasury Branches. Historically, what has been the oversight function in Alberta?
Mr. Hess: To the extent that they sell security products, we regulate them.
Senator Austin: There is no regulator in the area of prudential responsibility, is that correct?
Mr. Hess: There is the Treasury Department, which has a significant interest since they are the guarantor.
Senator Austin: There is an internal controller?
Mr. Hess: I do not know the structure. I know it is in the Treasury Department.
Senator Austin: There was a news story in the Edmonton Journal in the past few days about the possibility of Alberta Treasury Branches and Canadian Western Bank becoming one entity. I was rather interested in what the consequences might be for regulation. However, I will leave that subject until later.
The Chairman: I remind honourable senators that representatives of the Alberta Treasury Branch will be here in about three hours, so that question can be raised with them.
Senator Carney: I was interested in following up the remarks of Senator Oliver about cracks in the system that is evolving. Aside from the hammering that the B.C. Securities Commission takes occasionally in the media, in the last few years you have been operating in a generally favourable investor climate. Perhaps there are some cracks in the system that have not emerged.
Many of the things you are talking about, such as real-time declaration, electronic filing, harmonization requests and mutual reliance, relies on some harmonization of technology so that you can actually communicate with each other. Whose responsibility is regulating technical compliance with things such as the computer problem in the year 2000? Whose responsibility is it to ensure that there is a technological capacity to meet these goals of yours of mutual reliance and harmonization? Do you see that as a federal or a provincial responsibility? It also deals with the consumer protection aspect.
Mr. Hyndman: If you are talking about issuers and securities dealers, our initial view is that the primary responsibility for ensuring the year 2000 compliance lies with the broker. Securities regulators are working among ourselves with the industry to try to raise awareness about the year 2000 issue and to ensure, the best that we can, that brokers will comply. What that means and whether it is possible can be the subject of a lengthy debate but, to the extent that is technically feasible, we are pushing them to get themselves into shape if they want to continue to participate in the securities markets.
We adopted a rule on a national basis a few weeks ago requiring every securities registrant in Canada to make filings with the securities commissions reporting quarterly on their year 2000 preparedness. We have indicated that for those whom we are not satisfied that they are up to snuff in time, we will be looking at whether they will be allowed to continue in business or allowed to continue to participate in the market. We have taken that upon ourselves.
It does not say anywhere in the Securities Acts that year 2000 compliance is something for which we are responsible, but we see that as a market integrity issue. The securities commissions are moving in that area to ensure that our direct registrants get themselves in shape. We are also imposing, by way of interpretation on public companies and on issuers, an obligation to disclose to their shareholders their state of year 2000 preparedness because it could impact on the value of their investments if there are problems there. We have done some reviews of disclosure and will be doing a report on the adequacy of year 2000 disclosure by public companies as well.
Senator Carney: What will be the date of that? I am very reassured to know that you are tackling this problem, which is a practical, grass roots problem of ensuring that the system that is evolving actually works for the consumer. When will the consumer know the level of compliance of the companies that are handling their personal assets?
Mr. Hyndman: We are talking about the brokers and advisors. Their filings must be made effective October 31, so we should be receiving them in the next month, at which time they will be posted on the commission Web sites.
Senator Carney: Possibly this committee should continue to monitor what seems to be an important aspect of this subject under study, namely, the health of the financial system.
The Chairman: We will certainly take a look at that. Thank you, Senator Carney.
Mr. Hess's response to both myself and Senator Meighen, when we asked about consumer regulation, was that it would be highly desirable not to have federal regulation and provincial regulation; ideally, it would be combined. We would all agree with that. In response to Senator Meighen, when he asked how long this will take, recognizing the difficulty in getting federal and provincial agreement on anything in Canada, you indicated that we could probably guess at that better than you could. Why does it require government agreement?
If you already have consumer regulation as part of your mandate, and if federal legislation has provisions that require certain elements of consumer protection -- even if that were delegated, for example, to OSFI; which may well not happen, but we will assume that possibility for the moment -- why would it not be possible for the regulators themselves to make an agreement, thereby avoiding the real slow element of the process, namely, governmental agreement? If governments and cabinets can be kept out of it, you have a much greater probability of being able to achieve an agreement quickly and efficiently than if you require politicians to become involved.
Mr. Hess: The problem is the different products and services and institutions involved. We do not have the authority to impose disclosure rules on the sales of segregated funds by a federal insurance company. We do not have the authority to impose education or know-your-client tied selling rules on bank employees selling other than securities products. That is why the institutions are regulated at different levels.
The Chairman: I understand the problem. I am trying to find a solution that avoids having to obtain inter-governmental agreement.
Taking your two examples, is there no way in which you could be acting on behalf of OSFI in those kinds of things? I understand OSFI's legal obligation to do certain things. In some sense, is there some way OSFI can delegate to you to do certain things without a formal inter-governmental agreement or piece of legislation? I am not a lawyer, I am just trying to find out. Believe me, I have had experience with inter-governmental agreements, so I would love to find anything I can to avoid having to try to do that.
Mr. Hess: We are talking about things that OSFI does not have the authority to do. If OSFI had the authority to do market regulation and the authority to delegate to someone else, then there would not be a problem. We would have to look at it almost on a line-by-line basis.
The Chairman: In theory, the way out of this problem may be to assign certain responsibilities to OSFI, along with the power to delegate, and then let the group of you work it out.
Mr. Hyndman: That is certainly one possibility. It could be looked at not only from a delegation perspective but also from a mutual reliance approach among the provinces, where we do not make a formal delegation but understand each other's systems and rely on them.
The Chairman: It is cooperation rather than official delegation.
Mr. Hyndman: That is correct. I am glad you asked that question. We could do a fair amount with some rules enacted by securities commissions and some fairly simply legislative amendments.
The Chairman: Provincial or federal amendments?
Mr. Hyndman: Provincial, with one caveat which I will mention in a moment. A lot of the activity that we are concerned about, which is conducted in financial institutions outside the scope of securities regulation, involves the sale of products that are similar to securities but are excluded from our general regulatory requirements, either because they are defined out of the term security. That would include things such as deposits and some types of insurance contracts. They are technically securities, but they are given specific exemption with our legislation. There are a lot of exemptions for financial institutions that are founded on the premise that securities regulators do not need to regulate that because it comes under another regulator, when the other regulator does not regulate it from the same perspective of securities commissions. They do not look at disclosure or at the proficiency of the people selling it.
The elimination of those exemptions and the exclusions from the definition of "security" could give the securities commissions authority to bring in a lot of the activity that we are concerned about, namely, the boundaries of securities regulation for the securities industry that substitutes for products that are sold through the securities industry but come under a different regulatory regime. This becomes particularly evident when looking at the bank groups where a bank has a trust company subsidiary and now insurance company subsidiaries, and a dealer and the bank are making decisions as to which one of its subsidiaries will now include this other activity. One of the factors taken into consideration is: Where do we get the least regulation? What area will we have those busybodies sticking their noses into our affairs less than in another?
In our view, that does not make a whole lot of sense if they decide we are to put this particular investment advisory service in our trust company because we do not have to worry about securities commissions. However, if we put it in our dealer, we would. Getting rid of the exemptions or limiting them could go a long way to addressing that issue. It would not be the complete answer to the system that we talked about, but it would get us well down the road and could be done fairly quickly.
Earlier, I mentioned a caveat. From time to time, we hear arguments from banks that they are under exclusive federal jurisdiction and do not have to pay any attention to provincial law. I do not profess to be a constitutional expert and do not know whether or not that argument would stand up if it were challenged, but that is a potential impediment if that objection is made. The banks may say, "If we do it inside the bank, then we do not have to listen to you." They are subject to laws of general application in the province, but I would just as soon avoid that fight. The simple way to avoid it would be a federal law stating that the bank had to comply with provincial securities legislation and provincial investor protection legislation.
The Chairman: That is a thorough answer, Mr. Hess.
Thank you very much for coming here this morning. We appreciate you taking the time.
Our next witnesses are from the Insurance Brokers Association of British Columbia, led by Mr. Michael Megson, the President. The committee has received a four-page statement. I think it would not be unfair of me to say we know the argument you will make, since we have heard it everywhere across the country. We are happy to give you a few minutes to summarize your argument and then we will ask some questions.
We met with your national organization and we have talked to various regional organizations as we travelled across the country, so we are getting to the point where there is a significant element of repetition here, and we are not quite as dumb as we sometimes seem. I am not sure some of us could not give the spiel as well as you. Nevertheless, we are happy to give you a few minutes, but we have a tight schedule today. If you could be succinct in your presentation, we will be succinct in our questions.
Mr. Michael Megson, President, Insurance Brokers Association of British Columbia: That suits me fine. With me today are Mr. Roger Finnie, a director of the Insurance Brokers Association of British Columbia and a principal in a brokerage firm here in Vancouver; Mr. Chuck Byrne, the Executive Director of the Insurance Brokers Association of British Columbia; and Mr. Bruce Pollock, Deputy General Manager of the Insurance Brokers Association of British Columbia.
We are here on behalf of the property and casualty insurance brokers in this province. I will make some points and then ask my colleagues to join in on these opening comments if I miss any. It is important that you understand that the Insurance Brokers Association of B.C. is one of the province's largest trade associations. We represent over 750 member offices and 6,000 general insurance brokers across the province. A majority of our members are women, and we employ many younger British Columbians. We are in 160 communities across the province.
Studies have been done by the MacKay task force and also by the Insurance Corporation of British Columbia and other various media companies over the last number of years which have always shown that the public rates what we do and who we are very highly. They value our service, our knowledge and our competitiveness, and they trust and respect what we do.
We believe that banks have enough power as it is. The 1992 recommendations and the Bank Act of 1992, which allowed banks to get into the insurance industry by retailing products through subsidiaries that they may choose to form, was fine. We do not have a problem with that kind of competition at all. This point has been made by our predecessors at these meetings and we will make it again: We are not here to talk about reducing competition in the marketplace. Far from it. We have no problems with banks being able to retail the products through their subsidiaries. Our problem is with the special privileges that the MacKay task force seems to want to grant banks by allowing them to retail insurance products through the banks themselves.
Over the last number of years that our industry has evolved, I get the feeling sometimes that it is felt by government and, perhaps, by this committee and the House of Commons committee that we addressed earlier, that we are a stagnant industry. That is to say, we are not dynamic and we are not growing. We are not evolving and moving ahead. When the next millennium comes, we will still be doing the same old things that we always have without growth. Nothing could be farther from the truth.
We are highly competitive. Direct writers have entered our marketplace that were not here before. Internet sales will be commencing. Call centres are happening in our industry and becoming part of what we do. We are evolving, growing and changing and, by doing all those things, are serving the consumer very well.
There are approximately 230 general insurers serving the public in this country. We are highly competitive. If we allow banks to retail the products from their branches, this will serve to unlevel the playing field. I am sure we will get into the reasons for that during the question period.
As general insurance brokers, we sell general insurance product. It is a complex product. It is not like buying a pair of shoes off the shelf or going to a hardware store. It is a complex product and we lend to that product the skill and professionalism that a lawyer would bring to his task, or a CA would bring to his tasks. We view ourselves in the same way.
Some of the recommendations in the MacKay report seem to suggest that we, as an industry, want to get into banking or offering credit. Nothing could be farther from the truth for most brokers. They wish to be more professional at what they do because it is a profession in and of itself.
It is also important to point out that we act as advocates for our clients. One of the largest issues we need to bring to the table to make the committee understand is that, in the industry that we are in and the products that we sell, we bring advocacy to the table. If banks are selling their single product from branches to the consumer, whereby they grant a mortgage and also sell insurance, that linkage is almost a conflict of interest. There cannot be room for advocacy if the banks are in the business of doing that.
We have always taken a leadership role in trying to educate Canadians on issues such as drinking and driving, crime prevention, road safety and earthquake preparedness. In this province, we have entered into an agreement to contribute ten million after-tax dollars from small agencies toward road safety programmes over the next five years. We hope that that will have a significant impact on reducing accidents and saving lives. Those are the types of value-added items that we bring as an industry.
I am sure there are a number of things I have overlooked that my colleagues would like to add. I would like to thank you for allowing us to come here as witnesses today. I appreciate that what you must do is a difficult task and I know there are many things for you to consider. I hope we can add some value and, perhaps, illuminate you on some of the things you need to consider as to what we do and who we are.
Senator St. Germain: Thank you, gentlemen, for appearing before us today. There is no question that we, as senators and Members of Parliament in general, have been bombarded by your industry and the automotive leasing industry from the very beginning of these discussions.
In British Columbia, where the credit unions have sold insurance over the years, have you any data to prove that the addition of a credit union in a particular community has taken away any of your business, or has it just brought more business to the community? Is there any data on that? That is as good a comparison or analogy that we can use at this time. Possibly there are other comparisons worldwide where banks have been allowed to come into your industry and it shows what impact that has.
Mr. Megson: It is correct that credit unions in this province are able to be involved in the insurance brokerage side and in the selling of insurance -- that is, general P&C products. In 1989, the Financial Institutions Act was passed. However, that act does not allow credit unions to retail those products out of their branches. They must have separate and distinct premises. That is something that the regulators at the time put into place because they had concerns about the very things we have been discussing and you have been hearing about with respect to coercion and the inappropriate use of information on the privacy situation. They can be in the business such as the banks, through subsidiaries as a result of the 1992 act, but there are those safeguards in effect.
In Victoria, a large credit union has approximately 25 per cent of the personal lines market. That is the home insurance and car insurance sales in that area. Perhaps Mr. Pollock can expand on this, but the Insurance Council in this province, which is a regulatory body for our industry, receives constant complaints from the public about tied selling. Many complaints come to our people, who feel that they are compelled to buy a product because there will be a savings on some other side, and the implications that are involved in the granting of credit. That is something that happens a lot and something with which we must deal. However, they are not allowed to retail out of the branches because of this separate and distinct premises legislation.
Senator St. Germain: That is merely cosmetic in many cases, do you not agree? Have you any data that indicates that insurance brokers have had to close down their businesses because of the aggressiveness of some of these institutions? This is basically what we are talking about in a much smaller form because they are credit institutions like banks.
Mr. Megson: Speaking for the area of Victoria, where I live, prior to the credit unions being granted the ability to purchase brokerage firms, there were probably about 50 independent broker firms in the city; now there are about 50. Over that period of time, which has been well in excess of 10 years now, there has been a substantial growth in the population of the area. From that observation, there is no question that they have had a significant impact on that area and the marketplace in which I deal.
Senator St. Germain: Is this data that you have, or is this rationalization? I know that some of the larger broker firms in British Columbia are gobbling up the smaller ones. What we are looking for is data that would back up your argument. There is no question that the chartered banks are an institution developed by governments. They are protected by the government and they have been virtually guaranteed a $4-billion profit every year, as chartered banks. The main concern, however, is the consumer. I do not agree with the entire MacKay report, but it does say that they are trying to improve the plight of the consumer. Do you not think that insurance would be a bit more reasonably priced to the consumer if the banks were permitted to sell it?
Mr. Chuck Byrne, Executive Director, Insurance Brokers Association of British Columbia: One of the other key elements that the legislation includes is a restriction on data base mining and cross selling. To say that the distinct premises issue is simply cosmetic is not quite true because there are licensed insurance professionals in the brokerage office. You have them unable to walk people between those two offices and to send leads back and forth. It does act more like a distinct and independent insurance brokerage operation. The client being served is somewhat different because of the nature of credit unions. They have less commercial risks because they are dealing mainly with personal issues. However, they do operate much like any independent insurance broker. They are responsible for their continuing education credits and licensing, and they cannot cross sell or cross distribute products between the two of them. When we say that we are against banks retailing insurance from their branches, we are talking about a completely different structure and fundamental sales tool or bundling of products, which the credit unions are restricted from and do not have the opportunity in which to engage.
Mr. Megson made the point that there have been complaints and convictions on tied selling and coercion issues since those rules came into place, even with those rules on distinct premises and data base mining. It is quite clear that that protection was put in place to maintain the level playing field that we are here to try to protect as well.
Mr. Megson: Clearly, the credit unions are a force to be reckoned with, there is no question about that. They are credit-granting institutions and all the things that that brings to the issue. As a direct result of the legislation that is in force here, we can live with that because we feel there is this effect of the level playing field because of the separation and the fact that they have separate and distinct premises.
It is also important that the committee understand that they compete in a similar way, insofar as they are representing many insurance companies as well. They may not have as many markets as independent brokers, but they still have the three or four different markets that they might use. With respect to banks, that will not be the situation. The Royal Bank will have the Royal Bank Insurance Company. That will be what it uses. Consumers will not be availed of those choices in the banking situation that they are availed of here in the credit union situation.
Senator St. Germain: In your industry, does the aspect of selling your products, which are so complicated, not give you the protection that would allow you to continue because of the detail, the information and the professionalism that is required to sell them?
Mr. Megson: There is an element of truth to that. Professional brokers will do well in areas of the commercial side of the business. In general, the products are complicated. When someone is in a credit granting institution for a mortgage on their house, the house insurance product seems to them like a generic product. However, it is not. The problem is that it will get sold through the banks as a tie-in because the individual wants the credit to borrow the money to buy the house and the insurance will just come along for the ride. It will not be explained and it will become a marginalized product at that level. Should the banks be allowed that ability to sell through their branches? The whole concept of a complex product will be lost on those kinds of issues.
Mr. Byrne: The B.C. insurance company owned by the Hongkong Bank of Canada is another example. It is taking a one-product, one-fit mentality to the marketing of its coverage. Many people who buy insurance from them are not given the proper advice. We have had examples where someone has taken out insurance, received the so-called savings, and then found that their home does not qualify and they were at risk of breaching their policy. One situation involved an electrical panel, the other a bare land strata, and another person was going south for an extended holiday over two weeks time, which voids a policy. Those issues are not being properly explained at the time of sale. They are simply going for the quick sale and trying to pigeonhole everyone into that product.
Mr. Roger Finnie, Director, Insurance Brokers Association of British Columbia: In the short run, there will be some cost savings to consumers because these institutions created by Parliament will come in their oligopolistic manner and basically cross subsidize. It will end up with a narrowing in the product choice. If you go to the Blue Bank as opposed to the Green Bank, you will get a choice of one product as opposed to an independent broker where you have a choice of several.
If I may use an example, take a clause called the "standard mortgage clause." Honourable senators probably do not know what that is, but it is an industry-agreed clause that strikes a balance of interest between consumers, insurers and lending institutions. This spells out rights and privileges in the event that there is a loss and there is a lender with a mortgage and a homeowner with equity in their own home. If you go to the Blue Bank, will they say, "We do not have to oblige to any industry standards. We will rip out that clause and replace it with our own clause that happens to be tipped more in our favour." Is that good for consumers?
[Translation]
Senator Hervieux-Payette: We are talking about the possibility of a general ombudsman who would cover all financial services. The organization set up by the banks would have the possibility of extending to the insurance industry. Would you agree to share the costs, that there would be an authority that would try to reconcile all the interests and would allow consumers to go to the General Ombudsman of Financial Institutions, and this would cover your services?
[English]
Mr. Byrne: The key here is with the Superintendent of Insurance in each province, which usually has a consumer client division. In addition, the Insurance Council deals with the regulatory elements of licensing brokers and often will take the complaints themselves and deal with them. The idea of an ombudsman seems to be a duplication or a replication of that duty. If it was to represent the entire financial services sector, I would say that we have those people in place now. I may not understand precisely where your idea comes from, or what it is meant to achieve, but I think that the superintendents in each province and federally do an admirable job of regulating the industry and looking out for the consumer complaint issues.
In addition, something which is unique to our association is a growing awareness of alternate dispute resolution in the industry and for years more and more complaints have been dealt with by ADR versus the concept of litigation and the courts. Generally that moves the process quite handily and effectively and is a good answer for the consumer issue.
[Translation]
Senator Hervieux-Payette: In Québec, insurance brokers have a relatively advanced training, and the requirements are very important. The chairman of Desjardins told us that all their brokers, who sell general insurance in their branches, had to be brokers who had the same training as independent brokers.
Is this the case in the province of British Columbia? Did they receive adequate training, or are they bank employees who received training from within?
Do you think the broker training mechanism in Canada is similar and that it is more or less equivalent in all provinces? Do the people in your sector all have a comparable level of skills?
[English]
Mr. Finnie: In terms of the educational requirements to become licensed as an insurance broker, there is such a regime in British Columbia. The licensing is conducted by a provincial authority called the Insurance Council of British Columbia. There are examinations and course material which are required to progress to level 1. After a period of time and further courses, one progresses to level 2. Over time, there is level 3 or being named a nominee to a brokerage firm, which gets to a very high level in terms of the management compliance and so forth.
In terms of the quality of an insurance broker or the delivery of services, not only are there educational standards, there are also experience standards that one must confront. The major interest to the consumers is twofold. First, one must ensure that the availability of insurance and insurance product is there for whatever risk needs to be dealt with. Second, in the event of a claim, we must act as a de facto ombudsman to ensure that the claim is resolved, and resolved properly. There are those tiers here in British Columbia and they are of a very high standard.
We also have to maintain continuing education standards so that if there are new developments in the industry they are brought up to date. In terms of the equivalence across Canada, I do not believe it is exactly the same. Perhaps my colleagues might be able to better comment on that.
Mr. Megson: To begin with, the credit union brokers here must comply with the same levels of regulation, education and licensing that we have. They have to meet the same standard.
Let me point out that British Columbia was a leader in implementing continuing education and what we call step licensing, graduated licensing and experience. A great deal of that movement was driven by brokers in this province. We are not self-regulating per se, but we have had a lot of influence in driving up the standards ourselves.
There is no national harmonization of standards from a licensing and regulatory point of view across the country. The standards vary from province to province. However, at our national association level, the Insurance Brokers Association of Canada, we have national educational courses, which brokers have put together themselves. They are available to all the provinces and all the provinces use them. However, the respective provincial regulators have not been standardized or harmonized.
Mr. Bruce Pollock, Deputy General Manager, Insurance Brokers Association of British Columbia: Senator, with regard to the role of the ombudsman, the success of that role and of that person is dependent on the willingness of consumers to come forward to report incidents that occur in the course of dealings with a financial institution. In many cases, consumers might be reluctant to go to any ombudsman, or anyone in authority, to report those incidents for fear of somehow having that information and those issues come back to them through their financial institution.
We know that in the province of British Columbia serious incidents of tied selling and coercion have occurred. They have been reported by consumers. Mr. Byrne mentioned earlier one case in which there was a prosecution. It is not our view that an ombudsman would necessarily help to solve such issues.
When a consumer comes into a financial institution for banking or loan products, they may have the perception that if they purchase insurance from that financial institution they will somehow be able to get a better deal, such as a better loan arrangement. Having an ombudsman will not solve that problem. That is a critical issue to consider in respect of this conversation.
[Translation]
Senator Hervieux-Payette: I would only like to end my comment, Mr. Chairman, by saying that stockbrokers have a national training and a national standard. I understand that in British Columbia, you have one of the highest standards in the industry. My suggestion is that, for the protection of consumers, specially because of the complexity of the products you sell to consumers, there should be a national standard.
Is there a national standard in your sector? You may be in the best position to influence brokers across the country for them to have an identical level of skills.
[English]
Senator Kroft: Does your organization represent all insurance brokers in the province?
Mr. Byrne: We represent approximately 75 per cent to 80 per cent of all brokers. We have a sister organization called the Credit Union Insurance Services Association which represents credit unions, even though many credit unions are associate members of our association. In addition, there are a number of brokers who have chosen not to be members of either association.
Senator Kroft: As we have gone across the country, it strikes me that in nearly every case that I can recall the people from your industry who have appeared before us have been what I might call independent or local brokerages, as opposed to those who represent national brokerage organizations. I cannot recall having seen anyone from any of the large national or international brokerage organizations.
Can you confirm that you do not speak for those people, or do they have different views or different concerns? Why do we not hear from those national organizations?
Mr. Byrne: The major brokerage houses in Canada which also operate internationally are often substantial operations in their own commercial field. They maintain memberships with our association, as they do with most other provincial associations. They take an active part in the involvement and governance of the association. We have employees from major brokerages and managers on the board of directors in B.C.
Senator Kroft: I am interested in why those people never appear before us. It leaves me with the impression that they do not identify with your issues in the same way as you do. Otherwise, they would be joining with you in a more obvious common cause. I am trying to understand this situation a little better.
Mr. Finnie: Perhaps I could profile the insurance brokerage business. There is what we call the street-front type brokerages who might sell only homeowner, tenant and automobile insurance. On the other end of the spectrum are the large multinational firms which insure giant multinational corporations, principally for business insurance needs. In between, there are the middle market brokers.
Certainly, the range of interest on the part of the seller of consumer insurance to the guy on the street who buys his house and car insurance is different from a broker who is selling commercial insurance to large corporations.
Senator Kroft: Therefore, can I take from that -- and I have to mix own experience in with your answer -- that those firms that are largely dealing with more commercial accounts do not see the idea of the banks being able to offer services out of their branches as the same threat? Thus, they do not have the same preoccupation that would motivate them to be heard.
Mr. Finnie: I would say that is a fair assessment. Often, larger brokers have to have a certain size of account before it becomes economically efficient for them to take on a new account. Those account sizes could, perhaps, start at $10,000 or $25,000 of premium.
Senator Kroft: When talking about narrowing the range of options or moving toward, perhaps, that template type of policy, is it conceivable that a large merchandiser of an insurance product -- and I am leaving auto out of this -- could reduce homeowner, boating insurance or other basic common standardized risks to a common enough template that they could be marketed on the Internet? Or do you feel that the personal interface will always be there? Or is that a threat that you see the bank intervention taking us to, to the detriment of the consumer?
Mr. Byrne: I agree that there is the potential for that becoming a threat to the consumer, that is, the watering down and the lack of specificity to the design of the product. In a former life, I was involved with an insurer who did enter into an Internet form of marketing coverage. As we were developing templates for the homeowner and automobile side, it was clear that the myriad questions that had to be properly asked and answered required the review of a broker.
The way our system was developed at that time, and the way it works to this day, is that someone inquiring about the product would be given an application to complete on-line. They were quite detailed, unfortunately, and time-consuming to complete. However, with the speed of the Internet these days, it is not such an onerous task. If they were willing to pursue that quote, then it would be referred to a broker in the consumer's postal code area. The consumer could then chose from a list of brokers to have a follow-up interview to ensure that the company was not selected through some fraudulent means. More important than that, it was to ensure that the consumer was being looked after and that these issues were being covered.
Do we know about the $4,000 mountain bike owned by the individual? Do we know about the $6,000 musical instrument, or the jewellery or fine arts schedule? Those are the issues that have to be dealt with in a detailed manner.
Obviously, the danger is the ease with which one can take the pricing of a product and bundle it with your mortgage, your savings account, your RSP deposits and the lease on your vehicle. One could be a loss leader for the other. One could be more of a profit generator than another.
An interesting situation I have noticed over the years has occurred in the electronics industry. It is that the margins on computers, VCRs and televisions do not exist any more. However, electronics dealers are all selling extended warranty products on which they make a substantial amount of money. Clearly, those types of marketing techniques, the deep-pocket concept that the banks could bring to such a scenario, would be unfair and detrimental to the consumer.
Mr. Finnie: In terms of the template issue, certainly, there is an information-gathering process about a risk. That information then gets plugged into a formula for rating, et cetera. You must remember that brokers are instrumental in the ongoing development of insurance products or covering off things that may not have been covered before.
With the establishment by the Hongkong Bank of Canada's bank-owned insurer in British Columbia, we have picked up their wording. It is one wording as opposed to perhaps a dozen others that we might be able to offer through our office with different terms, conditions and prices. It is interesting to note how different words such as "vacancy" versus "unoccupancy" can change the policy wording and the coverage just like that. For example, if someone is on holidays, two policies may respond very differently. Even in terms of water damage claims or how a sewer might back up will be responded to very differently. Who is watching out for the consumer in that regard? These wordings are virtually unregulated. A consumer can receive by phone a quote which is cheaper because, of course, their product in those areas, is to a large degree, inferior. Does the consumer really know the difference?
Our role is to present the different products, stating that, perhaps, this one is cheaper, but it has shortfalls. They may not be of interest to the consumer, or it might not be the right fit, as opposed to one which is more expensive which has some additional features but which is a better fit.
The Chairman: Mr. Megson, thank you to you and your colleagues for being with us this morning.
Our next witnesses are from the Federation of Canadian Independent Deposit Brokers. Mr. Brad Minton, the president, and Mr. Jack Rothenberg, a founding member, appeared before the committee three or four years ago when we were looking at the last set of changes to financial institution legislation.
Mr. Jack Rothenberg, Founding Member, Federation of Canadian Independent Deposit Brokers: Honourable senators, I would like to begin by thanking the MacKay task force for the time and energy it spent in preparing its comprehensive report. I would also like to thank you for giving the Federation of Canadian Independent Deposit Brokers the opportunity to comment upon, and possibly add to, the report.
The federation is comprised of entrepreneurs who recognized the needs of consumers in the late 1970s and early 1980s. We became known as deposit brokers. We primarily shopped the interest rate market and identified the financial institutions with the best rates. As the years went by, we expanded to offer insurance products and mutual funds. Today, some of us are full-fledged financial planners and stockbrokers registered with the Investment Dealers Association.
As independent financial intermediaries, our role has been to find the best product and the best pricing and services available to the consumer in the marketplace. In brief, deposit brokers provide deposits on a cost-effective basis to financial institutions and provide Canadian consumers, regardless of where they live, with a complete range of financial products.
Presently, we have in excess of $13 billion under our umbrella. The Federation of Canadian Deposit Brokers has been conscious of limiting our investors' deposits to the $60,000 protection limit imposed by the Canada Deposit Insurance Corporation on each financial institution. We have become very distressed and apprehensive as a result.
Our distress and apprehension stems from two areas. First, with the upcoming inheritances of baby boomers, the average consumer's liquid wealth has been growing by leaps and bounds. These dollars have been accumulated through sweat and toil over several generations. In the past, we were able to distribute these funds evenly with a number of financial institutions, thereby ensuring the protection of the CDIC. This is no longer the case. With the demise of many of our trust companies and with the amalgamation of others with the banks, the average consumer is placing more and more of his or her funds with fewer institutions, mainly the banks.
Second, as you are aware, the investment strategies of these institutions have changed dramatically over the last few years. Earnings are no longer predominantly generated from the spreads between interest being paid on dollars taken in and interest being charged on dollars lent out. Investment managers have been hired with the exclusive responsibility of generating above average returns on the capital within these financial institutions. Vehicles of investment which would have been considered taboo only a few years ago have become everyday transactions. Some major investment houses have fallen victim to the irresponsibility of their money managers who have used derivatives, options and futures to enhance performance. As pressure mounts to continue to outperform the previous year's results, the consumer stands to lose, potentially, a lifetime of savings.
The view of the federation is that any consideration of mergers should address the twin issues of the safety of consumer deposits and of maintaining a competitive marketplace for such deposits. Merged institutions that do not maintain an equal number of CDIC-insured entities after they merge will reduce the available alternatives for insured deposits. Subsequently, consumers may find that a portion of their savings will become uninsured within a merged institution. They will then have to decide whether to accept that risk or whether to transfer the uninsured excess to another institution where they have not reached their maximum deposit limit, provided that such an alternative exists. Conversely, if the number of CDIC insured entities remains the same post-merger as existed pre-merger, the merged institution may have a disproportionate share of the market and thereby increase its competitive advantage.
Based on the foregoing it is suggested by the federation that consideration be given to increasing the CDIC limits, not only to protect existing deposits of a merged institution, but also to improve market competition with the non-merged institutions, which would, ultimately, be able to accommodate more deposits. The federation believes that an increase in CDIC limits would lessen the inconsistencies that exist in the marketplace between federal and provincial financial institutions.
As you are probably aware, the provinces of Ontario and Alberta both provide unlimited coverage of consumer deposits in their savings and treasury branches, which essentially offer the same services as do the banks and trust companies. It is with this in mind that the Federation of Canadian Independent Deposit Brokers seriously recommends that the limit of CDIC protection be raised to unlimited coverage or, at the very least, to $150,000 for registered funds and $150,000 for non-registered funds for each individual at each of the financial institutions.
Tied selling is another concern of the consumer that has been brought to our members' attention on numerous occasions. Branch managers of various financial institutions have been reported to offer capital business loans and lines of credit conditional on RRSP funds being transferred to their branch. In addition, it is not uncommon for a consumer to be told that his or her loans must be covered by life insurance, insurance that must be purchased through the financial institution offering the loan.
We are delighted to see the progressive stance of the House of Commons Finance Committee in amending the Bank Act to prohibit tied selling. However, the federation recommends that the definition of tied selling be more clearly defined. I draw your attention to section 459.1 of the Bank Act, which concerns itself with restrictions on tied selling. It provides, in part, that the Governor in Council may make regulations specifying types of conduct or transactions that shall be considered undue pressure or coercion.
We would like to see more meaningful definitions. We also encourage the task force to provide a mechanism for the consumer to remedy and to address these concerns independent of financial institutions.
Confidentiality is a right that every consumer deserves. Nevertheless, time after time financial institutions have taken advantage of information received indirectly. A particular case in point is that of a trust company that has used deposit brokers as intermediaries to have their clients invest in this trust company's guaranteed investment certificates. As required by the federation, direct deposit accounts are set up in order to deposit cheques directly to that trust company's bank account. The bank where the direct deposit account was set up photocopied these clients' personal cheques which provided them with residential addresses, as well as phone numbers. The bank proceeded to call the clients and offer their GIC products directly. This is a serious crossover of boundaries and of confidentiality.
The privacy model code of the Canadian Bankers Association is intended to help Canada's chartered banks develop, adapt and implement a privacy code specific to each institution. We are extremely concerned whether the privacy code is being adhered to in the strict sense of the word.
In this regard, the federation has two recommendations. First, we recommend that the privacy model code is adopted and practised by each bank, in addition to allocating an agency to monitor compliance of the code. Second, we recommend that there be introduced a privacy code by which all financial institutions must comply.
Heading into the new millennium we hope there will be a new corporate responsibility. The bottom line will continue to remain important. However, of equal importance is the security of the employee who has helped contribute to that corporation's profitability. The merging of behemoths for the sake of "bigger is better" is not a good enough reason for thousands of employees to face both the threat and the reality of unemployment. For example, it has come to our attention that some corporations use the tactic of offering job relocation positions on the other side of the globe to encourage employees to accept early retirement.
The Federation of Canadian Independent Deposit Brokers believes that in view of the fact that these corporations are extremely competitive and profitable, the downsizing of personnel through merging is morally wrong and without conscience. Hopefully, each of you here today will help implement the necessary measures to ensure the safety of consumer deposits, protection from tied selling, confidentiality and consumer privacy and sensible mergers and moral responsibility.
The Chairman: The underlying public policy rationale for deposit insurance, which this committee has looked at in some considerable detail, is to protect the unsophisticated investor. The idea was if you had up to $60,000 it was unfair to expect a person who was a novice at investing to be able to find somewhere to put their money. Therefore, many years ago the government decided it would protect a $60,000 investment.
Your complaint early on in your presentation is that if someone gives you $300,000 you can proceed to break it into five $60,000 parcels and place those parcels in five different institutions. This single individual is now treated as five unsophisticated investors all rolled into one. As the market is consolidated this particular investor has trouble because they cannot find enough CDIC-insured institutions in which to place their money. Tell me why there should be a public policy reason why we ought to be concerned about that level of investor. I am not arguing that what you are doing is illegal, but it runs absolutely counter to the entire intent of deposit insurance. Your solution to that is we either create more insured places to put the money or we raise the limit.
This committee is on record on a number of occasions as being in favour of lowering the limit, not raising it. You should know that in advance. You point out that in both Ontario and Alberta provincial institutions have unlimited limits. In my view, you do not have a problem because you could put $150,000 or $200,000 into one of the provincial institutions and thereby have it insured. I do not see why you have a problem.
However, more important, tell me why we should care about that.
Mr. Rothenberg: Mr. Chairman, I know initially what you are saying sounds very logical to everyone around the table.
The Chairman: This committee has been consistent on the issue. I am not presenting you with an issue that we have not thought about in some detail.
Mr. Rothenberg: Being involved with the consumer, as I have for over 30 years now, I can tell you that there are very few sophisticated investors. I do not care whether they have $500,000 or $2 million. If you think the investor with $100,000 and the investor with $1 million has a difference in education you are mistaken.
The Chairman: We do not have an obligation in government to protect everyone from their own stupidity. That is not a public policy requirement. Why should there be a public policy requirement to protect your millionaire? I do not understand why that is a responsibility of government. You can tell I feel modestly passionate about this subject.
Mr. Rothenberg: I am passionate about the same subject. What bothers me is that the government has set up a regulatory body to watch the banks and the large corporations. In the early 1980s, our six major banks were virtually bankrupt because they were caught up in the thrill of lending money to Third World countries. The view was to see who could lend money the fastest. Due to the leniency of the government, which allowed this bad debt to be spread over a decade, we managed to save our banks. On one hand the government is saying that it is looking over these financial institutions. If you are watching them for us, then you have an obligation to those individuals who put you into power. An individual may have worked hard and their father, who was a carpenter, may have laboured hard as well, and now they have inherited the parent's money. Perhaps that individual does not know about derivatives, mutual funds or investments in bonds. All that has happened is because of high interest rates in the 1980s their quarter of a million has grown to half a million or, perhaps, a million because a spouse's parents died and now they have $1 million, which they give to a bank because they figure they are solid and secure. Then they wake up one morning and see that everything is gone.
I am a very capitalistic individual. I am like you. I am saying this is not capitalism. You are talking Russia here, you are talking socialism, protecting all the individuals. You cannot have it both ways. It is one thing to stand up and say that there is no regulation on the banks; the government is not watching all of these financial institutions; and you guys worry about where you put your money yourselves because we are not worrying about it any more. If the government is legislating and it really thinks that it has control over what it can watch, I doubt it. The guys being sent out to watch do not even understand what they are supposed to be watching.
That makes me question your strength and the emotionalism that you have in taking away the CDIC. We need to cover all consumers.
The Chairman: The only place where you and I disagree is that you think we need to cover all consumers.
Senator Carney: My question partly deals with the question of why should public policy care about this issue. I would like to ask your views on access. If you have $120,000 in savings you would like to think, under your rationale, that there are two institutions into which you could park your money. If you have $300,000 or $450,000, you tend to want to go to those institutions from which you could get your money out if you needed it. In British Columbia, there are many communities that simply do not have enough financial institutions now. Yesterday, Ian Waddell discussed that when he talked about the report of the task force.
Armstrong, British Columbia, has 4,000 people and only one bank. Hope, with a population of 6,200 people, has only two banks. Invermere, with 2,600 people, has two banks. Gold River, which may have to close down, has 2,000 people and one bank. Nakusp has 1,700 people and one bank. Hudson Hope has more than 1,000 people and no bank service. Fort Nelson has 4,400 people and one bank.
Does part of your concern about the CDIC deal with the access of investors to a sufficient number of institutions about which they can feel safe but still access their savings when they want?
Mr. Rothenberg: That is exactly what we are saying. Incidentally, this is how we were born. We would open up in a little community like this and our one little office represented the Canadian Western Bank, the Royal Bank, the Toronto Dominion Bank and every other bank and trust company. We found it started to get smaller and smaller. As the years went, by and the clients' money started to grow, if they had $500,000 you had to look for quite a number of different areas in which to put their money.
Senator Carney: Inherent in some of your replies is that you have to look at the question of access. The access to financial institutions in downtown Toronto is somewhat different from the access in Lillooet.
The Chairman: Senator Carney, I agree absolutely with your access point. If you were living in a community with only one bank and had $300,000 you could give it to Mr. Rothenberg and he would put it in five different institutions, even though the branches would not actually be in the community in which you are located.
Senator Carney: In theory, I would agree with you. In fact, not everyone wants to do that.
The Chairman: They would want to do it on their own.
Senator Carney: They would want to have access to it themselves.
Mr. Rothenberg: There may not be a deposit broker in every little town and city across the country.
Senator Oliver: One of the things that the MacKay task force report talks about is competition. Part of the problem and the concern that you have can be overcome if there were more competition for the banks that you fear will merge, thus taking away some of the places into which you can place $60,000. Since I have been in British Columbia, I went to look at one of the little ING stores. I read some of their signs.
Do you place some of that $600,000 that comes into your hands with ING Bank? Is that not a new bank in Canada? If there were more of those, would that not resolve your problem and would it not be unnecessary for us to even consider raising the protection limit to $150,000 from $60,000?
Mr. Rothenberg: I know that our firm does not deal with ING. Perhaps Mr. Minton knows.
Senator Oliver: Can you tell me why you do not?
Mr. Rothenberg: I was not aware of them. Our head office is in Quebec. Perhaps they are not allowed to operate in Quebec. Usually, these institutions seek us out. We are the largest deposit broker in Quebec right now. We usually deal with everybody across the country, but there are a few that do not want to come into our organization because of political problems.
Senator Oliver: Have you heard of ING?
Mr. Rothenberg: No, I have not.
Mr. Brad Minton, President, Federation of Canadian Independent Deposit Brokers: If I am not mistaken, our firm is affiliated with the Wrights Financial Group out of Manitoba. We deal with a large number of companies. I am not sure whether ING Bank is there or not. I have not noticed their rates on our list. They could be, although I am not really sure at this point.
I deal with six to eight clients a day. I have been through some of the fiascos in the past. We woke up one morning to find that Standard Trust had gone down. We woke up another morning to find that Confederation Trust and Confederation Life had gone down. Those were scary times for us and our clients. I am glad deposit insurance was there and in place.
I am dealing with one client who has moved to Comox, British Columbia which is where I live. He had worked all his life for Bell Canada and had put a lot of money into a group RRSP. The wisdom of Bell Canada said Confederation Life was a good strong company. One morning he woke up and realized that he had $110,000 invested there. He panicked. He did not know what to do. I got involved and over a period of time we were able to work through the situation.
The difference between dealing with the CDIC and CompCorp is dramatically different. With the CDIC, within a matter of five or six weeks people had a cheque for their money. In the case of Confederation Life, we still have not got all the money back for this particular client. It caused a lot of concern, especially for an older gentleman of 72.
Senator Oliver: As brokers and as people actively involved in the business community, and pursuant to some of the provisions of the MacKay task force report, can you direct us, as policy makers, to what we should be doing to encourage the establishment of more tier one banks in Canada so that there are other places in which to place deposits?
Mr. Rothenberg: You have to make it easier for a bank to open up.
Senator Oliver: In what manner? Do you mean with regard to taxes or to regulations?
Mr. Rothenberg: The very first thing concerns taxes. They cannot operate when you realize the tax they have to pay on the capital. In Saskatchewan, the province figured out a way to tax debt. That is no way to be in the banking business. Absolutely, it has to be more competitive.
We sell life insurance. I listened to the previous discussion about general insurance. Here is my capitalistic view coming out. It is wonderful to have banks sell insurance for cars, houses and offices at their branches, making those services more accessible to the average consumer. What concerns me is the banks are so wealthy that rather than brokers placing the risks with insurance companies the banks will place it with themselves. They can cover their own losses. Ultimately -- and, hopefully, these companies will not go under -- the banks will be left as your sole provider. I can tell you that my experiences with my bank are terrible when they are sole providers. They raise premiums galore. It is not where they will be competitive. I find nothing wrong in banks selling insurance, if they behave as brokers and feed the premiums that they are receiving to the insurance companies, allowing them to earn a commission. Let them compete equally. However, they are not competing equally when they are allowed to be their own providers.
Senator Oliver: My final question in this series of questions will deal with some of your comments on coercive tied selling. MacKay dealt with this. He made several very specific recommendations on coercive tied selling. On page 135 of the main report it states:
-- we recommend that section 459.1 of the Bank Act be proclaimed after amendment in two respects.
He talks not only about the status quo, but he said you must go further. This is what he said:
The offence of coercive tied selling, which now applies only to ties to a "loan" should be extended to apply to ties on all credit products and to insurance products. Further, in view of the pace of change in the marketplace and the desire for flexibility in regulation, regulators should be given legislative authority to designate other specific products or services to which the coercive tied selling prohibition would apply.
Is that not going far enough? Were you familiar with this provision when you made your presentation to us?
Mr. Rothenberg: When I read it the impression I had was that it will all be self-regulatory. Is that not what it says?
Senator Oliver: He talks about legislating it.
Mr. Rothenberg: It is legislated that this and that cannot be done, but the so-called bodyguard watching it is someone hired by the bank and within the bank. That is the impression I had. What the federation was suggesting is that there be an outside source.
Senator Oliver: Do you mean the ombudsman, perhaps?
Mr. Rothenberg: Perhaps. I have heard of the ombudsman, which was new to me when I heard about it. I did not even know an ombudsman existed.
May I talk personally for a moment and not as someone representing the federation?
Senator Oliver: Please do.
Mr. Rothenberg: I run a deposit broker agency and we are also stockbrokers. We are licensed with the Investment Dealers Association. I have a line of credit at the bank which is quite sizeable. Being a deposit broker I also own personally investments and term deposits. They are placed with different trust companies or banks at which I can get the best rate. I also enjoy the privilege of getting the commission from whoever I give my own money. The bank said to me that they wanted my term deposits as collateral. I had no problem with that and gave them $200,000 in term deposits. As they came due they said to me that they did not accept the fact that they were with the Canadian Western Bank or the TD Bank because it would become too much of a hassle for them to collect if I were to go bankrupt and they would have to get the money from my term deposits. They insisted I change them over to their bank.
Senator Oliver: Were they prepared to give you the same rate?
Mr. Rothenberg: No. They refused to give me the best rate that I was able to get. The also refused to give me the commission on my own term deposit.
Senator Oliver: But you were able to turn around and walk out the door and invest your money where you could get the best terms. That is what we can do in Canada.
Mr. Rothenberg: I cannot do that if the bank is going to pull my line of credit.
Another very interesting thing happened last week. A manager came in and said, "You are in the stock brokerage business and stock markets are falling. We understand because we own a stock brokerage firm and in just a matter of weeks the revenues that are coming in have gone down to a trickle. We do not like your line of credit being as high as it is. Mr. Rothenberg, we want you to cash in those term deposits of $200,000 and lower your line of credit." I said that I have confidence in my company. I will take my $200,000, cash it in and pay it off against my line of credit. I did that.
Because my line of credit is not as high as it was before the bank sent me new forms in the mail. In an accompanying letter they asked me to pay a fee of $1,000, along with a $100 monthly fee based on the fact that they have to watch my line of credit every month. I did not sign the forms. My bank manager called me up and asked when I was sending back the forms. He said he must have them as his bosses were complaining. I said that I was not sending them. I asked why I had to pay a $1,000 fee after I paid $200,000 to lower my line of credit. He said, "Mr. Rothenberg, we spent a lot of time with you. We came up to your office, we talked to you about how the stock brokerage business is having trouble now and you have to lower your lines of credit and you have to cash those term deposits."
Was this big work? I became very emotional. I crossed out the fees and after yelling at him and using some English language words I cannot repeat here, we agreed that we would discuss the fees at some later date.
Senator Oliver: You have not paid?
Mr. Rothenberg: I have not paid yet. My business is cyclical and our best months are October, November and December because we handle Registered Retirement Income Funds, RRIFs, and their conversion. People procrastinate. Those who have to do it do it only at the last minute, which is December 31. October, November and December are our biggest months. We can be losing money by June, July, August. Our bank manager gets to know us and he lives with us. He understands we are in the red a little bit, but at the end of the year everything is fine.
Bank managers change about every eight months, and a 25-year-old kid, who is wet behind the ears, determines whether or not I stay in business. I cannot tell you how frustrating it is. I have been running my business which is a multi-million dollar concern handling in excess of $600 million. This kid comes in and tells me I should let go six of my people because it is a slow period, not knowing what it takes to train capable people to take care of the consumers. Really and truly, it is very frustrating.
Senator St. Germain: What is really scary is that it is true.
Mr. Rothenberg: It is true. When I go to my accountants, who are one of the largest firms in the country, and ask them if I should go to another bank the accountant will tell me not to bother. This bank has known me for 28 years. If I go to another bank I will be faced with the same dilemma.
Senator Kelleher: Like you, Mr. Chairman, I want to declare myself. I identify strongly with the views of the Chairman. This is something our committee has looked at for quite a few years. We even recommended that there should be some self-insurance or deductible with respect to the CDIC coverage. Do you not think that there is some responsibility or onus on the person who is depositing their funds to ensure that they are depositing those funds with an institution that has a good track record for investment?
Mr. Rothenberg: Quite frankly, senator, I think it is absolute nonsense. With all due respect, I do not mean to insult you.
Senator Kelleher: My skin is pretty thick.
Mr. Rothenberg: The consumer does not know. You do not know, senator, if the Royal Bank will be bankrupt next month. If you receive their quarterly reports, I challenge you to tell me what they mean. Are you telling me the consumer should show some kind of responsibility? It is nonsense. How? My father passed away and left my 85-year-old mother $500,000. Does she know whether or not the Royal Bank is in good shape?
Senator Kelleher: Some of these 85-year-old mothers know a heck of a lot more than you and I.
Mr. Rothenberg: They have wonderful experience, that is true. But when it comes to financial planning or knowing, how do you know? That huge behemoth in England recently went under because some young kid was investing billions of dollars in derivatives and nobody knew about it. They woke up one day and found that they owed $6 billion. If they do not know, how are we supposed to know?
Senator Kelleher: If every deposit made is guaranteed -- and you are even suggesting that guarantee be to an unlimited amount -- are we not encouraging recklessness with the institutions where these deposits are made because they can say they will offer a higher rate? That way they will get the business and it really does not matter if the risks are too great because it is all insured by the government any way and they will pay it.
Mr. Rothenberg: They do not run their business based on what is being protected. They do not care if you protect everything or nothing. They run their business on what kind of profit they will have at the end of the day. What is the bottom line? If they offer 11 per cent just to get the money, yet they cannot lend it out at 13 per cent, they will take a loss. Whether this money is insured or not, they have to watch their bottom line or they will be out of business. Whether they are out of business and the deposits are insured or whether they are out of business and the deposits are not insured, they do not care. They are not responsible to the consumers. I do not think that deposit insurance determines how the institution behaves with its investments.
Senator Kelleher: You do not have much experience with what happened in Ontario about 10 years ago if you say that. With that, I will end my statement.
Senator Kroft: I qualify myself as being a kid from Winnipeg who recently walked into this committee. I do not know, in parliamentary terms, to what degree I am bound by decisions this committee has made. I sit here, at least for this moment, feeling myself to be a free agent.
Do you exclusively place your funds in insured products?
Mr. Rothenberg: Not at all. We are also stockbrokers. We invest in mutual funds and stocks and bonds, none of which are guaranteed.
Senator Kelleher: In placing your funds as an individual, and looking at it in that perspective or on behalf of your client with whose wealth management or asset management you are concerned, you can look at a range of investment opportunities in the placement of those funds, can you not?
Mr. Rothenberg: Yes.
Senator Kroft: The fact that a certain fund is insured or not is a factor you would bring to bear, along with rates and other matters. There may be individual clients for whom you undertake to place their money only in insured funds.
Mr. Rothenberg: Yes.
Senator Kroft: I come as a capitalist to the marketplace. Let me express this view. As I say, I am riding the risk of not knowing my status here. Would it not be reasonable to suggest whether or not an account is insured is just another market factor which an investor takes into account in deciding where to place their money? As a kid from Winnipeg, not Toronto where the financial institutions are established and powerful and beyond risk, as they are, I identify more with Mr. Pollock who sat here yesterday and asked us to raise the CDIC limit. He is terribly disadvantaged against large financial institutions because they are a principal source for raising the capital needed to allow him to build his business.
Part of me is with you in the case you are making. In response to the MacKay report you would strengthen the economic argument, your credibility and, perhaps, defuse some of the emotion of our chairman if you were also making the case that what you are doing is helping, in a knowledgeable way, on a risk assessment to direct funds toward growing institutions that need some playing-field levelling done, if the aspirations of the MacKay committee and, indeed, if the aspirations of this committee were served in helping to broaden, strengthen and increase the numbers of our financial institutions.
Mr. Rothenberg: I thank the senator from Winnipeg. I am delighted you are here.
If you intend to allow more competition and if Mr. Minton and I decide to create a little bank, there is no way that we could compete if there was no CDIC or if there was some resemblance of co-insurance.
Senator Callbeck: I want to go back to the issue of tied selling. You are not the first witness to express concern about that matter. We asked the financial institutions about it. They indicated it is not a concern. They quote statistics to show that people really have not complained. The Royal Bank indicated that in 1996 they had one complaint; in 1997, they had zero complaints; and, in 1998, they have had one complaint. Why do you feel people do not complain?
Mr. Rothenberg: I only heard the word "ombudsman" when I was in Saskatoon speaking in front of a hearing similar to this one today. You do not know to whom to complain. You complain to your wife, your accountant and your lawyer. To whom do you complain? It is crazy when they say there have only been a few complaints. You do not know where to go. You are at a loss. You have to realize that there are those who do not have the experience. At least I have the strength to yell back. Many of my friends who run little retail organizations and who have been placing their RRSPs with me for years will come to me and say that they do not want to offend me, but they are moving their RRSPs out from under my blanket. When I ask why, they tell me that the bank manager has indicated that if they want to raise their line of credit he wants all their business. They tell me that they promised him their RRSP, but do not take it personally, they have to do it. He is not complaining to anyone. He is compliant and just does it. He is not strong enough to object. This is why you are not hearing it.
Senator Callbeck: Yesterday, the Canadian Banking Ombudsman indicated that his polling shows that 40 per cent of Canadians know about the ombudsman.
Mr. Rothenberg: When did you find out about it, senator?
Senator Callbeck: I knew there was one. Do you think this should be voluntary or do you think that every financial institution should have to belong to it?
Mr. Rothenberg: I do not know if having an ombudsman is the answer. Perhaps they really work. I do not know anything about the history of the ombudsman. In fact, I feel uncomfortable with the word "ombudsman." I would like to feel there that there is some strong regulatory body that really watches what goes on. Maybe it is economically unfeasible, but I know the IDA. I do not know if you have heard anything about stockbrokers coming under the umbrella of the IDA, but it is a vicious organization. I cannot tell you how closely they watch us. They really and truly monitor us. Perhaps there should be such an organization to monitor branch managers at the various banks. The individual branch manager has tremendous pressure on him to raise the deposits in the bank. This kid who was hired by the bank has an objective of raising the funds within that branch from $50 million to $60 million next year. His job performance will be reviewed at the end of six or twelve months. That will determine how he is doing. He feels under such pressure so that he has to ask clients to bring him their RRSPs. Nobody will stop him from doing it unless there is a real watchdog who can.
Senator Callbeck: Would you make the ombudsman's recommendations binding?
Mr. Rothenberg: Of course they should be binding, if the ombudsman is not an employee of the bank, if he is truly an ombudsman, and if he can really take himself away and be the judge. There are very good judges. The legal system, by and large, works beautifully. If there is an independent person who is really independent, it has to be binding. How else could it work?
Senator St. Germain: Mr. Rothenberg, this is a replay of when I left business 15 years ago and went into politics. What you have explained here has not been in the glossy terms of the bankers' associations when they made their presentations, but you are dead on. They are using blackmail. I can recall trying to access loans and being told to start paying administration fees, balloon payments and what have you, something that they used to tell us was so unethical before. All of a sudden they became part of our chartered banks.
There is concern because of the number of banks. I am not certain whether this whole process will improve competition. They are protected. I remember Mulholland saying he was only putting his money in Brazil and offshore and that you guys could just go down to the credit union, sign your life away and try to get $50,000 or $100,000 to do a subdivision.
The Chairman: Gentlemen, thank you for coming this morning. Mr. Rothenberg, this is the second time we have debated this subject, and I am sure it will not be the last.
Our next witness is Mr. Youssef Nasr, President of the Hongkong Bank of Canada, which in spite of its name is a Canadian Schedule II chartered bank.
Mr. Youssef A. Nasr, President and Chief Executive Officer, Hongkong Bank of Canada: Mr. Chairman, the Hongkong Bank of Canada operates 177 branches in 71 communities and nine provinces in Canada, as well as two branches in the western United States. Hongkong Bank is Canada's seventh largest full service bank and is a wholly owned subsidiary of HSBC Holdings plc. of London, one of the world's largest financial service organizations.
Hongkong Bank of Canada, since its founding in 1981, has enjoyed rapid growth, first through acquisition and subsequently through organic growth reflecting the continued expansion of the Canadian economy during the current decade. Our reputation for high quality service, our expanding array of services, including brokerage, asset management, trust and other related wealth-management functions, mutual funds, as well as car and home insurance, combined with hard work, have allowed us to realize a satisfactory rate of return on our capital. We are optimistic about the future of our organization in Canada and we plan to be here for a long, long time.
I believe the task force is to be commended for the excellent work it accomplished in a relatively short time. We were pleased to see that they concurred with our recommendation for full functionality of automatic banking machine networks. If that recommendation is acted upon it will mean that all customers rather than be limited to just those machines operated by their own bank could both withdraw as well as deposit funds in the vast majority of such machines.
Hongkong Bank believes that this move is one of the most significant moves that can be implemented to increase competition in the financial services sector. Such a move would substantially improve consumer choice, facilitate entry of new firms and is consistent with the main theme of the task force's report, that is, the financial services sector exists to serve consumers and must be responsive to their needs.
Since the early part of this century, the greatest barrier to entry in the field of deposit taking and, therefore, full service retail banking, has been that of branching. The capital cost of building a branch network is enormous and the payoff is long in coming. Full functionality would provide each new entrant with an instant 19,000 new locations from which to offer their services, thereby ensuring that other players, however large, would continue to face intense competitive pressures in all regions of the nation.
From my reading of the report I see the task force as having concluded that there are forces external to Canada over which we, as a nation, can have only modest or limited influence. Recognizing those forces, the task force asked itself what can Canada, as a nation, do to make sure that those forces provide Canadians with a financial services sector that is best suited to their needs. The report calls for a competitive, innovative, responsive, open and accountable system.
The central message of the report goes to the very heart of understanding what is and is not within the power of government to change.
Because of the advent of instantaneous and reliable communication, financial markets around the world are now linked ever more closely to each other. It is no longer possible to isolate one market from any or all markets without exacting a substantial price in terms of reduced growth potential and the probable development of non-competitive industrial and service sectors. For a nation dependent on trade for more than 40 per cent of its GDP, such a course of action is both impracticable and unacceptable.
Our financial institutions, be they banks, insurance companies or mutual funds, now must compete worldwide for capital, clients and investment opportunities. If one examines the financial service sectors in Britain, the U.S. and Canada and you account for changing exchange rates, differences in inflation rates, as well as taxation, the fact remains that Canadian banking institutions have a lower sustained rate of return than their major competitors in these other two countries. This puts Canadian banks at a distinct disadvantage when competing for both capital and investment opportunities.
In the past this was not a huge problem. The foreign content restrictions on holding bank shares and how individuals could invest retirement savings, combined with market divisions flowing from the strict enforcement of the famous four pillars, ensured that the vast bulk of equity capital stayed in Canada. Moreover, the dominant profile of the banks within the four-pillar construct meant the banks were able to obtain their required capital. That, in my opinion and I believe in the opinion of the task force, is no longer a viable option. With the likely expansion of the freedom of investment choices for individual Canadians, the ability of the banks to rely upon such artificial investment constraints to provide needed capital will soon disappear.
CEOs and boards of directors worth their salt do not spend too much time on day-to-day events. Rather, they have the task of focusing their thoughts on five years to ten years down the road and asking questions such as: What will the markets look like? Where will the firm be able to obtain capital? Where will it be able to use the funds and how can it hope to remain competitive? That is why several of the largest institutions have begun listing their stock on major world exchanges. It is the beginning of the process of opening up the possibility of raising capital in those markets.
However, if they want to attract new capital beyond the capacity of the Canadian economy, they will have to increase their level of profitability to those of their peers in competing jurisdictions in the U.S. and Great Britain. If they do not, the capital will not be forthcoming, their growth will be curtailed and one of Canada's most important and vital sectors will soon decline to also-ran status in the expanding North American economy.
Canadian banks can increase their earnings in only two ways -- either they increase revenues or they decrease expenses. There is no magic formula. If there were, all of us would be using it. In my estimation, and I have been an active banker in all three jurisdictions, Canada, the U.S. and the U.K., there is little room for substantial increases in revenues, although the report's recommendation to allow banks to sell insurance and conduct automobile leasing through their branches will provide some modest help. The fact that such moves will also significantly reduce the cost of such products to consumers should not be overlooked.
Therefore, the only hope lies in cost reductions. That is what I believe is the motivation behind the announced merger plans. I can tell you first hand that the greatest potential for cost reductions is with the massive continuing investment that each institution has to make in systems development.
The easiest way to visualize the importance of electronic data processing is to imagine that Canada had no computers, no ATMs and no credit or debit cards and, therefore, had to sort manually all of the hundreds of millions of cheques passing through the clearing system in a day. That is a veritable torrent of paper. Without the benefit of computers every man, woman and child would be employed in sorting the material and posting the results. The potential for error, delay and confusion would be immense. Your ability to go into any branch of your bank and find out your balance or make a withdrawal would be non-existent without substantial costs. Our economy would slow down and return to the levels of the 1950s. I doubt any of you would want that.
The institution I head is able to compete and prosper in a highly competitive Canadian market. We are able to offer the full range of services nation wide because of the immense benefits we derive from being a member of the HSBC Group. The support systems we use in our trading rooms are state of the art and are developed and provided to us by our parent. Similarly, much of the operating platform we use in our retail operations comes from the parent. Yet, despite that assistance, we also invest substantial amounts in adapting those systems to the particular features of the Canadian economy. Without the systems support coming from the parent our costs would be so high as to render us virtually non-operative in Canada.
HSBC Holdings is able to spread the cost of this systems development work over a much wider deposit base than the $25 billion in the Hongkong Bank of Canada. I am convinced that it is in the area of software development wherein lies substantial potential for economies of scale and improved customer service.
Back at the turn of the century, Canada was undergoing a wave of consolidation within the banking sector. Many of the same arguments and fears concerning the planned mergers were raised at that time. There were economies of scale to be achieved in supervision and in risk management and more efficient ways of raising capital and funding growing clients. In the competition for capital in particular the smaller regional banks did not have the earnings sufficient to attract investors. Relying on natural deposit growth was not a viable option. The regional banks, such as the Bank of New Brunswick, the Eastern Townships Bank, the Bank of Ottawa and the Metropolitan Bank, found it impossible to keep pace and were eventually absorbed by what are now the big six national banks.
I think most would conclude that Canada did not suffer as a consequence. Consolidation played a critical role in providing the growing industrial sector with the financing it needed as Canada was transformed from an agricultural to an industrial power. We also enjoyed a remarkably stable banking system during periods, particularly in the 1930s and the early 1990s, when others, most notably in the U.S., suffered substantial losses.
Then, as now, legislation was adopted that strove to maintain competition and maximize consumer choice. The task force report, by concentrating on those factors within the purview of the nation and the federal government, has done us all a favour. There are steps we can take to maintain privacy, to facilitate competition, instil flexibility, make all institutions more accountable and maximize consumer choice and ensure that the system is secure and stable. Those matters should be the primary concern of this committee.
Size is inconsequential if the financial services sector serves the population in an efficient and responsive fashion, providing a suitable range of choices at competitive prices. Attempting to limit the efforts by banking institutions to realize cost savings in their efforts to survive and grow is extremely short-sighted. The long-term consequences of such actions would be an anaemic and stunted financial services sector unable to meet the nation's needs in the coming decades.
Banking today is a major employer in Canada, and it will continue to be so only if it is allowed to adjust to market realities rather than being constrained by old-fashioned views of the global economy on the eve of the 21st century.
Factors affecting competition, choice, flexibility and innovation you can and should influence. Designing the right framework is not an easy task. Fortunately, the task force has charted the basics of such a system. Your challenge, and I think it an exciting and important one, will be to provide the details.
Senator Austin: I welcome your remarks because they focus very much on the matrix which this committee is examining. At the beginning of the process we were asking ourselves, as you are asking in your remarks, what is the vision we should have of the financial institutions, the banking community, using the word widely, five and ten years from now? If we were to continue in the current course, what would it look like? If we made changes, what would it look like? Public concern is raised if there is too much concentration in the banking industry because it leads to reduced service and, perhaps, an attempt to gain some of those revenues in a less competitive environment. I read your paper as being relatively unconcerned about that kind of banking concentration. Is that a fair conclusion?
Mr. Nasr: Yes, with the proviso that the 124 recommendations in the task force, many of which relate to providing that consumer choice, are implemented. You are dealing with a package which was very carefully put together, recognizing what is happening with globalization but, at the same time, saying that the consumer has to be protected. The task force did a remarkably good job of balancing all these issues in coming up with a framework that, hopefully, will achieve the two objectives, namely, a viable and competitive financial services sector, but also one in which all the safeguards are in place for consumer choice and quality of service.
Senator Austin: One of the observations I make on your argument with respect to the profitability of financial institutions in this country is that our economy is not as productive as some other economies, including that of the United States, which is the principal area of focus for a banking system, which means that the unit cost for Canadian bank competitiveness, in a continental and international environment, is a larger burden on the Canadian consumer bank services. If you agree that that has to be the case, the question, then, is: How does permitting that competitive return benefit the Canadian consumer?
Mr. Nasr: It is in the area of systems development. I am convinced that more and more of the cost burden in the banks will be in systems development. By being able to spread the cost of systems development over bigger operations, the unit cost will be lower and, therefore, the competitiveness of the industry will rise.
Senator Austin: One of the concerns in discussing the large bank mergers is that on the expense/savings side the efficiency on the revenue balance will be derived from reductions of staff and other cost savings which the Canadian consumer will bear. Are there measures that you think this committee could recommend in that respect that would see those gains in efficiency more in the international marketplace than at the expense of the Canadian consumer?
Mr. Nasr: First, some commitments have been made about job security by some of the banks that have expressed a desire to merge.
Second, if you look at other countries, you will see that the demand for financial services increases as an economy develops. Canada is not the first country to see this kind of consolidation. I am pretty sure we will continue to see rising total numbers of people employed in financial services. What they do will change. We will see less and less of the routine banking transactions being handled by individuals. We will see them being handled by electronic and other means. Increasingly, I see the employees of financial services gearing themselves toward financial advice, financial planning, retirement planning and issues like that. If you look at countries that are even more concentrated than what is being proposed in Canada, and I refer to the Netherlands and Switzerland in particular, ultimately the total number of employees in financial services grew. However, they are doing things that are different from what their predecessors were doing 10 years or 15 years or 20 years ago.
Banks, along with every other financial institution, are growth motivated. The way you develop, the way you grow your company is by doing more business. It will result in a redeployment, as opposed to an actual shrinkage, in the number of workers.
Senator Austin: The MacKay report recommendations included an area that we in the committee have not touched on very much. The heading on page 215 is "Responding to Expectations about Social Performance." From recommendations 88 to 90 what you have is a set of steps which the report suggests are necessary to ensure access to basic banking services.
One of the concerns that we have heard flows from a statement by a CEO at one of the major banks that the pressure that you have mentioned, which he also mentioned, to produce acceptable rates of return would force the banks to drop their current role as nationwide, full-service providers and specialize only in those areas of wealth management in which they could achieve that rate of return. I do not know if your attention has been drawn to these particular recommendations.
Mr. Nasr: Yes.
Senator Austin: I wonder if you would comment on the concern I have just expressed and the recommendations in the MacKay report. Recommendation 90(c) reads:
Deposit-taking institutions should make standard basic accounts available at reasonable charges.
That is to say that there should essentially be a basic cost structure for the consumer, without the bells and whistles. The underlying question is: Do banks, as entrepreneurial organizations, have any greater responsibility to the public than Safeway or the Hudson's Bay Company?
Mr. Nasr: With the technological developments that have occurred, there is room to offer differential service, all the way from wealth management to basic banking. I am particularly enthusiastic about the fact that there are experiments going on around the world in terms of how better to deliver the basic banking packages. In the U.K., for example, they are offering the services through supermarket chains. There is some of that in Canada, but not yet to the extent that it is being done in the U.K.
There are also entrepreneurs there who have decided that offering basic banking packages is a good way to make money, if you position yourself accordingly. I mentioned Richard Branson in the U.K., who has gone after that segment.
As long as there is access to the functions that are needed to provide the banking services -- and I go back to my point about the need to have the ATM network fully functional and the infrastructure in place -- there is room to offer both aspects of the service.
Senator Austin: You would endorse basic access to services?
Mr. Nasr: Not only do we endorse it, we have such an account available. We made a commitment to the government a couple of years ago that we would offer a no-frills, basic account package, very competitively priced, that could provide those services.
Senator Austin: Do you agree that banks have a "social responsibility" as well as an entrepreneurial responsibility to the public?
Mr. Nasr: Yes, sir. Juggling all these responsibilities is what bank management is all about.
Senator Tkachuk: As a non-domestic bank, you have taken the opportunity to develop a branch system in Western Canada. I know that in my home town of Saskatoon there is a Hongkong Bank. I believe there is one in Regina. Why have other banks not mirrored your example and made at least some attempt to get into branch banking and offering consumers at the street level competitive options to the traditional banks? In my home town, at least, you seem to be alone in that.
Mr. Nasr: It is because it is very expensive to start such a network from scratch. These days, it costs $1 million to build a branch from scratch and equip it properly. The payback takes many, many years. If a branch starts breaking even after five years, you are very lucky. Some take much longer.
We were fortunate in that over the years a number of failing institutions became available which gave us the basics of a national network. The Bank of B.C. enabled us to get our system set up in the western part of the country. More recently, the old Continental Bank of Canada, which soon became known as Lloyd's Bank of Canada, became available. That was primarily a Quebec, Ontario and Atlantic provinces organization and we picked it up. That gave us a basic nucleus of branches.
These are branches that had been in their communities for a long time and the customers knew them. Most customers do not have a relationship with a bank itself but rather with the employees who work in the bank. Starting with that advantage, it became easy for us to add product lines and to open up a few more branches to complete the network. If we had started from scratch and opened up 117 branches, we probably would not have shown a return until well into the 21st century.
Senator Tkachuk: If that is so, is it the 10 per cent rule that hinders the development of strong foreign competition in Canada to the new merged banks? In other words, people will not come in on their own? They will look at an opportunity to buy the Bank of Nova Scotia or the Western Bank, for example, and then build from there. Is that what is necessary?
Mr. Nasr: Right now we are in a transitional phase between branch systems delivering the majority of banking services and more of an electronic delivery mechanism. Right now it would have to be done, in large part, through physical branches. As long as it is not possible to access those branches, I do not think you will see much happening.
However, we are rapidly evolving toward electronic delivery. I was listening to the discussion earlier about ING. That bank has decided to try the next phase, which is to try to deliver the service electronically. As the availability of technology and consumers' comfort with technology improves, much will happen. There is also the advent of Smart cards. The delivery and taking of cash is still one of the main functions of the banking system. If we move toward Smart cards such as the Mondex card, which is now undergoing trials in Guelph, Ontario, it will be possible that we will not need branches. Every telephone in the country, with a small attachment, can become a branch, so we will go from having 6,000 branches to having 20 million branches.
Senator Tkachuk: Regardless of Smart cards and all the other technology, people still have cash. People like cash. Of course, when you have this technology, there will be another tax on that capital. When you use the Smart card, you will be charged for taking the money out of the bank that way rather than physically going to the branch to get cash.
Let us deal with that functionality. If we have the full functionality of automatic banking, what will be the charge for me to make a deposit in a Hongkong Bank to be transferred to a Royal Bank in another city?
Mr. Nasr: We are advocating that the Interact system be run as a utility, which means the same pricing for everyone. I use the analogy of the telephone industry. It was difficult to allow competition at the level of the household, because if the phone lines are already installed in your house, it is very difficult to get a second and a third company to also install lines in your house. However, there was room for substantial reductions in the price of long-distance phone calls. The whole philosophy of the phone business was changed. Long-distance competition was opened up, the consumers benefited from the declining prices, but the local provider was forced to give equal access to all long distance providers.
Now, with one phone call, you can choose the long distance provider that offers you the best package and your local provider, who may or may not be the same as the long distance provider, has to allow them in your house at the same cost as anyone else.
Think of the ATM system in the same way; that is, we can all compete in terms of the rates we pay on our deposits, the service levels we give and the rates we charge on our mortgages. However, you need the ability to either take cash or deposit cash, so to choose between all these providers think of the ATM system as the local lines and make that equally accessible to everyone at a charge which just pays for the system, not one which becomes punitive, and you will get a lot more competition.
Senator Tkachuk: Would the Western Canada Bank, for example, have to pay a start-up fee to get into the network?
Mr. Nasr: It would not be very significant.
Senator Tkachuk: Who would they pay?
Mr. Nasr: The association itself.
Senator Tkachuk: In the end, the consumer will pay for the whole thing. What will they pay for that service?
Mr. Nasr: If it is run as a utility, the way the telephone companies are now supposed to price local service, I think the cost will be very reasonable because the bulk of the cost, in terms of setting up the network, has already been paid. The cost of running it and the cost of updating it is a very small part of the total cost that has gone into it. It is a sunk cost.
Senator Tkachuk: Do you think there would be some regulatory framework, a CRTC-type board, that would regulate the cost of using that utility across the country?
Mr. Nasr: That is possible, yes.
Senator Tkachuk: Would this utility set service fees?
Mr. Nasr: No. The utility charges the providers. The charge to the consumer would be a function of both. What the utility charges the provider would be in addition to what the providers need to charge. However, because there will be a lot more providers under that scenario, if --
Senator Tkachuk: Do you believe that?
Mr. Nasr: Not only do I believe it, I would look forward to it because it would enable us to widen our business base beyond the 117 branches that we have.
Senator Tkachuk: When I opened my first bank account, although there was not all the technology that exists today and the branch was only open from 10:00 a.m. to 3:00 p.m., when I wrote a cheque for cash I never paid anything for that service. It was free. The bank made its money on the loans. With all the technology that exists today, there is a charge for every cheque written and a charge to keep the account open. Unless I make special arrangements, they will not pay me any interest. Frankly, it is a money-losing proposition to keep my money safe in a current account.
With all that technology, why do you think that all the competition on this particular network will make it cheaper for me? Why would that be good for the consumer? You are going to be regulated as a user, but the consumer will have to face the monopoly of the system, basically, to pay fees. The consumer will be obligated to pay even more fees for this service.
Mr. Nasr: If there is access to the system for everyone, and if the existing users price their services uncompetitively, other people will come in and compete. The problem right now is that someone who sees an opportunity where service charges are higher than they should be cannot access the final consumer. This is the way you make it possible for them to gain access.
Senator Tkachuk: You spoke of the wave of consolidation at the turn of the century. You said the banks that could not compete were forced to become the grandparents of the five banks we now have. Why is it that in the United States there were more than 270 small banks starting up in communities? Why is it that that is not happening in Canada? How can we make it happen in Canada, and will it be successful?
Mr. Nasr: I have some doubts about it being successful because the barriers to entry, primarily the capital taxes, discourage the formation of new financial institutions. In the United States, the restrictions that existed on nationwide banking opened up pockets of opportunities. However, given the consolidation that has begun in the United States, I would be very surprised if there are nearly as many banks in the U.S. in five or ten years.
Senator Oliver: I have been struggling with the necessary obligation for safety and soundness in our financial system and the burden of regulation. I know that the task force report makes a lot of recommendations for new regulations on privacy and tied selling.
Does the report of the task force go far enough in calling for deregulation in the Canadian financial services sector?
Mr. Nasr: It goes far enough in calling for deregulation for the purposes of consumer choice and pricing, and I agree 100 per cent with that. However, it does not yield an inch in terms of the sound management and financial policies needed to keep the system sound and prudent. It is a good combination. The last thing we would want is a weak banking system. Look at what has been happening in Japan. Despite all the efforts to deflate the economy, interest rates have been reduced to a quarter of 1 per cent. All the tools at the disposal of government to re-invigorate the economy have come to naught because of a sick banking system.
First and foremost, there should be no debate about the fact that the banking system must be very strong. The task force then talks about other things that can be done to gain more consumer trust.
Senator Oliver: I am aware that you and your economist who appeared before the committee yesterday have given us an answer to the question I am about to ask, but I want to look at another part of it. The task force report says that we must have more competition and that one of the ways to have more competition is perhaps through foreign banks or by strengthening credit unions and so on. Yet, the chance of foreign banks coming in and buying a branch network is not too great, for the reasons you have stated. It is way too costly and you have to wait too long to get a return on your investment. You have said that the real answer to getting more competition is the full functionality of automatic bank machine networks. As policy makers, what else should we be looking at to encourage more foreign banks to come in so we can develop a bigger and stronger second tier?
Mr. Nasr: Let me correct one thing. I did not say that foreign banks would not come in and buy networks if they were available. I said they would not set them up from scratch. If, as a result of the consolidation, networks of branches were to become available and therefore we could avoid the very heavy capital cost of setting them up from scratch, I can assure you that this organization would be very happy to pick up many of those branches.
Senator Oliver: Canada Trust told us they would as well and there are others sitting in the wings.
Mr. Nasr: My comments did not address the situation of existing branches becoming available. I will actually go to the opposite extreme and reaffirm our great interest in expanding the network. It is setting up from scratch that is not feasible.
Senator Oliver: What else should we as public policy makers be considering to encourage a greater second tier, more foreign banks coming in and doing business in Canada?
Mr. Nasr: The things that are set out in the task force report. We have decided that we are big enough that we want to have a bank incorporated locally with a head office here. That is good for us. However, many of my colleagues who run other foreign banks find that the costs imposed on them under the current Schedule II structure is onerous. They would like to be here as branches, in the same way that Canadian banks can operate as branches in the countries of origin of those banks. That recommendation is in the report and I believe the legislation is on its way.
We need the ability for people to come in on a monoline basis. We will see more and more people who will decide that it does not make sense to come and compete on a full-service basis, but a credit card provider will come and do that business and a small business loan provider will come and do that business because, based on the scale of business they have in their country of origin, they can deliver that product at a good price with a satisfactory return.
Senator Oliver: What about the fact that some of these monolines would be unregulated while you would be regulated?
Mr. Nasr: It is a question of what portion is unregulated. If someone wishes to offer credit cards here, I do not see a public policy issue about the need for them to be regulated because they are not using the deposits of Canadian consumers to make these loans. If they start taking consumer deposits without being regulated, that is a different story. It depends very much on what business they have come to offer.
Senator Kroft: I wish to pursue your case on accessibility or, the new word we learned yesterday, "contestability" -- availability of opportunity for foreign banks to come in. You made the point that you were able to acquire a mixture of failing or existing institutions. You also made the point that it was not bricks and mortar but the people that are important. I assume you were telling us that it is very important to you that you acquire the going concern, with the people in place, and not only the building.
Mr. Nasr: Exactly.
Senator Kroft: That being the case, I want to turn to the stock of possible available acquisitions in that area because I am having trouble seeing where it exists. One contributor to the stock of bricks and mortar might be closed branches of existing financial institutions, but that would not meet your requirement because they will be empty buildings and not be going concerns. In theory I understand your answer, but in practice I am not sure from where the stock of available acquisitions will come.
Mr. Nasr: I will give you an example of something that is happening practically every day now in the United States. As you know, there is massive consolidation going on. Every time two banks propose to get together, they have to go through the justice department to see whether this is causing any concentration issues. A framework has been developed which seems to work very well. In those parts of the U.S. where there might be an issue of concentration, a consent order is signed which requires the merging institutions to dispose of a certain number of branches. The framework has been developed so that these are viable branches. It is not the case that you sell them one day and then, because you have all the customer files and all the information, the next day the remaining branch across the street takes back all the business. You actually sign a commitment that over a period of time you will not target the clients of the branch of which you just disposed.
I was asked earlier why there have been so many start-ups in the United States. One of the reasons there have been so many start-ups is because of the consolidation that is taking place. All the branches that have been forced to be spun off for concentration reasons make it easier for a start-up to pick up a few of those branches and become viable.
If the Competition Bureau decides that there are parts of the country where there is a danger of concentration, a similar model could be adopted, making those branches available for sale. Between foreign-owned banks which might be interested and some of the non-big five who might be interested, I think we could get something going.
Senator Kroft: That is interesting and we have examples in other industries where that has happened as well. Canada Trust, in their presentation, are advocating that required disposition process. In the U.S. model that you describe, in each of the branches that are sold to new banks or growing banks are the staff included in the sale?
Mr. Nasr: That is the usual model, yes. The branch is a viable business entity in its own right, so you are selling the business. Think of the branch as a company. It has its employees and its business.
Senator Kroft: I understand that, but the branch is not a complete entity. To the best of your knowledge, are the people given a choice of where they will work or does the vendor bank position itself by drawing away the best of their talent? You can conjure up a number of scenarios as to how this might work. I see it as quite different from you acquiring a Continental-Lloyd's or something that had been a going concern vertically as well.
Mr. Nasr: There are different models. It is usually negotiated. Some of them come with all the employees, some with fewer employees, and some with no employees. It is done on a case-by-case, regional basis, literally by street corner. There are many variations.
Senator Kroft: To turn to another issue, I would like to intrude into your five-year or ten-year plan. You were unique in terms of scale and your position in the marketplace. I would like to get a better understanding of where you see your institution going. Who are your real competitors? I ask this because knowing where you are going will help us understand where others like you may be enticed to go and therefore goes directly to the question of other foreign banks coming in.
As you are planning your strategy, where do you see the credit unions, the other chartered banks and other foreign competition? What kind of niche do you see for yourself, or do you have a universal approach?
Mr. Nasr: We have very much a universal approach, that is why we are across the country.
Senator Kroft: So presumably we would look at your strategic plan and see it like that of any of the other major banks on a universal scale?
Mr. Nasr: With the additional feature that, because we are part of a global organization that is in 81 countries, we can provide a network of seamless service for anyone who needs international services -- exporters, importers and people who travel a lot.
Senator Kroft: You have an extra arrow in your quiver.
You made a very strong statement in your presentation about the centrality of software systems to this whole question and the competitive advantage you have by being given so much of this by your parent. So say that your parent, in turn, has the opportunity to spread that cost over such a large organization.
You put this in such stark terms that, merger or no merger, you almost put yourself beyond the competition even of most Canadian institutions. You described the cost threshold as being so enormously high that, depending on which Canadian organization you chose, it almost leaves the suggestion that this is beyond the capacity of most Canadian institutions, merged or not merged.
Mr. Nasr: We are all in an experimental phase now to learn the ideal size to continue to have economies of scale on systems development. Strangely enough, although there have been all kinds of mergers taking place around the world, people ultimately catch up with each other. If you look at the differences between the five or 10 largest banks in the world, one of them is not six times the size of the next one. We are all experimenting.
It is also a function of what the global ambitions of merging organizations are. If the goal of the Canadian banks is to be major players in the North American market, I suspect that the scale that would result from two of them getting together is sufficient to serve that niche. However, if they wish to be among the five or ten institutions to emerge as the global banking institutions, there is the need for a larger scale. It is a question of where you define your market, because the broader you widen your market the more systems you need to cope with all these regional differences to be up to date on the local variations, and so on.
Senator Carney: You have made the point very eloquently that bigger is better for the banking system, both in terms of service delivery to customers and in terms of product cost. Since you bought the Bank of B.C., you have displaced the credit unions, which were the biggest banking institutions in British Columbia, and have become the biggest.
Do you now have more branches in B.C. than you had when you bought the Bank of B.C.? What product costs have been reduced, netting out interest rates, since you expanded to your present size?
Mr. Nasr: Yes, we have many more branches and we still open two to three every year in B.C., in addition to the network.
Senator Carney: Perhaps you could give us comparative figures later, so that we can have the statistics.
Mr. Nasr: I will give you the exact numbers later, but roughly speaking we have increased from about 40 to 55 branches in B.C., and we are still opening them at the rate of two a year. Next year will be a good year because we are opening five new branches in B.C.
I do not think the Bank of B.C. would have been viable on its own.
Senator Carney: That is a hypothetical. We do not know that.
Mr. Nasr: On their own, they would have been a $5-billion organization trying to keep its systems up to date.
Senator Carney: What about the costs of financial products? Where have those costs decreased to the consumer as you expanded? You have made the point that costs will go down and service will increase. You have said service has increased. Where have the costs gone down?
Mr. Nasr: I will give you a simple example. The net interest margin that existed in the early 1980s was in the neighbourhood of 300 basis points; that is, the difference between what we paid on our deposits and what we charged on loans. Now it is closer to 200 basis points. The spread that the bank is taking out of its basic deposit taking and lending business has shrunk by 33 per cent since then.
Senator Carney: My second question deals with your emphasis on the importance of electronic data processing, the need for automatic banking machine networks, and your own bank's reliance on the support system coming from your parent group. What is your bank doing about the computer problems that are envisaged for the year 2000? Can Canadians trust their banks to be open for business on January 1, 2000?
Mr. Nasr: I believe so. The superintendent's office has done a very good job of ensuring that Canadian banks are ready for it ahead of time. We are now dealing with the secondary aspects of it, which is whether our clients and our suppliers will be compliant.
I am happy with the progress our people have made in terms of ensuring that our systems are compliant, given the guidelines that have come up from the regulators about how the industry should be ready.
Senator Carney: From where do these guidelines come?
Mr. Nasr: They come from the superintendent's office.
Senator Carney: You think they are adequate and will get the job done by the year 2000?
Mr. Nasr: Yes, in terms of the bank's own systems.
The Chairman: Mr. Nasr, one of the major things you want is full functionality of all ATMs. How do we get there, given that, presumably, someone has copyright or patent provisions on the software required to make ATMs fully functional? In other words, how do you deal with the intellectual property rights associated with the software of those machines? If we are going to say that every ATM in the country must have these additional features, how do we achieve that while avoiding lawsuits and ensuring reasonable compensation?
Mr. Nasr: The change does not take place at the level of the machines but on the computers in the banks themselves. There is no magic about it. We have an existing, fully functional network which operates in B.C., parts of Alberta, and all the way down the west coast of the United States called the Exchange. You can see them in banks in Vancouver.
The Chairman: I was under the impression that you had to do something to each ATM. You simply rewrite the software at the computer level.
Has anyone given any thought to the legal process through which we must go to achieve this?
Mr. Nasr: I must admit that I have not. I was very happy to see that it was dealt with by the task force.
The Chairman: Because the idea had originated with your bank, I thought you might have gone the next step and suggested the implementation process.
Mr. Nasr: We have made some suggestions about it, but part of the reason for appearing before this committee and the House of Commons committee is to get a sense of how best to achieve that.
Senator Kenny: As there is some interest in this, is it possible for you folks to do some more work and report back to the committee on how you think it might best be accomplished?
Mr. Nasr: Yes.
The Chairman: In your opening statement you made the observation that the main role of the chief executive officer is to look five to 10 years down the road rather than trying to find short-term solutions for today's problems. Would you say the same is true in terms of setting public policy in the sense that we need to be looking at setting a framework that will last for some time rather than setting a framework that will simply deal with whatever the crisis of the moment is because we cannot change it fast enough?
Mr. Nasr: Absolutely. We are learning more and more, especially with the recent turmoil in the market, that there must be a broad policy as well as the ability to react to things as they happen. The way in which governmental bodies have dealt with the recent financial crises shows how resilient the system is and how able it is to deal with issues once the basic foundations are in place.
The Chairman: Mr. Nasr, thank you very much for coming. We appreciate the time you took to appear before the committee and we were pleased to be so close to your head office.
Senators, our next witness is Mr. Robert Ascah, Senior Vice-President for Policy and Strategic Planning for the Alberta Treasury Branches. Mr. Ascah has distributed an opening statement.
Mr. Robert Ascah, Senior Vice-President, Policy and Strategic Planning, Alberta Treasury Branches: Mr. Chairman, it is a pleasure to present the views of the Alberta Treasury Branches on the MacKay Task Force to the Senate Banking Committee. I will give a little background on the Alberta Treasury Branches.
ATB is a full service, deposit-taking financial institution created under the Alberta Treasury Branches Act, which was proclaimed October 8, 1997. We are a provincial Crown corporation, accountable through the provincial treasurer to the legislature of Alberta. Under the act, a board of directors is appointed by the provincial cabinet which directs the management of ATB's business and affairs. Deposits, principal and interest are guaranteed by the province. ATB operates throughout Alberta with 148 branches and 127 agencies. ATB is the tenth largest deposit-taking institution in Canada. It is a direct clearer with the Bank of Canada and has a seat on the board of directors of the Canadian Payments Association.
Last year, ATB earned $85 million and had $8.7 billion in deposits and $7.5 billion in loans, with a capital deficit of $66 million. At March 31, 1998, ATB had nearly one million deposit accounts and over 200,000 loan accounts, and we have approximately 3,000 full time equivalent staff members. At the end of June, we reported a net income of $23.5 million for the quarter.
The following comments are those of the ATB management and do not represent the views of ATB's shareholder, the Alberta government. I will not address possible future directions concerning ATB as decisions respecting privatization or other broad policies are the prerogative of the shareholder. My comments on competitive issues will be cast in the context of the status quo. However, ATB is obviously very interested in the round of discussions taking place as a result of the publication of the MacKay task force.
ATB competes directly with chartered banks, trust companies and provincially regulated credit unions. The changes proposed by MacKay to business powers, ownership rules and consumer regulation will affect the business environment in which ATB operates. I will briefly address three issues: the history of ATB; the question of whether a regional financial institution be viable in the long run, which I think is of particular interest to the committee; and, finally, some comments on MacKay.
During the 1930s, Canada experienced a traumatic depression. In particular, Alberta's income fell precipitously, and I have some charts in the presentation that show that. This created an environment fertile for Social Credit theory. In 1935, William Aberhart was elected based, in part, on that theory. That theory was to provide a social dividend. He promised $25 a month, which offered hope for people in the midst of the Depression.
Recognizing that the creation of credit was central to the government's agenda, the Alberta government applied to the federal government for a bank charter, but it was refused. In 1938, the government passed the Treasury Branches Act, which, with slight modification, remained intact until 1995. In 1995, the provincial treasurer introduced amendments to the act. The Treasury Branches Amendment Act, which created a board of directors, was proclaimed in 1996.
In a letter to the chairman from the then provincial treasurer, the policy mandate of ATB was articulated. ATB was to operate on sound banking and business principles and not to be a lender of last resort. ATB was to remain a provider of services to all areas of the province. ATB was to optimize profit by giving fair value to customers and meeting the commercially viable needs of Albertans. ATB was to concentrate on three target markets, those being independent business, agri-industries and consumer services.
Can a regional financial institution be viable in the long run? This was a question that our board of directors posed during a recent planning session. We had Arthur Andersen Business Consulting review the attributes necessary for ATB to become an independent financial institution, headquartered in Alberta, viable over the long run. In undertaking the assignment, Andersen looked at the experience in other countries and concluded that the best comparison was the United States market.
Andersen's analysis looked at financial ratios of 72 regional banks in the United States with assets of between $4 billion and $30 billion Canadian. They also compared five regional Canadian financial institutions. The analysis was structured to determine the differentiating success factors for these regional financial institutions. It is interesting to note that size was not a major factor for profitability. Rather, the factors were skill, the employment of resources, and specializing in certain areas such as non-interest income through mortgage origination, or development of certain software.
Significant findings of the assessment were that ATB compares favourably on financial performance with its Canadian peer group, but less so with its U.S. peers. ATB can be viable as an independent financial institution over a reasonable period of time with a reasonable amount of investment in people and technology. The direction that ATB is going was confirmed, with its focus on agri-industries, independent business and individual financial services. In order to become sustainable in the long run, ATB would need to have an investment grade credit rating.
Obviously, ATB faces many challenges in the future. Andersen indicated that investments in technology, process re-engineering and people are vital. There is a need to move quickly, with a two-year implementation timetable, and we must transform ourselves to a sales-focused, profit-motivated culture. Andersen indicated that ATB must obtain financial results that would enable it to obtain an investment grade credit rating and meet a minimum return on equity threshold of 12 per cent.
ATB's management is confident that with a focused business strategy ATB can be a viable independent player. Over the course of the past two years, a new management team has been assembled which is extremely enthusiastic about our vision as Alberta's first choice for financial services in the three target markets which I mentioned earlier. The proposed mergers, if approved, clearly represent an opportunity to grow our business in the Alberta market. ATB has a strong franchise, particular in rural Alberta, on which to build.
ATB strongly supports the thrust of the recommendations of the MacKay task force with respect to open competition and greater consumer choice. We support the entry of new financial institutions through lower capital requirements, an accelerated application process, streamlined regulation, and certain tax holidays. Easier access for foreign institutions, along with appropriate safeguards on electronic commerce, is important. However, note that not every person in our society has access to the Internet.
We also support broader access to the payments system on the basis of ensuring that we maintain the existing integrity of the system. This is very important in terms of barriers to entry.
Finally, MacKay talks about transparency and disclosure when important decisions are made with respect to mutual funds, proceeds from insurance, and estate planning. Better disclosure will assist consumers in understanding the pecuniary motivations of sellers of these financial products and services.
Mr. Chairman, I would welcome any questions.
Senator Kenny: Alberta Treasury Branches have a unique history. Do you think there is a role for other provinces to encourage and assist banks of a regional nature to form in Canada?
Mr. Ascah: That is probably a question for the shareholders. Over 60 years, ATB has grown from initial capital of $200,000 to a $9 billion organization which I believes means that the organization is meeting the needs of many Albertans.
I will not add anything to that because I do not want to speak for the shareholders.
Senator Kenny: Would you care to comment, from the perspective of your management, on what the MacKay report missed?
Mr. Ascah: It did not go in great detail into the regulatory system. It may be that the thinking was just in terms of the current situation, where banks are very well reserved and there have not been problems in the financial system over the last two to three years.
The question to which we allude in our submission about international regulators is important. Another area is how to properly regulate conglomerates that are operating in investment banking in particular. That is one area which comes to mind that the report did not address.
Senator Kenny: Could you comment on whether banks or financial institutions that are particularly vulnerable to geographic risk, such as your organization, should be regulated differently.
Mr. Ascah: Institutions that have geographic risk have historically posed problems because in an economy like Alberta there are not a lot of sectors. If one sector of Ontario is going down, other sectors may be going up. Alberta is unique in the respect that the entire economy goes in the same direction.
That should be dealt with through very prudent credit risk policies and through looking at other instruments, potentially credit risk swaps. Also, although this is not relevant for ATB because we have a AA+ guarantee, it could be dealt with by having a very strong equity base. In fact, the Andersen report is suggesting that as an independent player we would need about 8 per cent tier one capital as a percentage of risk equated assets. Those three things would be quite critical for a regional financial institution.
Moving into other regions is another way of controlling risk and managing the portfolios from one industry to another. Another way of being more conservative would be more residential mortgages -- consumer loans as opposed to commercial and independent loans, which are volatile.
Senator Kenny: On that point, do mortgage loans not go into the dumpster along with oil prices? If oil goes from $18 a barrel to $10 a barrel, do a whole lot of folks not walk away from mortgages?
Mr. Ascah: That does happen but individuals do not generally give up their home willingly. The losses in CCB, Northlands and others were more in the commercial area.
Senator Kenny: No one willingly gives up their home, but you have experienced situations where people have had negative equity in their homes.
Mr. Ascah: Yes, and in those cases, people will walk. In certain resource-based towns, many people did walk when the boom raised the prices and the market did not exist to sustain it.
Senator Kenny: Can you be more sensitive, if you will, to the nature of cyclical industries inasmuch as you live with them, you know them and you have been through the cycles before? Can you ride it out with the oil man, the cattleman or the farmer and see them through when one of the big five might not?
Mr. Ascah: It is common knowledge that had the banks been incorporated in Alberta in the 1980s, they would have failed as well. I can provide the committee with the income of ATB during that period, but we did lose quite a lot of money during that period and we went to a significant net deficit.
To reiterate, prudent lending, resources that are able to deal with commodity cycles, which resources we are building up in-house, and a good general provisioning can ameliorate the problems. Regional financial institutions do face economy based issues and we watch the economy very carefully now.
In the 1980s, there was a huge investment boom. Thirty per cent of GDP was investments. Currently, it is 22 per cent. Therefore, while we are concerned about how the international outlook will impact on Alberta, we are not in the boom economy that we had before.
Philosophically, bankers always have to be vigilant in situations where people believe that prices will always go up. That happened in Toronto as well as in Calgary and Edmonton. You have to get out of the box and think when you start hearing those things.
Senator Kenny: We all understand straight-line thinking. You have already alluded to Toronto, which probably has a different basket than you have. Should regulators require you to have a different set of reserve ratios than banks that do not have a significant geographic risk?
Mr. Ascah: We are not really subject to regulation. I have provided in your package the Alberta Treasury Branches Act. We have a capital adequacy requirement, but it is notional capital. It has been designed to control our growth by ensuring that we earn the income to support the incremental growth.
In general, I think it is prudent for the regulator to demand more capital in situations where there is a geographic risk concentration.
Senator Kenny: What does that do to small banks that want to serve a community? They have a burden which is not borne by the folks they are trying to compete against and it is not a level playing field.
Mr. Ascah: MacKay talks about giving those institutions a break in terms of allowing them to accumulate additional retained earnings without being taxed.
Another issue will be the mix in their mortgage portfolio between consumer mortgages and residential mortgage loans. That is one way to address that.
Senator Kenny: Do you support those recommendations?
Mr. Ascah: Yes, I do.
Senator Kenny: There is a fair bit of interest in expanding the payments system. Do you have any comments on how that might be accomplished? Who should share the burden? Who should pick up the costs?
Mr. Ascah: This is a very difficult problem. We support broader participation, and that would be participation at the board level, not merely the stakeholder advisory committee, and that would include retailers and other financial institutions that are not just deposit taking.
There are two approaches to the containment of risk. One is regulation, and that has to do with capital adequacy and sound business practice. The other issue is access to liquidity. There are differences between access to the Bank of Canada and access to interbank lending lines.
This really gets to the issue of competition and stability and soundness. We do not have a solution. Perhaps one of the ways to deal with this is to build it up incrementally. New entrants might have limits for a cheque of $10,000, for example, and certain liquidity requirements in order to gain access to the payments system.
We are clearly on the side of wanting more competition and an opening of the payments system and see the ability to have a chequing account as a fundamental power for those institutions, like the insurance companies and the mutual fund dealers.
Senator Kenny: If you could manage to do that thinking in the next few weeks, we would welcome it if you shared it with us.
Senator Kroft: I should like to understand your marketplace a little better. On page 3 of your presentation you have four bullets in which you set out the mandate, which is basically a broad banking mandate without any obvious qualifications, other than the geographic emphasis and the emphasis on independent business and agriculture.
I apologize for not having a clearer understanding of this. What is the position of credit unions in Alberta?
Mr. Ascah: There are roughly 80 credit unions, two of which are major players; First Calgary with around $700 million in assets and Capital City in Edmonton with around $900 million in assets. They are regulated by the province. The total system has approximately $4.5 billion in assets and there are roughly 170 branches.
Senator Kroft: I am not too preoccupied with absolute detail. I am trying to get a sense of how the existence of ATB may have affected the development of the credit union movement in Alberta.
Mr. Ascah: The acts creating the ATB and credit unions were passed within a year or two, so I think there was a common philosophical thrust of encouraging these institutions.
Until a refinancing of the system took place in 1985-86, the credit unions were supported by the Stabilization Corporation. They did not have the government as a backstop. Since that time, it has had the government as a backstop. In that respect, we are in about the same position.
Senator Kroft: You are talking about the insurability of deposits without limit?
Mr. Ascah: That is right. We have that as have the credit unions. Alberta Treasury Branches is more into agricultural and independent business and commercial lending than are the credit unions.
Senator Kroft: Let me go to the Business Development Bank and the Farm Credit Corporation. You have just defined three areas where, between the two of them, they have their focus more on the commercial side, with FCC on the agricultural side. What is the marketplace interaction with those institutions? Do you see the Business Development Bank as a head-on competitor with you?
Mr. Ascah: No, we do not see BDB as a head-on competitor. Our competitors are the chartered banks in commercial and independent business lending. We may, in the future, be getting into subordinated debt, mezzanine-type financing, and we may potentially intersect with federal agencies in that area.
Senator Kroft: There has been much emphasis here in the last couple of days on the technological side of banking, the enormous costs involved in operating the technology of banking and the necessity for that investment in order to be cost effective in the marketplace. How you are doing in terms of the technological revolution?
Mr. Ascah: As I said earlier, new management has come on board within the last couple of years and one of the first areas of focus was the investment technology area. We had been making significant investments in technology. It was decided that this was not a core function of the organization and we have, in the last year, taken steps to outsource both our information technology group and our development of programs, as well as our document processing centre, one to IBM and the other to Intrium. That process will be implemented in the next four months to six months. That was done primarily because of the capital investment involved and also because it was not a core competence. We wanted to pair up with industry leaders to get the benefit of their knowledge and skills.
Senator Kroft: Do you believe that by doing this you are able to be competitive in the marketplace in terms of both service and costs, or is the jury still out?
Mr. Ascah: I think the jury is still out. We think it is a very sound approach to solving that problem.
Senator Tkachuk: Did Premier Aberhart ever pay that $25 a month?
Mr. Ascah: No, he did not. The prosperity certificates are probably worth about $100 each.
Senator Tkachuk: That is what he sent out instead. Does that have a collector value?
The Chairman: In fact, the antique value is probably substantially more than the $100 face value.
Senator Tkachuk: When you described the Alberta Treasury Branches you talked about 148 branches and 127 agencies. What are the agencies and how do they operate?
Mr. Ascah: The agencies are fairly novel. I think the Toronto Dominion Bank is establishing some agencies in rural areas. The agency is essentially deposit taking and provides information on our lending programs. They can be in hardware stores or gas bars. Twenty-five to thirty of our agencies are with insurance agents or brokers. It runs the gamut. They are in small towns throughout the province.
Senator Tkachuk: How small are these towns?
Mr. Ascah: They are in towns of 100 to 200 people, although Canmore, with a population of 10,000, has an agency.
The Chairman: You said that the agencies are deposit taking. Do they also provide withdrawal services?
Mr. Ascah: Yes.
The Chairman: I do not mean this in a pejorative sense, but it is a bank branch where the simplest of transactions can be performed?
Mr. Ascah: That is right. As well, we want to get referral business for loans. Each agency has a branch to which it reports.
Senator Tkachuk: Therefore, if you had a branch in Vegreville, for example, it would supervise a group of agencies in smaller surrounding towns?
Mr. Ascah: That is right.
Senator Tkachuk: You spoke of how you are regulated. You said that in 1996 legislation was passed which gave you a board of directors. You did not have one before?
Mr. Ascah: That is right. It was like a department. It was technically a division of the treasury department with branches throughout the province, and the superintendent reported to the minister.
Senator Tkachuk: How are you regulated now? Is there a regulatory unit in the department of finance which would be equivalent to OSFI, on a smaller scale, that governs the affairs of the Alberta Treasury Branches?
Mr. Ascah: It is not that clear. We have two types of relationships with our minister. One, as I said before, is as the shareholder. Second, there is regulation in the sense that under our regulations we have a number of rules. For example, we cannot lend to any person and connected persons more than 1 per cent of our total assets. We have rules with respect to mortgage investments and equity investments. We have to prepare a report to our board saying that we are complying with the act. That information is sent to the treasury department.
The minister has a power, which is similar to a power of OSFI, which can require ATB to cease doing something. The cease and desist type of power is really the only intervention power it has.
Another example of shareholder power is, if we wish to create a subsidiary -- and we have a listing of subsidiaries that are similar but not identical to those under the Bank Act -- the investment has to be approved by the provincial cabinet.
On capital adequacy, we have a deficit which should be gone in the next quarter. However, we have a notional capital which the government has given us and that is another thing on which we have to ensure that we are in compliance.
Senator Tkachuk: Are there ATM machines in the agencies?
Mr. Ascah: I do not believe so. We are bringing in some Internet banking in the near future to allow for the posting of deposits electronically. I am quite sure we do not have ATMs in the agencies. In effect, there is an individual handing out the cash.
Senator Tkachuk: Are they profitable?
Mr. Ascah: We are not losing money on them.
Senator Tkachuk: There is a small commission to pay for the deposits, right?
Mr. Ascah: That is right.
The Chairman: Mr. Ascah, I have one question which you may prefer to answer in writing in the next week or so. I listened to your answers and I read your statement and some of the documents you provided to us. You said that for a small institution, typically a regional institution, to be successful there are six criteria, two of which are business criteria and four of which are public policy criteria. Obviously, we cannot do anything about the business criteria.
Of the two business criteria, the first is that the institution be clearly a niche player in the sense that it have a targeted market. You and previous witnesses who operate successful small institutions have described the niche as oriented toward geography in some cases and toward a particular group of customers in others. Your geographic niche is Alberta and your particular group of customers are agri-business and, to a lesser extent, small business. The business niche of the Canadian Western Bank, from whom we heard yesterday, is by and large the oil and grass industry. They also serve a niche of a particular demographic group with the First Nation's Bank.
The first principle is that small institutions had better be niche players. The second is that they had better operate very efficiently using the efficiency ratios you have described in your report. Those two we can do nothing about. They are business issues.
There are four specific public policy issues about which we can do something and which the small institutions seem to believe are critical to encouraging the introduction of other small institutions that could be successful.
One of those is to lower the initial capital requirement. Accompanying that is the notion that it has to be closely held because you are not going to raise $10 million or $20 million and have it distributed with no one holding more than 10 per cent. The second is that the regulatory cost of operation should be less than for large institutions. That we can do by legislation. The third is that the tax burden should be less, which would deal both with capital tax and with what you have called a tax holiday. The fourth is direct access to the payments systems. The fifth was full functionality of the ATM system, which was argued most notably by the Hongkong Bank of Canada.
Assuming we can do nothing, which we cannot, about the two business criteria, are there public policy changes other than the five that I listed which we need to make in order to encourage the creation and growth of new small institutions in Canada?
Mr. Ascah: Speaking hypothetically -- and it was discussed with respect to outsourcing -- you have an ability to contract with other players that are offering back-office type of services and that market may not be fully competitive --
The Chairman: You are saying that the new small institutions should be able to contract with the big players for back-office computer transactions at the same cost as the big players get them?
Mr. Ascah: That would be one public policy.
The Chairman: That is very helpful.
Mr. Ascah: Although I may sound as if I am retracting what I said earlier, with respect to streamlined regulation and the balance for regional financial institutions, it is important to realize that the degree of regulatory and supervisory requirements and the sophistication of systems for a global investment and commercial bank that is trading derivatives that are offering across the globe are very different from those for a regional institution that is focused on three or four core businesses.
That question of concentration has to be addressed, but on the day-to-day mechanics I do think that the book is not as complex as the larger institutions and I would make the distinction that there should not be that degree of regulation.
That is the only area that I can think of but I will reflect on that.
The Chairman: Could you let us know by the end of next week? As indicated by its questioning, this committee is clearly in favour of encouraging small institutions and it would be helpful if we could compile all the things that will make small institutions successful.
Senator Kenny: For clarification, you stated that the book was not as complex. Would you concede that it might be far more risky?
Mr. Ascah: It is far more risky in the strict sense that the way the Alberta economy is structured today it is more volatile than other economies. That poses a lot of issues for our credit department in how we manage the risk. One area in which we have not taken a large role is the oil and gas industry. We certainly lend to the oil and gas industry, but that is not one of our key markets.
Senator Kenny: You said that you would give some thought to how regulators might address this and get back to us on that.
The Chairman: Mr. Ascah, thank you very much for appearing here.
Senators, this completes our week of hearings in Western Canada. It was a good idea to come to this part of the country to hear from a variety of spokespersons operating small businesses and other types of businesses here.
Thank you very much to all the staff who have been with us this week on the road: translators, support staff, Hansard reporters, et cetera.
The committee adjourned.