Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 36 - Evidence - Morning Sitting
TORONTO, Monday, November 2, 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 (Chairman) in the Chair.
[English]
The Chairman: This is the first day of our hearings in Toronto on the Report of the Task Force on the Future of the Canadian Financial Services Sector. This is our fifth, and last, week of hearings. We will be in this city for three days and then we will have a final day of hearings in Ottawa on Thursday.
Our first witnesses today are from the Canada Deposit Insurance Corporation. Dr. Grant Reuber is the Chair and Mr. Jean-Pierre Sabourin is the Chief Executive Officer. Please proceed with your opening statement.
By the way, I have just one additional comment. Senators, you will notice that on today's agenda I have actually given you start and finish times for the witnesses. I do not do that normally, but for the rest of this week, we have such an incredibly tight schedule that we are going to have to run on time. Therefore, I thought I would put in finish times for most witnesses so that you do not accuse me of cutting you off at the last minute. This was made long in advance of the person who happens to have the floor with about two minutes to go. So that is the only administrative issue for today.
Mr. Reuber, please proceed with your opening statement and hit the major points because there are a number of issues and points in here we would like to ask you questions about.
Mr. Grant Reuber, Chairperson, Canada Deposit Insurance Corporation: Ladies and gentlemen, I am pleased to be with you and let me just say that we have circulated to you, in addition to our statement, two briefing papers. One is called "Aspects of the Development of CDIC's Powers and Approach," which reviews some of the history on how we got to where we are. It is fairly brief and I think quite helpful in judging the situation as it stands today. The second paper is simply an outline of what we do and how we do it. I will leave those for your reading; I know you are short of things to read these days.
This is obviously "an era of turbulence in the financial services sector everywhere in the world."
The truth of this statement by the task force is even more evident from recent events, which have forcefully brought to light the impact that instability in one market can have on others.
Turbulence creates risk. Risk assessment is fundamental to an insurer that CDIC is far and away the major insurer of deposits held at Canadian financial institutions. Accordingly, in the time available, these remarks will focus on issues raised by the task force, with particular relevance to the safety and soundness of the system and CDIC's effectiveness as an insurer.
Now, before I turn to matters of particular interest to CDIC, I want to acknowledge that the MacKay report represents a major achievement. It provides an excellent basis for reviewing the financial services sector in this country.
The report focuses on a broad framework and has the advantage of ensuring that the larger picture remains clearly in view and is not lost in a plethora of detail. But with respect to implementing the recommendations, it is necessary to dig into the details and as always, "the devil lies in the details".
From the point of view of the deposit insurer, the recognized turbulence of our times raises issues regarding the desirability of shaking up the system in order to make it more competitive with whatever additional risks that may entail, and concurrently, changing the role and functions of the insurer. There are trade-offs between some of the task force's objectives, such as increasing competition by various means and existing objectives, ensuring the safety and soundness of the system and seeking to minimize exposure to loss.
The critical policy issues include identifying and assessing the significance of the various trade-offs that have to be made. For example, while allowing new entrants into the payment system may be a desirable goal, the basis on which it is permitted can make a major difference to the safety and soundness of the system. This is particularly true if the new entrants include enterprises beyond the reach of federal jurisdiction and if they function without government guarantees, such as mutual fund companies and investment dealers. Because of the absolutely central role of the payments system, some of the revised rules and regulations regarding entrance, and perhaps the roles of direct versus indirect clearers, may have to be worked out before fully revising other parts of the system.
Finally, before turning to specific issues, I wish to underline the importance of a range of federal/provincial issues that arise at many points along the way to modifying the present system of regulation and compensation arrangements. These are issues that, in my view, the task force does not specifically address.
I have classified the questions that arise from the task force report affecting deposit insurance into two general categories. There are general propositions, which I will very briefly comment upon, and then I will deal with the more specific issues.
One general issue concerning holding companies. There obviously are benefits from holding companies, but it should be pointed out that CDIC's experience with holding companies to date has not been free of difficulty. One major concern is how to contain failure in one part of the enterprise and keep it from spreading to the insured sections of the enterprise. The public frequently does not differentiate between a "Trustco" and its trust company.
Another area that I think has implications for deposit insurance is the mixing of commercial and financial ownership interests. In the past, we have generally kept them separate. In Canada, ownership links have been permitted mainly in the trust and loan company sectors, and that has not been a very successful experience. Successful linkages can be cited, but Canadian experience with upstream ownership links for the trust and loan companies in many cases has been very unsuccessful.
Finally, there is the question of new entrants. The report proposes to stimulate more competition in the financial services sector by encouraging new entrants, especially in the deposit-taking business, and to this end, it proposes to loosen somewhat the rules governing admission to the payments system and so on.
One obvious question is to what extent all deposit-taking institutions, or at least those admitted to the payments system, may seek to have comparable, if not identical, deposit insurance in order to level the playing field. If an insurance company is going to be able to offer cheque-writing and debit-card facilities, and is going to have deposit insurance, particularly government-backed insurance, what about an investment dealer and a mutual fund company wishing to offer the same facilities?
In this connection, it should be recognized that at present, life insurance companies, investment dealers and mutual fund companies can -- and some have -- set up separate subsidiaries that have access to the payments system. What is being considered is a different form of access that may be easier and cheaper. It is interesting to note, however, that a number of small independent trust and loan companies function quite successfully under present arrangements.
Let me now turn briefly to the recommendations specifically related to deposit insurance. The main one of these is the proposed organizational change. There are really two considered in the report. One is to amalgamate CDIC with OSFI. That proposal was rejected by the task force, as it has been by numerous earlier reviews of similar proposals, and I shall not comment on it further.
The second proposal, which is recommended by the task force, is to blend CDIC and CompCorp under one umbrella, either as a Crown corporation, which CDIC is now, or as an independent corporation without an explicit but with a "virtual" government guarantee of its liabilities.
The proposal is based on three premises. First, CDIC's role in securing the safety and soundness of the financial system is no longer as important as it was. Second, in protecting small depositors, CDIC puts the products sold by the life insurance industry at a market disadvantage. For CDIC's liability is guaranteed by the government, but the guarantee provided by CompCorp is not backed by the government. Third, federal/provincial jurisdictional issues can be handled without serious difficulty. All three of those propositions, in my view, can be seriously questioned.
I believe CDIC continues to have an important role to play in stabilizing the financial system well beyond that of protecting the payments system. It provides a separate voice. It has: an expert staff devoted to assessing and managing risk; its own priorities reflecting its financial exposure; its own investigative and intervention powers, performance standards and information sources when participating in the intervention process, as companies move down the ladder from "no problem" to "insolvent."
As such, it provides an important and informed opinion on the intervention actions taken or not taken by OSFI or provincial regulators. It acts as a safeguard against both undue regulatory forbearance and arbitrary and unwanted or unwarranted actions seen from the standpoint of minimizing the impact on losses to the deposit system. If competition is to be promoted, as recommended by the task force, CDIC's role in this area will become even more important. The importance of CDIC having and making use of these powers was made clear in the findings of the Estey commission. In addition, CDIC, because of its government guarantee, can assure the public that a dollar on deposit is the equivalent of the dollar in its wallet; that is to say, it can avoid runs on banks.
The point was reinforced last week in The Globe and Mail when there was some discussion in the column about the difficulties one of the large chartered banks faced in the 1980s.
Further, unlike the Bank of Canada which, for good and sufficient reasons, is limited to making short-term liquidity loans and then only on a fully collateralized basis, CDIC can lend on an unsecured basis and can provide guarantees. In the past, these facilities have been used as institutions have experienced difficulties. There is no reason to expect this function to be any less important in the future, if, as the task force proposes, new and different institutions are encouraged to accept deposits on an increasing scale to increase competition.
What is more, removing or reducing CDIC's role in reinforcing the safety and soundness of the system would be inconsistent with CDIC's present mandate to minimize its exposure to loss.
Let me look briefly at the second assumption, market disadvantage. The task force has accepted the view of the life insurance industry that they are at a significant competitive disadvantage in the market because CompCorp's insurance does not carry a government guarantee, whereas CDIC insurance does. This alleged advantage for deposits applies only to a small portion of the products covered by CompCorp: deferred annuities with a definite term of five years or less, which are comparable to term deposits insured by CDIC.
At present, these make up less than a third on average of the annuity business of the insurance companies, although the amount changes widely depending upon the shape of the interest rate curve. With the aim of levelling the playing field, the task force proposal would bring not only short-term annuities, but also many other products: annuities with a maturity of over five years and retirement, health, disability and death benefits, which are sold by the life insurance companies under the same insurance arrangements as those applying to deposits and they would do so with either an explicit or a virtual government guarantee.
This represents a substantial increase in the financial exposure of the government. Moreover, it does not deal with levelling the playing field beyond the range of life insurance products to private pension plans, to property and casualty insurance and to cash accounts and the deposits and other savings products available at investment dealers and mutual fund companies. Now, if you spread the guarantee even further, you further increase the financial exposure of the government.
This is an example, in my view, where the devil does lie in the details. As already stated, there are important differences between the coverages afforded by CDIC for deposits and by CompCorp for life insurance products. In part, these differences reflect the very different nature of the products. Life insurance products are perceived as being of a longer-term nature than deposits, and they fulfill a very different function. The task force proposal refers to one plan with parallel coverage. If the proposal were to be adapted, it would be necessary to define what constitutes "parallel coverage."
I go on in the paper to comment on some of the substantial differences that need to be faced when considering this issue between the life insurance products and deposits. These issues are serious: for example, the business of creditor priority, and the fact that life insurance products are beyond the reach of the policyholder's own creditor, whereas deposits are not, and so on.
I provide this list primarily to indicate that there are a lot of things that will have to be worked out if the government were to combine these two organizations.
The final point I want to make in this regard, is that if you do really level the playing field, it is not at all clear that all the benefits will accrue to life insurance products. For example, creditor proofing and various other things might go the other way.
Let me talk finally on this point about the problem of federal-provincial relations, which I think are serious. We have, as you know, established between CDIC and the Quebec Deposit Insurance Board and between CDIC and the provincial regulators, ongoing arrangements and understandings. It is quite conceivable, to me at least, that if you went into the organizational change the task force proposes, some of those might be seriously affected and there could be additional federal-provincial issues.
Let me turn to the other two proposals, which I will not dwell upon. One is the transfer of standards to OSFI. At present, these are within CDIC's jurisdiction. They are part of our mandate under the act. We developed them in close cooperation with OSFI and provincial regulators. They are widely accepted as being of a very high standard and they have been emulated by others. We have established a process whereby members self-assess themselves relative to the standards. Their self-assessments are acknowledged by the directors and senior management of membership institutions. The whole process is monitored by OSFI and examiners of provincial regulators.
I think it is fair to say that both OSFI and CDIC believe that the benefits arising from implementing CDIC standards have been substantial. The system runs smoothly and the criticism of wasteful duplication in costs is unwarranted. SARP was developed to fill a gap in the information that we obtained, and assuming the substance of SARP remains the same, it is not at all clear how changing a reporting line would change anything else.
There are, however, two reasons for keeping SARP and standards where they are. First, because the requirement to comply with standards and SARP emanates from CDIC, the requirement applies to provincial as well as to federal institutions. If all references to the standards were removed from the CDIC act and transferred to OSFI, provincial institutions would no longer have to comply unless required to do so by new legislation in each province.
Second, because the standards emanate from CDIC, CDIC's ability to deal with the problem institutions is greatly strengthened. The same is true of its ability to take legal action in cases where CDIC suffers from the losses because of neglect or wrong-doing.
In my view, the present arrangements regarding standards are working well and there are clear advantages in leaving them under CDIC's jurisdiction.
The final point made in the report that specifically related to CDIC is the matter of obtaining data. This reflects a complaint by the Canadian Bankers Association. We generally have a policy of not requesting information from members unless it is necessary to meet our obligations and it is unavailable through OSFI or provincial regulators.
Levying differential premiums is the responsibility of CDIC, not of OSFI, and CDIC has to do its best to ensure that the differential premiums levied are fair and equitable. The differential premium system was designed so that virtually all the information that it uses is that which is currently collected by OSFI, although some information has been adapted for insurance premium purposes. The remainder of the information is currently readily available at member institutions for their own sake. Also, this task force proposal does not take into account the fact that some of the information is from provincial institutions. It is not all collected by OSFI and is not collected by OSFI.
Levying premiums is similar to levying taxes. To be effective and efficient, it is desirable that accurate information be submitted directly by those paying the premiums to CDIC, as is now the case. Submissions on which differential premiums will be calculated will be required only once a year and will be based on a clear and well-understood format. After the initial data formats are established, the additional cost and effort to member institutions will not be very significant.
Let me conclude, Mr. Chairman. The task force has marched to much the same drummer as that of the Porter commission 35 years ago, emphasizing a need for competition, to improve customer service and open up the industry to new entrants and more enterprise, even if it means taking more risk. No one questions that there has been an enormous increase in innovation and competition in the industry over the last 35 years. It is also true that most of this was driven by developments in the market.
As for deposit insurance, the task force's major recommendation is that CDIC and CompCorp be combined. This recommendation rests on the assumption that the government guarantee now offered on deposits via CDIC significantly affects the competitive playing field between deposits and short-term deferred annuities and that this effect is important enough to warrant a major change. However, one also has to pay attention to other differences in the playing field and where such a change may lead.
Another factor is trying to assess the extent to which the proposal carries with it potential for a huge increase in the government's financial commitments. It should also be recognized that life insurance companies at present can gain access to CDIC's guarantee by setting up subsidiaries. In addition, the proposed change could well seriously erode the effectiveness of CDIC's role in supporting the safety and soundness of the system.
Finally, substantial questions remain about the access to the payment system, the arrangements for closing failing firms, and federal/provincial relationships. This type of proposal is not new and has been examined before. In each case, the conclusion has been that the present system reflects lessons learned, is well understood, runs well, has not generated significant federal-provincial difficulties and serves the various requirements of the system reasonably well.
That said, change is inevitable. I am sure there are going to be lots of changes in the future. There is little merit in maintaining the status quo, but we must always question what changes can be justified in terms of costs and benefits and when they can they be made most appropriately.
The Chairman: Before turning to Senators Austin, Oliver and Joyal, I wonder if I could ask you a question about new small entrants.
The task force, as you know, argues that one way of encouraging new entrants into the deposit-taking business is to allow closely held companies, as long as the shareholders' equity is less than a billion dollars.
Historically, I am now thinking back over testimony from CDIC. Even dating back to before you were the chairman, CDIC has been quite uneasy about smaller institutions on the grounds that they are substantially more risky. I notice that you do not touch on that point in raising the question of new entrants. You do not really take a stand on whether you have any views, either in favour or against the encouragement of new small entrants into the business.
Mr. Reuber: We certainly have no views against the entry of new players into the game. I think we believe, though, that the terms on which they enter have to be such that we do not have a repeat of the experience we had before.
In 1967, we had quite a change in the legislation. We had a very large number of new entrants. In 1983, at the peak of our membership, we had 188 members. Today, it is 110, and you ask yourself, "What did we benefit? What was the net benefit of that to the system, this sort of rise in the number of entrants and then the decline?"
It is important for us to ensure that if there are new entrants, they come in on terms that give them a fighting chance to remain in business. Second, we must be very diligent in terms of appraising the risks and their performance, so that if they are failing, we deal with the problem before they become a very heavy cost to the system.
The Chairman: So the fact that they might be closely held, which is what the MacKay proposal is, is not a problem.
Mr. Reuber: The problem with being closely held is two-fold. First of all, we are concerned that the regulator be able to look through the machinery and see what is happening throughout the entire enterprise, because in the past that has not been possible and that has been a problem.
The second concern is that when there are troubles in a closely held organization, a closely held system like that, it is frequently very difficult to unscramble the omelette if you are dealing with the deposit-taking part of it, and so that makes life a little more difficult and complicated. It is not a showstopper, certainly, but it is an added complication, and further complication ensues in the sense that leakages happen, sometimes visible and sometimes invisible, when you have a bank within a larger setting.
Senator Austin: We had a submission, Mr. Reuber, from the Canadian Life and Health Insurance Compensation Corporation, CompCorp, to the committee. Not to your surprise, they favoured the second of the two recommendations of the MacKay report, and that is that there be created by legislation an independent insurer, which would take on the responsibilities of CDIC and CompCorp.
If that were the policy decision of the Minister of Finance, how would you see that particular private entity operating, and in particular, how would you see the removal of the government brand or the government security as a factor in market behaviour?
Mr. Reuber: I think those two models are really a distinction without much difference. If you look at the second model, effectively it is guaranteed, but they appoint all the people to a board and the management, and the rules are set out and they have a line of credit to the government, so you know what you are talking about. I think it is much the same animal with somewhat different coloration.
I think the main problem with that scheme is that if you are really interested in levelling the playing field, then you have to consider a lot of other players besides the insurance companies, such as investment dealers and the mutual funds. Now, that all is contingent on their getting into the payment system one way or another. That has not been done but is certainly being discussed.
I think it is a little surprising that because of this small residual overlap between deferred annuities of five years or less, the life insurance companies have argued that the protection should be accorded to all their products. That includes death benefits, disability benefits, health benefits and so on. In principle, of course, the government can guarantee anything it wishes, but it takes on a fairly substantial package of obligations when it does that. There are, for example, additional areas you might want to consider if you were in that mood, such as the private pension benefits, private pension funds, and similarly, property and casualty insurance.
Therefore, I cannot tell you where you draw the line, but there is a problem of where you do so. As I said before, I think that the insurance companies can already get into the payments system, as do some insurance companies, as do some of the investment dealers, and so on. I cannot predict any more than most people what is going to happen to the payment system, but certainly, the trend of the discussion suggests that it will be broadened to include some of these other groups that will have to be incorporated into the arrangement.
There would have to be a lot of reconciliation, for example, between some of the factors I have mentioned in my brief, such as the creditor proofing and all that. I think it would be difficult if you only levelled the playing field on one point and did not take into account a variety of other problems.
The Chairman: Mr. Sabourin, did you want to make one additional point?
Mr. Jean-Pierre Sabourin, President and Chief Executive Officer, Canada Deposit Insurance Corporation: I just wanted to make one comment, Mr. Chairman.
From what we read, the second option will basically fragment a national deposit insurance system, in that the new entrants in competition in regard to federal institutions would no longer have an explicit government guarantee.
So the question would be whether we are putting small companies at a disadvantage in competing with provincial guaranteed funds. We are all aware that in all provinces, you have a credit union movement that is provincially government guaranteed, so if you were to remove, under option two, the specific government guarantee, it would put a number of financial institutions at a disadvantage, from a deposit insurance perspective.
The other issue is that we would be competing on different levels when it came down to deposit insurance. Would the provinces then be forced to increase their deposit insurance guarantee to other provincially incorporated companies, other than credit unions?
Mr. Reuber: There is also Quebec. Under the present system, of course, Quebec has its own guarantee arrangement, a government guarantee arrangement. If you privatize, to use that word loosely, CDIC, you would have a situation where one deposit insurance system in the country was guaranteed and the others were not. The federal one was not, which gives rise to interesting arbitrage possibilities.
Mr. Sabourin: There is another point, that the accountability issues under option two would reduce insurance powers. In option two, from what I have read, the policy insurer would have no control over entry and has no ability to order members to take specific action. Before 1987, the CDIC did not have control over entry, and in that case, you had no control over entry, no control over assessing risk, and the minimization of exporter loss would also have had to have been removed. You then come back to a deposit insurer who should be strictly paying at the end of the day when the institution fails.
Senator Austin: I appreciate those points. I have thought that model two would also, in competitive terms, be biased towards the large banks. Would you see that as a reality? Their balance sheets are stronger. Nonetheless, the lack of a government guarantee might create an enormous marketing difference. Is that a real worry or not?
Mr. Reuber: My own instinct is that it is not a very substantial worry because, as I say, I do not regard those two models as very different because model two is a very controlled model with an explicit line of credit to the government.
Senator Austin: Maybe this is still a distinction without a difference, but the problem is that in model two, the Minister of Finance has a discretion to exercise. Therefore, there is a stronger overview than in model one, where you have a government regulatory body with its own decision-making process. You have moved the decision-making process in quite a different way in model two. Is that something you would agree with?
Mr. Reuber: I think there might be a marginal change. If you are talking about a situation where somehow or other the deposit insurance system is unable to meet the obligations and the minister has to step up to the plate and put some cash in, I think that in those circumstances, we all know that he may have little alternative. He may have discretion in the sense of choosing which day he does it.
Senator Austin: At the moment he has CDIC with its overview and its decision-making capacity and you send a memo up to the minister explaining what it is you are about to do.
Mr. Reuber: Right.
Senator Austin: In the model two case, the Minister of the Department of Finance needs a supervisory person, an entity, a group. On whose advice would they act?
Mr. Reuber: I imagine it would be OSFI to a very substantial degree because as Jean-Pierre points out, depending a bit on what else you do, if you really make CDIC into essentially a paying agent, then OSFI would be the primary source of decision making. Indeed, that was the case prior to 1987. That was changed precisely because the Estey commission found that that was not satisfactory, that the incentive structure within the organizations was such that action was too late in coming and so on. You needed to increase the role of people who end up paying the cheque, who took an interest in taking action more promptly and so on.
Senator Austin: In the report, there is an observation on which I would like your comment: "We believe that the primary rationale of deposit insurance in today's marketplace is protecting the savings of unsophisticated consumers who cannot make appropriate risk calculations about the safety of the institutions with which they are entrusting their savings." Is that also your view?
Mr. Reuber: I do not share that view, no. I believe CDIC in the present structure, and this would be true of the FDIC in the U.S. as well, has an important role to play in the safety and soundness of the system, and in terms of all of the machinery that has developed to provide, in a sense, a view about when to intervene and how to intervene. It is not just safety and soundness, but also the cost of the insurance system.
I think they diminish greatly the role of CDIC in dealing with financial instability problems and I would not view that as being insignificant at all. There is no doubt that CDIC has a role to play in dealing with the security of small depositors. Nobody denies that, but it is the sort of implied priority that they have, that I disagree with. Indeed, if they did not have that implied priority, the rest of their recommendations would not follow.
Senator Austin: Yes, exactly, and they also say that, "Deposit insurance is relatively less important than it may have been in the past as a mechanism to avoid payment system crises." So they take your mandate down by two steps.
Mr. Reuber: CDIC at the moment is the gatekeeper as to who gets into the payments system. I suspect that may change, although we need to wait until we hear what the proposals are to change the payments system.
It seems to me that until we know that, it is pretty hard to say that CDIC's role has diminished.
The argument about the payments system is not new. It has gone on for a long time. We have dealt with the large value issue, but what is called the "paper system" is still the way it was, and I expect that there will be proposals to change it. I cannot tell you or predict what those will be. I believe that CDIC's role in that will remain very important because in some cases. For example the Bank of Canada is restricted in that it lends against collateral for liquidity purposes. We are not.
Senator Austin: Is $60,000 in your opinion a good definition of an unsophisticated investor?
Mr. Reuber: We have a system that allows almost unlimited stacking, so we do not hear many complaints about the ceiling. It is a very porous ceiling. So if somebody changes, I would be fairly indifferent to a change in the ceiling because I do not think it makes much difference.
The Chairman: It is sort of like the 20 per cent rule in terms of being able to get around it.
Senator Oliver: My first two questions follow logically from the last two of Senator Austin. His second to the last question dealt with some of the public policy reasons for the existence of CDIC.
My question is going on with more public policy and certainly, part of the public policy behind you is to protect depositors and to stem bank run-ups, as you mentioned earlier today, and to lower the level of risk in the financial system from the insolvency of individual financial institutions.
In your opening remarks, you said that you recognized the turbulence of our times, and that this raises issues regarding the desirability of shaking up the system in order to try to make it more competitive, with whatever additional risks that may entail, and concurrently changing the role and functions of the insurer.
Now, you did not go on to tell us ways in which you think the role and functions of the insurer might be changed.
Mr. Reuber: I was referring there to the changes in the role proposed by the task force.
Senator Oliver: But in order to meet the changing time, the effects of the Internet and new technology and so on, things can happen. Do you not think that we should be looking at the public policy ways in which you can afford the safety and soundness that has always been inherent in our system? Are the needs not changing with technology?
Mr. Reuber: Yes, there is no doubt that the needs are changing. We try to follow those as they are reflected in the deposits that we insure. Where we are at the moment in technology, in my view at least, has not made that much difference as far as the insurance of the deposits is concerned. Now, with the development of the Internet and all those new arrangements, it may make a difference.
We may have to change the arrangements, but at the moment, we are mainly concerned about insuring the deposits. We are not insuring the transactions flow. It is more a matter for the payment system, and while we support that payment system, it is the insurance of the deposits that is growing; that has been central to our role. Second, as more players get into the arrangement and start holding deposits, such as investment dealers, mutual funds and so on, then I think we will have to modify some of our arrangements to deal with the deposits held at those institutions.
Senator Oliver: What types of modifications do you envisage?
Mr. Reuber: I cannot tell you that we have a clear view of what they would be because what they would be would depend very much on what happens with the payments system.
Senator Oliver: Senator Austin's last question concerned a $60,000 limit. When we were in Vancouver on Thursday, we had a presentation from an individual who said that the average Canadian consumer's life savings are being put at increased risk because they are being forced to be placed in funds in fewer financial institutions.
One of his suggestions for overcoming that problem -- that is if the bank mergers go ahead -- is that there would be fewer and fewer places to get that $60,000 protection. One of the things he suggests is that maybe the limit should be increased to $150,000. What do you say about that?
Mr. Reuber: In the United States, it is $100,000. I mean, it is an arbitrary number off the wall and I cannot tell you whether $60,000 is better than $100,00 or $150,000. It is a political decision.
I was at a meeting in Washington and some people tried to describe how they derive these numbers from a lot of research and so on. In the end, it is pretty obvious that it is an arbitrary number. It used to be $20,000 and was raised in 1983 in a statement by a minister, the Minister of Housing, I think, to the surprise of a large number of people. In my own view, it depends on how much liability the government wants to take on.
Senator Oliver: Do you have any guidance for this committee?
Mr. Reuber: My own view would be to leave it the way it is because, as I say, with the stacking arrangements we have, it is a fairly porous ceiling. I cannot believe that anybody is not getting much more insurance than $60,000 if they wanted to.
Mr. Sabourin: Mr. Chairman, we receive a number of phone calls. In some years, we get 60,000 phone calls on our 1-800 lines, so we are very in tune with the message we are receiving from concerned depositors.
There has been no pressure to increase the level. If the committee was looking at an increase, I think we would like to go back and try to find out more information as to what the effects would be and what kind of demands would there be to increase, and to what level. We would have to do a bit more work. If you were to increase it to $150,000, how many deposits would that cover? How many percentages of depositors would it cover, how many accounts? We would like to have the opportunity to obviously do the work and come back with some information to make an informed decision.
Senator Austin: I wanted to offer the observation that anyone sophisticated enough to understand stacking is probably not an unsophisticated depositor.
Mr. Reuber: I think the public understands stacking very well.
Mr. Sabourin: It is also a marketing tool that is used by some of our major financial institutions. Some of them have eight subsidiaries.
Senator Austin: So who is the deposit insurance supposed to be protecting? Those people are quite sophisticated.
Mr. Sabourin: It protects the depositor and the stability of the monetary system.
Senator Callbeck: The question I wanted to cover was really the $60,000 coverage that has already been explored. But in looking at the list of presenters in the back of the MacKay report, I do not see the Canadian Deposit Insurance listed. Did you come before the MacKay commission?
Mr. Reuber: We met with them at least twice, and perhaps three times, and we were in touch with MacKay and his staff.
Mr. Sabourin: I think the list in the back of the book refers to submissions. We did not make submissions, but we were asked to appear in front of the committee and provide some insight.
Senator Callbeck: So they are fully aware of your views then on whether it be rolled in.
Mr. Reuber: I believe they are. We were not aware of their proposal when we went before them, so we did talk about some of the questions that are arising, but we did not specifically address their proposal.
Senator Callbeck: On the bottom of page 7 of your brief, you mention that CompCorp has a flat rate for all companies. Has that always been the case? It seems very strange to me that a huge company would be charged the same rate as the smaller ones.
Mr. Reuber: That is true. We used to do, until this year. We did exactly the same thing in the CDIC. It was only about three years ago that the government passed legislation to have differential premiums reflecting risks associated with various companies. It has taken a very long time to put that into place, partly because the ones who get the break are very pleased about having lower rates, of course, but the ones who find their rates are relatively higher take a little persuasion. You have to have a system that is reasonably satisfactory, so that there are not too many complaints. But in the case of CompCorp, it is a flat rate across the country.
Senator Callbeck: At CDIC, what would be the high rate and what would be the low rate?
Mr. Reuber: I cannot give you a detailed answer. In the past, we have charged 16 basis points premium, and we have paid off our debt last year, so that will come down substantially. Until we get the returns from the various companies, we do not know what the bottom rates or the intermediate rates are, but under the law, the top rate is 33 basis points. That will be the rate charged to the ones with the very highest risk profile.
At the bottom end, the rates are going to be very much lower than they have been in the past, but until we get the detailed returns from the institutions this spring, we cannot say exactly how much. Everybody will get some rate reduction, we believe, except for the very top, the very high risk ones, which will go up.
Senator Oliver: I wanted to ask about your premium revenue. With the shift away from deposit products, such as guaranteed investment certificates, which are eligible for CDIC insurance towards non-insurable financial products, what is the impact on CDIC? Your premium revenues are based on the level of insured deposits held by member institutions, so is that affecting you?
Mr. Reuber: Premium revenue has actually gone down. We think we are going to lower the rates because we have paid off all our debts, so that inevitably, the premiums will go down.
Now, it is interesting to observe, though, that the share of total deposits in our members that are insured has also diminished. The non-insured deposits, in other words, have been the ones that have grown.
There has been substantial growth in deposits and again, in uninsured deposits, in those held by investment dealers in mutual funds. Of course, times have been very good in recent years and the presence of deposit insurance has perhaps received less attention than it would have if things were not quite so rosy.
Senator Oliver: In terms of some of these areas that are uninsured now, are there any that you would like to call our attention to with a view to suggesting that perhaps they should be insured?
Mr. Reuber: No, not particularly. I think, though, that this matter of expanding the payments system is really at the centre of a lot of these questions. If you expand the payments system to include investment dealers, for example, then that issue of deposits held by investment dealers will come up for consideration.
Senator Oliver: And if that happens, your premium income would start going.
Mr. Reuber: But as I say, we look at our costs and we gear our premium rates to cover our costs, essentially. We are not in a profit-making mode.
Senator Joyal: I would like to come back on your conclusions on the last page, on the bottom of page 10, when you said, "This proposal carries with it potential for a huge increase in the government's financial commitments."
Can you give us an idea of what would be the additional exposure of the government in terms of money? On page 3, you mention that the mutual funds and the investment dealers, of course, are not covered at present. They would add significantly to the responsibilities of the government. In order to conclude that it would be a huge increase, did you make a study of those who failed in the past that, if in fact they had been covered, would have increased the government's responsibility?
Tell us what increases we are talking about if we accept the MacKay recommendation.
Mr. Reuber: I cannot give you a quantitative number. We can try. By that I mean, if you extend the government guarantee, it would include all of CompCorp's obligations, which are big. It would also include, presumably, if you go further than that, the deposits held at investment dealers and some of the short-term assets held by mutual funds. Now, that is not a small number, but I cannot tell you how large.
Senator Joyal: But you did not make a model of --
Mr. Reuber: No, we did not make a model.
Senator Joyal: If those changes had been implemented say two or three years ago, what would have been the net effect of the coverage that we would have had to face, taking into account those who fail and those who were in trouble?
Mr. Reuber: I make a distinction between the government's liability, which covers the guarantee for all these agencies, and the actual losses. Now, there have not been many losses in the last two or three years because times have been good. But if there were a more severe economic climate, then the losses presumably would have been greater. For example, if the Confederation Life failure had been included, that would have had to have been covered, as it was by CompCorp.
Mr. Sabourin: Mr. Chairman, I think it is important to note that the difference between CDIC and CompCorp is that CDIC has a statutory obligation to repay depositors in case of a failure. That is not the case with CompCorp. If you were to extend the government guarantee to products issued by life insurance, which is what the task force is recommending, then annuities, retirement, health, disability and death benefits would all be included in the government guarantee, which are not currently included.
I am sure CompCorp has or can provide you with the number of the amount that they cover currently in all the life insurance companies, so that number is available.
Mr. Reuber: This brings us back to the question of the differences between the two systems. In the CompCorp arrangement, they deal with the problem by moving insurance to another insurer. That is the first point on page 7. Whereas in our case, we may sell the deposits out, but by and large, we pay out the depositor as fast as possible. That is normally done within two weeks. He or she gets whatever amount is an insured deposit in the bank, the insured portion gets paid off and he or she has a cheque.
To do that requires a fair amount of funding, even if it is a relatively small institution. There are quite different arrangements in the two institutions and that would have to be reconciled.
Senator Joyal: The last one is about the agenda of implementation. We have been advised by many witnesses not to cherry-pick, but to take MacKay as a whole and implement the recommendations you are dealing with this morning. In terms of your own responsibility and how it would be affected, how much time would you need to implement all of those, do you think?
Mr. Reuber: It depends on how big the changes are.
Senator Joyal: As I said, take it as it is now, the way you have answered to us this morning. You have answered to those recommendations that you think would be the most difficult to implement and the consequences that have to be evaluated. Suppose that at the end of our sitting in December, we recommend that the government accept MacKay as a whole. If we were to add additional competition to the system, we have to change the rules. If we are changing the rules, how much time do you need yourself to implement all those changes with all the intricacies of difficulties that you have outlined this morning and that we think are real?
Mr. Sabourin: I think that our brief is showing that the MacKay task force suggests that you open up competition. If you open up competition, there are trade-offs and benefits. Some of the trade-offs may be more failures, and our point of view is if that is the case, I think that the system needs a strong deposit insurance system to deal with further failures.
If you are talking about putting all of these changes together, the concern might be that you may want to increase competition, make the changes and then look at deposit insurance in the future, because you are changing all of the elements of the system. We might find that there are some trade-offs and benefits that may accrue that you may not want.
Mr. Reuber: You have a very highly interdependent system. If you have to change the payment system, you are changing a whole lot of other stuff. You might want to prioritize the way the changes come in. Even if you accept the package, we would come down the road after you have done a lot of the other changes that you may wish to do.
There is no question that these issues can be reconciled. I am not holding out the proposition that they cannot be. It is not going to be easy. It is not going to be perfect, but you know, you can always do it if it comes to that. The question is how to do it in a way that is the least costly and which keeps the system as good as you want to keep it.
If you take all of MacKay and so on, the place to start would not be with the deposit insurance arrangements, but rather, to start putting in some of the other features first. As you fill in the features, then the implications for the deposit insurance will become clearer.
Senator Kolber: Mr. Reuber, I am going to ask you a question you may not want to answer, but in any event, you once were a top official at the Department of Finance. You were, I believe, president of the Bank of Montreal. You probably have a more intimate knowledge of the Canadian financial industry than almost anybody. Since we have you here and we are discussing the MacKay report, which is the future of the financial industry in Canada, would you be willing to give us your view as a private citizen on the question of the big banks' mergers?
Mr. Reuber: I think it would be inappropriate for me to voice a private view on that subject.
Senator Kolber: Okay.
Senator Oliver: He is a politician.
The Chairman: Gentlemen, thank you very much for coming this morning. We appreciate you taking the time to be with us.
Honourable senators, our next witness is Mr. David Brown, Chair of the Ontario Securities Commission.
Mr. Brown, although this is your first appearance before this committee, your predecessor was kind enough to appear before us on several occasions during his tenure. We are delighted to have you with us and look forward to hearing your opening statement. Following that there are a number of questions I know we would like to ask you.
By the way, congratulations on your new appointment -- or maybe we should offer you condolences. I am not 100 per cent sure which, but what you have taken on is a really important task on behalf of all Canadian investors, and we appreciate that. Those of us who have been involved in public service over the years understand that it is not always a thankful task.
Mr. David A. Brown, Chair, Ontario Securities Commission: Well-wishers, I think, have alternated between congratulations and condolences, depending on the newspaper stories of the day.
Thank you for that introduction, Mr. Chairman, and I thank the members of the committee for the invitation to appear and speak with you today. My principal reason for coming is to be available to answer any questions that you or members of the committee might have for me as a securities regulator, but I thought that I would like to take advantage of the opportunity just to address a few opening remarks to you about some of the aspects of the MacKay report that have attracted considerable attention among the securities administrators in Canada.
My colleague, Jean Martel, President of la Commission des valeurs mobilières du Québec, appeared before you in Montreal on October 23. I have had an opportunity to review the prepared text of M. Martel's remarks, as well as the written submissions that accompanied his remarks, all of which I fully endorse. In my remarks I will amplify some of the points addressed in Mr. Martel's presentation: in particular, the role of the Canadian securities administrators in regulating the market activity of all financial institutions in Canada. This role is particularly significant in light of the recommendations in the MacKay report calling for improvement in measures to protect consumers of financial products in Canada.
Before addressing these issues specifically, I thought I should, first of all, talk a little bit about a national securities commission and some of the expressions of interest that have been in the press and elsewhere about one. This ties in to some of the suggestions that we as securities administrators would like to make in order to address the recommendations of increased consumer protection contained in the MacKay report.
Clearly, with ten separate securities regulators in Canada, and indeed there are 12 if you count the two territories, there is concern about the potential for a regulatory fragmentation of what is essentially a single capital market in Canada.
There have been various attempts throughout the years to achieve a national securities regulatory agency, and in fact four royal commissions and task forces over the last three decades have examined this issue and made recommendations for a national securities commission. The most recent of these was approximately two years ago.
It is, I believe, a matter of record that those initiatives were unsuccessful, partly due to the inability to satisfy jurisdictional concerns of the Province of Quebec and partly to satisfy concerns of some of the provinces that regional discrepancies could not be accommodated.
Interprovincial cooperation, though, has long been a focus of the securities regulators themselves and this has resulted in the creation of what the press and the financial community have dubbed a virtual national securities commission. This has been built around a system of mutual reliance, and indeed a proposed memorandum of understanding has now been published by all of the securities administrators across the country. It covers situations in which issuers or registrants find themselves in the position of having to deal with more than one securities regulator or, in other words, with more than one jurisdiction.
The memorandum of understanding indicates that each of the commissions across the country will be prepared to rely on the analysis or review and recommendations of the staff in the principal jurisdiction for the particular issuer or registrant. If an issuer of a prospectus, for instance, wishes to qualify that prospectus in more than one jurisdiction across the country, the issuer will only have to deal with the principal regulator -- basically, the jurisdiction in which the head office is located.
The securities commissions of the provinces other than the principal jurisdiction agree that they will normally accept and rely on the recommendations of the staff given in the principal jurisdiction.
This virtual national securities commission means that issuers and registrants and others that have to deal with the security system will normally have to deal with only one jurisdiction. It has the strength of having the full participation of all jurisdictions, including the Province of Quebec, and it allows for sensitivities to regional realities.
Coming back then to the MacKay report, and the MacKay report's identification of the need to strengthen protection of consumers of financial services, this is an issue that has also been very high on the priority list of the Canadian securities administrators. We have been seeking ways to bring greater efficiencies to the marketplace to eliminate duplication, some of which is identified in the MacKay report, but principally to fill some regulatory gaps that are also identified in the MacKay report.
One of the challenges, of course, arises from the constitutional division of powers in Canada. As we all know, regulatory and legislative jurisdiction over banks and banking is the exclusive purview of the federal Parliament. Courts have awarded securities regulation to the provinces under the "property and civil rights" power. Trust companies and insurers are regulated in accordance with the jurisdiction of incorporation.
The result has been that the regulatory field has been divided along institutional lines rather than by category of activity or business. We have seen in recent years that the role of market participants has changed dramatically since the present regulatory structure was put in place. In large measure, these changes were facilitated by the demolition of the four pillars concept approximately ten years ago.
We now have a financial marketplace where domestic and foreign banks, securities dealers, trust and insurance companies, credit unions and other intermediaries offer many similar services, but under quite different regulatory regimes. In fact, the left-hand sides of the balance sheets of most of these players are virtually identical. The business activities of banks and their investment dealers and trust subsidiaries are becoming increasingly integrated.
We, as the Canadian securities administrators, are currently examining whether it is time that we should be rethinking the regulatory split, that regulatory responsibility should be divided according to business activity and not by institutional type. We think, for example, that it is unlikely that the regulation of banks exclusively by federal authorities and the exclusive regulation of their wholly owned investment-dealer subsidiaries by the provinces will produce the best regulatory result. Clearly, we believe that the state of affairs has contributed to the concern about consumer protection set out in the MacKay report.
Much of our thinking has been influenced by the new regulatory system that has just been implemented in Australia. As the committee members may be aware, effective on July 1 of this year, the regulatory system in Australia was reorganized into two separate regulators -- a prudential regulator, which concentrates only on the safety and soundness of market participants, and a market regulator, which regulates the market activity of all financial service providers.
In the Canadian context, OSFI would be the natural choice for the prudential regulator. That is currently OSFI's principal thrust, and indeed, OSFI currently has very little involvement in market regulation. We believe that the prudential regulation of provincial trust companies and insurers by provincial bodies should also be slowly transferred or migrated over to the federal authorities by provincial agreement.
Clearly, we also believe that the security commissions through the Canadian securities administrators would be the natural choice to regulate the market activity of all financial players. It is essentially what the securities administrators do. We have the regulatory systems and infrastructure in place. Our mutual reliance system has created a national system of harmonized regulation across the country with the regional presence necessary to accommodate differences in local practices.
Under this model, the securities commissions would assume responsibility for the market practices of all financial institutions, including banks, trust companies, insurance companies and credit unions, and would set the standards for portfolio management for all pools of capital -- not just mutual funds, but including pension funds and segregated insurance funds.
Over the next few months, the Canadian securities administrators will continue to develop these concepts and to discuss them with our provincial governments. Our objective will be to be in a position to submit proposals to the federal authorities, so that they can be factored into the continuing consideration of the MacKay report.
Mr. Chairman, the other issue addressed in Mr. Martel's remarks on which I wish to comment concerns the statements in the MacKay report about Canada's role in the international regulation of securities markets. Again, I specifically adopt and support the comments made by my colleague from Quebec.
As Canada's newest securities regulator, I was pleasantly surprised at the stature that we Canadians enjoy internationally. The positions that Canadians occupy in the world securities bodies and the influence that we are able to bring to bear on major policy issues are far greater than our proportionate share of world capital markets would support.
Clearly, the world views us as having a single securities regulatory system, which is administered regionally by provincial securities regulators and which imposes some of the most advanced securities regulatory systems to be found anywhere in the world.
As M. Martel pointed out, he has just been elected as vice-chair of the executive committee of IOSCO, which is the international securities organization with approximately 96 member countries, and I was recently elected as the vice-chair of the technical committee of IOSCO. Mr. Joe Oliver, who is the president of the Investment Dealers Association of Canada, is the chairman of the advisory committee of SROs within IOSCO, and the staff of the OSC sit on all of the working committees of IOSCO. So, clearly, Canada plays a very important role in the international coordination of securities regulations.
Mr. Chairman, I shall stop there. I would be pleased to answer any questions that any of the committee members might have.
The Chairman: Thank you, Mr. Brown. Before turning to Senator Di Nino and then to Senator Austin, may I ask you one question? It may reflect that part of my life spent trying to get federal-provincial agreements -- which may account for my optimism not being quite as good as yours, although, given the lack of success with the national securities commission, I suspect that you are not far behind me.
I understand how, theoretically, it would be ideal to separate market regulation and give that to the securities administrators and give prudential regulation to the federal government and specifically to OSFI, but do you have any evidence that we can be any more successful in accomplishing that than we have been in accomplishing a national securities commission?
I can certainly understand that most provincial governments would be prepared to accept the one-way transfer from the federal government to them. My question is whether there is any suggestion at all that the provinces would be prepared to give up the element of prudential regulation that several of them now have.
Mr. Brown: There are some very encouraging signs, Mr. Chairman, that that is already taking place. At least two of the provinces have already concluded agreements with Ottawa to transfer some of the prudential regulation over to Ottawa.
The Chairman: Can you identify those provinces?
Mr. Brown: Yes, I believe Manitoba and Alberta have already concluded agreements with Ottawa. Ontario, as you know, approximately one year ago today, as a matter of fact, moved away from the equals approach, which had been a very serious thorn in the sides of most persons trying to operate trust and insurance businesses; now Ontario has had discussions with Ottawa about transferring the prudential regulation to Ottawa.
We have had discussions with the staff of our own masters here in Ontario, and they seem to be quite intrigued by the prospects that we are talking about; so we are quite encouraged with the discussions we have had so far.
Senator Di Nino: My question really follows on the same line. Could you give us an update as to where the national securities commission talks or discussions or negotiations are at this point?
Mr. Brown: As far as I know, there are no discussions about a formal national securities commission going on at the present time. All of our efforts as securities administrators, and supported by our respective governments, including, as I understand it, the government of the Province of Quebec, have been focusing on putting the securities commissions together in a contractual way on a harmonized, cooperative basis, to create, as I said, what has been called the "virtual national securities commission." I know of no initiatives that are currently under way for a national commission.
I personally would be quite reluctant at this point to see a discussion of a national securities commission re-emerge. I say that for this reason: As your chairman indicated, I have only been the chair of the Ontario commission for six months. One thing I discovered soon after taking office was that there was virtually a two-year hiatus in the securities regulation in Canada in addressing the very serious issues that are before the securities regulators. That was just the result of the evolving markets, which I know you have spent a great deal of time discussing, but, during the period of discussion of a national securities regulator, things virtually ground to a halt.
I would be reluctant to see that same hiatus again when I think we are making such great strides with a virtual national commission. I would much rather see us get on with the agenda and try to catch up to where we should have been.
Senator Di Nino: Would you just clarify for me the difference between a virtual commission and an agreed-upon contractual relationship?
Mr. Brown: This is a contractual relationship in the sense that a memorandum of understanding has now been agreed to by each of the provinces. A number of the provinces, Ontario included, have a procedure whereby memoranda of understanding go out for public comment; being in the public-comment phase right now, we have not signed the memorandum of understanding, but I fully expect that within the next month or two that will be available to be signed.
So we do have a contractual arrangement, if you like. It does not go the full way to totally integrating all of the commissions. We have only chosen three of the major areas where we deal with issuers and registrants, but what has also happened is that the staffs of the commissions across the country are becoming much more unified.
In fact, we are hosting in Ontario in three weeks' time a prospectus review school, if you like, and each commission is sending its prospectus reviewers to Toronto, and each commission is sending some of the senior people to run a four-day school on prospectus review.
So what we are expecting will happen from that is that, when an issuer files a prospectus in any province across the country and wants to have it qualified across the country, the staff in the jurisdiction where the prospectus is filed will review the prospectus, approve the prospectus and then communicate their approval to all of the other commissions, and the other commissions will rely on that approval rather than having their own staff look at it.
So, essentially, we have for that process, I think, a national securities commission with the regional offices in every province.
Senator Di Nino: Would there be some sharing of information between the different jurisdictions on the potential issuers of securities?
Mr. Brown: Yes, there is a tremendous amount of sharing that goes on at the present time, and there are many policy issues that are now being addressed jointly by the commissions across the country. We had a meeting in P.E.I. three weeks ago. There were 22 policy items on the agenda that are now being worked on cooperatively by all of the commissions across the country.
Senator Di Nino: From a practical standpoint, Canada has had a black eye, in effect, over some issuance of securities from one coast to the other, particularly Bre-X, of course. Is this virtual commission going to help us in making sure that that does not happen? Or will it at least lessen the opportunity of this happening?
Mr. Brown: It is very difficult to say. I would hope that it would enable us to uncover a Bre-X problem at an earlier stage than we did. I think it would be going too far to say that even a national securities commission would prevent that kind of fraud.
Senator Di Nino: From what you are saying, this virtual commission will be able to address some of the issues that the national one would. Is there not also the fact that we do not have a national securities commission affecting or costing us business from those who wish to issue shares that would go elsewhere?
Mr. Brown: No, we have seen no evidence that that is affecting us, Senator. No, none at all.
Senator Oliver: Mr. Brown, you mentioned the presentation that we heard in Montreal. You should also know that we heard from regulators in Western Canada last week; we had a very useful exchange with them on this virtual national securities commission.
I have two questions on points that were raised before the MacKay task force by the former superintendent, Michael Mackenzie, and I would like you to comment on them. He raised the matter of securities regulation in his submission to the task force. Among other things, he was concerned that, if there were a solvency threatening loss in derivatives trading, such as the case of the Barings Bank, foreign markets would become very concerned about the lack of integration between the bank and securities supervision. Can you comment on how realistic his concern was?
Mr. Brown: I think the proposal that we are talking about will address Michael's concern, but I have not spoken to him about these proposals. What we are suggesting is that there be a single prudential regulator.
Senator Oliver: So far, only two provinces have agreed to do that, though; so it is still fragmented. Did you not say that only two provinces have agreed to have OSFI become the prudential regulator?
Mr. Brown: Only two have signed agreements so far. Our indication from preliminary discussions is that many more of the provinces are very interested in this.
Senator Oliver: Including Ontario?
Mr. Brown: Including Ontario, yes. Very much so. If we are successful in the model that we are talking about, then I think Michael Mackenzie's concerns will be quite nicely handled, because we will have a single regulator who is responsible for the solvency of all financial institutions across the country.
With respect to securities dealers, there will have to be some shared responsibility so long as the securities commissions are responsible for the Canadian Investor Protection Fund -- and we have just heard from the CDIC. Of course, the Canadian Investor Protection Fund is the industry's protection fund for securities dealers. So as long as that responsibility remains with the securities commissions, there would be some shared responsibility.
However, what we are proposing is that the prudential regulator, and we are suggesting that OSFI is the natural choice, would be responsible for the safety and soundness of all financial institutions, including the securities dealer subsidiaries of banks that are doing the derivatives trading that Michael was talking about.
Senator Oliver: When do you think we might see it come to pass that everyone is in agreement and OSFI is, in fact, the national prudential regulator? Before the millennium?
Mr. Brown: Yes. Our target would be to do it sometime during the course of 1999, if we can maintain the momentum that we think we have going at the present time.
Senator Oliver: That is encouraging. The second point that Mackenzie made to the MacKay task force was that with banks carrying on an extensive bond and derivatives trading business on their own books, and with the expansion into the mutual fund business, the federal regulator would be required to duplicate the securities expertise of the provincial securities commissions.
Mr. Brown: Again, that is exactly why we have started our thinking down the road that we have talked about. The MacKay task force talked about a federal regulator, presumably an expanded OSFI, assuming much more responsibility for market conduct and consumer protection. Obviously, that is something that OSFI would be capable of doing, although it would require a significant injection of additional funding; they would also have to expand into areas that we are already doing, but, if it was thought the better way to go, they could develop the types of staff that we have doing prospectus review and licensing and market conduct and ethics and so on. However, it seemed to us that that was an unnecessary expense, because the securities commissions already have that infrastructure and the personnel in place.
Senator Oliver: You mentioned that one reason we have regulatory fragmentation is that there was a fear that the federal regulators would not be sensitive enough to some of the provincial concerns. Is that sensitivity problem not going to arise once again?
Mr. Brown: Well, it would arise, I submit, if the decision were to be to have OSFI become the market regulator, because I think OSFI would not be able to do it without regional presence for that very reason. It is another reason why we think that the securities regulators are ideally positioned because of their provincial locations.
Senator Austin: Mr. Brown, it is a very interesting concept that you bring us and one that I am sure takes us quite away from the MacKay recommendations. Perhaps you could give me your thoughts on one of those recommendations, based on your experience as a regulator, and in the context of your presentation.
The MacKay report suggests that OSFI should include within its purview a responsibility for fostering competition. What do you think of that recommendation, first of all, and in your new matrix, would that be a function that would be adopted by the new securities regulatory or market regulatory regime?
Mr. Brown: To answer the second part of your question first, the theory on which securities regulation proceeds at the present time is to have very few restrictions or barriers to entry into the securities field. Our regulatory approach is based on transparency: we require market participants to tell all and let the market decide. So there are very few barriers. Indeed, just since you asked the question, I have been trying to think of barriers to enter, and I cannot think of any at the present time. We have licensing requirements, obviously.
Senator Austin: Capital sufficiency.
Mr. Brown: And capital sufficiency, but those are available to anyone who wishes to take the Canadian securities course, pass the exams and become certified, or anyone who has sufficient capital.
As to the other part of your question, it is not something that I think that securities administrators do now and it is not something I think could be easily adapted.
Senator Austin: Could I just add to your answer that the present securities regulatory regime also is post-audit on new products and innovation. You do not try to pre-audit or pre-approve. You let the market decide and you see how these new products operate. Is that correct?
Mr. Brown: That is correct. As long as we are comfortable that the risks of the product and the full ramifications of an investment in the product are explained in language that a prospective investor can understand, then we allow the product. That is exactly right.
Senator Austin: Would you go on with your answer, please.
Mr. Brown: In terms of whether or not OSFI can or should foster additional competition, clearly, fostering competition in our financial markets is a very desirable objective. I am afraid I cannot tell you whether OSFI has the ability to do that or whether that is something that has to be embedded in the legislation itself.
Senator Austin: But is it the role of a prudential regulator to foster competition as the MacKay report seems to encourage?
Mr. Brown: I would have thought not.
Senator Austin: In Australia, the Wallace report has resulted in the regime that you were describing, and there is much to observe there in how to operate; but my understanding is that that is a case where the state surrendered its role to the federal power in Australia. Is that correct?
Mr. Brown: Yes, that is correct. The Australian system actually happened in two steps. About ten years ago, the states agreed to a national securities commission in Australia on the basis that there be regional offices, and so, virtually, a national regulator took over the securities administration of each of the states and left the administrative personnel in place. That happened in about 1988.
The Wallace commission then recommended the change in the regulatory landscape so that there would be a single prudential regulator. As you know, Senator, the prudential regulator was pulled out of the Reserve Bank of Australia and was set up as the equivalent of OSFI, more or less, and then all of the market regulation for all financial institutions was vested in the national securities commission.
About a month ago I spent a week in Australia. It was just at the time the MacKay report came out. Everybody in Australia considers the MacKay report to be our Wallace report, and everybody was pleased to offer comparisons and contrasts between the two reports. I had a fascinating time talking to the banking administrators, the securities administrators and the investments regulatory organizations.
Senator Austin: I imagine you did. I wondered, because you are looking at Australia's new functional approach, whether part of the discussion in Australia also looked at the single regulatory approach of the U.K., the Blair government's new FSA.
Mr. Brown: There was a great deal of discussion on that very contrasting approach. A summary will not do it justice, because it is an extensive topic, but to put it briefly I think the Australians believe that FSA might work in a unitary state, but they are sceptical that it can even work in a unitary state. Nobody there thinks that it could work in a federal system.
Senator Austin: Maybe they have not noticed that the U.K. is now moving toward a federal type of system.
It is interesting that we see Australia going in one direction, the U.K. going in another, and the U.S. having overlapping systems between the currency comptroller and the Federal Reserve, and now you bring in a concept which certainly deserves a great deal of study, and which I hope this committee at some point in time will take a very specific look at.
I would like to turn to another topic completely that relates in a passing way to the consolidation of the banking system here, but impinges on securities. The question is whether there is any concern on your part that as the number of players decreases, if it does, that there will be an impact on capital markets, both the income, fixed income and equity sides, because you will have fewer participants in those markets. Is that something you have looked at?
Mr. Brown: Senator, yes, it is. It is something that we have considered both internally at the Ontario Securities Commission and nationally with the Canadian securities administrators.
First of all, as you know, there is no requirement in our legislation that a merger of two investment dealers be approved by us. We would have to approve the issuance of a licence, but that is based merely on concepts of whether or not the newly merged entity is fit to be a registrant. I suspect that will be fairly simple in the context of the two mergers that you are referring to.
First, we have concluded that size is not a factor in respect of our ability to regulate the markets. We think that our regulatory powers can be just as efficacious with a few players as with a number of players. That is the first point.
Second, we are encouraged that the Toronto Stock Exchange is looking at its particular model of demutualization. Assuming that they are able to achieve the objectives set out in their proposal, then the ability of a large or very large member of the stock exchange to influence the stock exchange's policies will have been diminished, or in fact, it will have been eliminated.
Third, we, with the Canadian securities administrators in Ontario taking the lead, are about to promulgate new rules permitting alternative trading systems, principally electronic trading systems, to come into Canada. We will give them the option of being licensed either as stock exchanges or as members of existing stock exchanges.
We see that as opening up Canada to competition in the world of stock exchanges. We expect that a number of players who already have the systems in place in other jurisdictions will come into Canada, so that we see that there will be a tremendous amount of competition in the stock exchange business. Again, we think that the ability of any one player to influence will be much diminished.
Then lastly, I think we all saw when the major banks started to buy up the major investment houses in 1987, 1988, that there were a number of new entities that were spawned as a result of that. Although no one can predict for certain, it would not surprise me if the mergers of the four investment dealers into two spawned that same type of activity.
Senator Austin: But the two would control a substantial part of the trading, if they were fully merged.
Mr. Brown: They would be responsible. Yes, they would be responsible for --
Senator Austin: -- about 40 per cent of the trading.
Mr. Brown: Yes, they would be responsible for a substantial part of the trading. Absenting the types of rules that the Toronto Stock Exchange have in place, and that we are contemplating, it would be theoretically possible for one of the large dealers to internalize trades. With such an order flow, they could run a mini stock exchange internally.
Senator Austin: Exactly.
Mr. Brown: The existing rules of the Toronto Stock Exchange will not permit that, and we will.
Senator Austin: The Toronto Stock Exchange would prevent that internal trading because it would be contrary to membership rules.
Mr. Brown: That is correct, yes. That is right, and we will perpetuate rules designed to have that effect. Whether that will be the same as the rules that exist now depends a little bit on how these new systems develop.
Senator Austin: Lastly, how do you control the offering of securities on the Internet? How do you begin to deal with the regulatory problems of an open market system? There are a lot of products offered on the Internet. What happens when somebody in a Caribbean island is offering securities on the Internet into Canada?
Mr. Brown: You have hit on probably the single liveliest topic that we discuss at the IOSCO meetings, and we are also members of the Council of Securities Regulators of the Americas, which includes the entire Western hemisphere. IOSCO has just completed a task force report on the Internet, Internet offerings and Internet trading, and we in Canada have just in the last two weeks, I would say, issued for comment our own Internet trading and offering rules.
Essentially, we are trying to use the same philosophy of regulation electronically as we do with paper-based systems. We will be looking at where the offering emanates from and the jurisdiction in that home location will be primarily responsible.
It requires a tremendous amount of cooperation around the globe and as you know, it requires in some cases trying to find out where the true source is. There are rules that are designed to try to bring that into effect. I think we are at the very early stages of coming to grips with this, but every member of IOSCO seems to be committed to try to tie all of this together in a global way.
Senator Joyal: Mr. Brown, your colleague, Mr. Martel, mentioned to us that he was not contacted by the MacKay group, nor was he asked to submit a brief. Could you tell us if you were yourself contacted or if your predecessor was? Were your views conveyed to the MacKay group task force?
Mr. Brown: My situation may be a little different than my colleague, Jean Martel. When I was in private practice, I spent a fair amount of time talking to Mr. MacKay and members of his task force about some of the work that they were doing. When I became chair of the securities commission, I kept right on talking to them. I did not wait to be invited and so yes, I had a number of discussions with Mr. MacKay and with Mr. Gorbet and with others on the task force.
It is unfortunate, in a sense, that some of my other colleagues may not have had that opportunity, but I did more because of my own unique circumstances.
Senator Joyal: But was it in your capacity as Ontario Chairman of the Security Commission or was it in the private enterprise?
Mr. Brown: It became that, when I changed hats. I did, indeed, talk to him on a number of occasions, including about the very proposals that we are talking about here today.
Senator Joyal: Was it in the form of a brief or just in the kind of conversation?
Mr. Brown: No, it was just in conversation, not a formal brief.
Senator Joyal: So are you the only chairman of a Canadian securities commission who has been contacted by Mr. MacKay?
Mr. Brown: I cannot answer that. Mr. Martel remarked that he had not been, but I cannot answer with respect to the others.
Senator Joyal: In the memorandum of understanding that you have referred to in your opening remarks, you mention that the memorandum covers three areas. Could you spell out those areas?
Mr. Brown: Certainly.
Senator Joyal: Are there other areas that you would like to see included in an expansion of the memorandum that would make sure that the cooperation among the Canadian securities commissions are best assured?
Mr. Brown: Certainly. There are three areas. I referred, just by way of example, to the prospectus filings, which is one of the major areas where issuers are, under the current system, required to deal with a number of jurisdictions across the country.
The other two areas are the registration, and so this is the registration of investment dealers. Many of the large investment dealers have registrations in every province and heretofore have been required to deal separately with each of the provincial authorities. Of course, their salespeople have the same problem, and so that is part of the memorandum.
The third is the request for exemptive relief. Each of the securities' statutes across the country have provisions allowing the commissions to exempt those who have to deal with the commissions from some of the provisions of their statutes, and so that is the third area, the applications for exemptive relief.
That third area is one that we have been working on a test basis now for I guess about eight months and it seems to be working quite smoothly. There have been, I think, 80 applications under this test regime for exemptive relief. Only five of them have not worked and they have not worked because the exemption provisions in the statutes are not all the same. We are working to harmonize those across the country. We have recommendations before our own government here in Ontario to make some fine-tuning changes so that ours will be harmonized with the rest of the country. That is the first part of your question.
The second part is that yes, by all means, we think that there are other areas that we can start to build on. One of them is insider trading. We currently have slightly different rules in some of the jurisdictions for insider trading and we see that that will happen as well.
Then the whole policy question across the country is already moving in a much more harmonized way. Whether it will ever become part of a memorandum or not, it is too early for me to say.
Senator Joyal: On your second aspect of the registration of investment dealers, we were advised by your predecessor at the table this morning that the opening up of the payments system to investment dealers will cause a major element of readjustment to the regulation and the institution. Could you advise us on what you see as being the major problem in that?
Mr. Brown: I know that Mr. Martel had some remarks on that issue. I must say that I have not given it the same thought that he has. I understand that members of a payments system will have to meet minimum criteria in order to be members of that system, in order to guard against systemic risks.
I do not see that that is a difficulty, or that that form of regulation will necessarily conflict with the type of regulation that we as securities administrators are doing, but I must admit that I have not seen a proposal for what that regulation would look like. I think it is possible for those to coexist.
Senator Kelleher: Mr. Brown has already partially addressed one of the questions I wanted to ask him, and that was with respect to insider trading.
As you know, there is a concern out there that there is an unduly lengthy period within which people have to report their insider trading. I was wondering if you could just be a little bit more explicit as to what progress has been made in this area. Second, could you give us any idea of the length of the period you are looking at to achieve the report of insider trading. I think now in some cases you can have almost up to 40 days, and the report is not much help to a lot of people when it takes that long.
Mr. Brown: Ontario allows a longer period of time. The rule is that you must file a report of the trade within 10 days of the end of the month in which the trade took place. If the trade took place today, for instance, the report would not be required until ten days into December in Ontario. Many of the Western provinces require the report to be filed within 10 days of the trade.
We have proposals in Ontario outstanding now to move to the Western system and I am hopeful that we will be able to implement them. I am afraid I cannot give you a timetable, but we are addressing those. I am not certain whether any of the other provinces are still on the same rule as Ontario, but we are committed across the country to achieving harmonization.
The second thing that we are doing is that we now have proposals that we are working on to allow all insider-trading reports to be filed electronically. We currently permit prospectuses to be filed electronically using the SEDAR system. In fact, they are now required to be filed electronically, and we are hoping in the first quarter of 1999 to bring forward proposals for an electronic insider trading reporting system, which will also speed up the reporting and dissemination of insider trading. It will allow a single filing only in one location and that will be sufficient for all of the provinces. We think that if we are successful, and there is no reason to think we will not be, we will have regularized that insider trading system.
Senator Kelleher: If my company is trading on the exchange here in Canada and in the United States, as some are now, will we be in any way harmonized with the American reporting requirements?
Mr. Brown: We have not gone that step yet. It is a logical one for us to be thinking about, but I admit we have not gone that far at this point. We have been looking only at Canada and not across the border.
Senator Kelleher: Does this present any problems at this time?
Mr. Brown: I cannot think of any problems, but I just have not gotten into it at this point.
Senator Kelleher: I believe that you said in your opening remarks that you have harmonized various matters. With offerings or IPOs, a filing for one really will now constitute a filing for all. I want to be very careful because my neighbour here is Senator Callbeck from Prince Edward Island. Am I able to do an IPO filing in P.E.I.?
Mr. Brown: Yes, you are. If your head office is in P.E.I., you will be able to do an IPO using P.E.I. as the principal jurisdiction.
Senator Kelleher: But only in that case?
Mr. Brown: Yes. You can do an offering in P.E.I. if your head office is in Ontario by filing with Ontario and requesting that that be qualified across the country, including P.E.I., so you can do it that way as well.
Senator Kelleher: With some of the smaller provinces, they might not necessarily have the qualified staff to handle a large or extensive IPO.
Mr. Brown: That concern is what gave rise to the prospectus review school that we are running in Toronto in three weeks' time and, in fact, we are going to do it on an annual basis. Quebec has already agreed to do it next year, and so people from P.E.I., to use your example, will be in Toronto working with their prospectus review colleagues across the country.
The Chairman: Mr. Brown, thank you very much for taking the time to be with us. We look forward to ongoing conversations with you over the years ahead.
Senators, our next witnesses are from the Canadian Vehicle Manufacturers' Association and the Association of International Automobile Manufacturers of Canada. The primary witness will be Ms Maureen Kempston Darkes, the President and General Manager of General Motors of Canada, and I believe she has several people with her.
Ms Maureen Kempston Darkes, President and General Manager, General Motors of Canada Limited: I do, indeed, senator.
The Chairman: Senators, you have a three-page opening statement which I believe has been circulated to all of you. Is that correct?
We are delighted to see you again. We have not seen you since we dealt with the corporate governance issues in the Canada Business Corporations Act about 18 months ago, so thanks for coming again.
Ms Kempston Darkes: That was an interesting discussion then and I am sure this morning's discussion will also be very interesting, so good morning, Mr. Chairman and honourable senators.
We do appreciate the opportunity to appear before you today. With me today are Mr. Andy Menzyk, President, Canadian Credit Operations, Ford Credit Canada Limited and Mr. Brian Vasey, Vice-President and General Manager of Nissan Canada Finance Inc., representing the Association of International Automobile Manufacturers of Canada, and Mr. Mark Nantais, President of the Canadian Vehicle Manufacturers' Association.
We are here before you today because of one issue, recommendation No. 21 of the MacKay report which would permit federally regulated deposit-taking institutions and life insurance companies to lease light duty vehicles.
As a preliminary point, I should like to stress that a key shortfall of the MacKay report was that it failed to recognize the very significant impact that changes in financial services policy would have on other segments of the economy.
The automotive industry's long-standing opposition to bank entry into vehicle leasing is well-known. This opposition extends from the manufacturer through to the dealer. We believe that if banks are allowed to enter into this market, there will be a long-term reduction in competition, a lessening of consumer choice, an increase in leasing costs, adverse impacts for automobile dealers operating in virtually every community across this country, and disruption of the automotive industry as a whole.
This is a very bleak scenario for what is now a very healthy and productive industry. We believe that bank entry into auto leasing would bring about these results for six reasons.
First, leasing is not the equivalent of lending. Current restrictions on banks recognized this distinction. Leasing involves vehicle ownership, which entails responsibility for residual risk and liability risk management. Addressing these issues requires a continuing commitment to the automotive business that banks simply do not have.
Second, banks would be able to use their legislated cost of funds advantage to drive competitors out of the market. Moreover, it is not a viable option for finance companies to become a bank in order to compete on a level playing field. The costs of entry into the banking business are exorbitant, as has been previously stated to the committee by other witnesses.
Third, due to their dominant position in the financial services industry, banks have a history of capturing market share and driving out competitors in new markets through the use of loss leaders. Such a policy is not conducive to long-term support for the auto leasing industry and would be followed by reduced competition and hence higher prices for the consumer.
Fourth, if banks were allowed into the leasing market, Canada's local dealers would be forced to compete with the same deposit-taking institutions that provide them with the majority of their operating credit. This would clearly be a conflict of interest.
Fifth, vehicle leasing is a critical part of the automobile business, while it is only tangential to the business of banks. Vehicle leases, and particularly rate-supported leases as low as 0 per cent, a level unheard of for the banks, which seldom drop below prime, were developed and popularized by auto manufacturers and their affiliated finance companies as a means of addressing vehicle affordability. This was particularly important during the period from 1988 when sales peaked at 1.5 million units to 1995 when sales fell to less than 1.2 million units.
Without leasing, it is entirely possible that the trend of declining sales would have been further protracted with the loss of many more dealerships and jobs across this country. Would banks have a similar commitment to the industry during economic downturns? It is very doubtful. If banks are allowed to enter leasing and drive out competitors, including many smaller dealers, the industry will have fewer tools with which to support sales and economic activity.
Finally, affiliated finance companies are committed to providing support to dealers in various ways other than lease financing, such as wholesale floor plan inventory financing, in-house lease financing, equipment financing, mortgage financing, and loans for working capital. They have acted as a lender of last resort for some business dealers whose financing needs have been rejected by banks.
If banks are allowed to enter and ultimately dominate the vehicle lease business as they now dominate the loan business, affiliated finance companies would not be able to sustain their current services to dealers. The result would be fewer financing options for dealers and, ultimately, fewer suppliers of automotive products to consumers. Rural Canada would be particularly vulnerable.
Mr. Chairman, the MacKay report highlights the fact that there are some 1,300 dealers involved in vehicle leasing, 20 affiliated finance firms, many credit unions, caisses populaires and bank-administered near-lease programs. There is significant competition for consumer business in the auto leasing market -- far more competition, in fact, than in the banking business itself.
From the point of view of the dealers, many of whom are low volume retailers, the 25 to 30 lease transactions that they undertake per year represent almost 10 per cent of annual sales volume and probably $20,000 to $25,000 of profit. Notwithstanding the MacKay report's failure to acknowledge the importance of these figures, these lease transactions could make or break some small dealers, often in the areas where automobile suppliers are few and far between. Is it worthwhile to disrupt this market to allow a small number of banks to enter and capture market share in yet another business?
Bank representatives have even gone so far as to voice concern about the foreign finance companies operating in Canada. But the automotive industry, which directly or indirectly employs one in seven Canadians, has invested in Canada more than three times the profit earned in Canada by automobile manufacturers and their affiliated finance companies over the past decade, and that amounts to over $23 billion.
In closing, we see no long-term benefit to consumers from bank entry into vehicle leasing. That is a business that involves the buying and selling of cars, which is our area of expertise. Canada has benefited tremendously from the current leasing market with lower prices than in the United States and consumer-friendly, full-disclosure leases. All of that should not be put in jeopardy.
We ask you to reconsider the MacKay report recommendation and we suggest strongly that banks not be allowed into vehicle leasing, and with that, I should like to open the floor for questions from the senators.
The Chairman: I wonder if before turning to Senator Austin I could direct your attention to two points in the task force's report and then ask you to give me your comments on them.
The first is an excerpt from page 98 of the MacKay report and it reads as follows:
Canada appears to be the only developed country where bank leasing powers have been a major policy issue. Indeed, General Motors notes that the major competitors of General Motors Acceptance Corporation (GMAC) are "banks and credit unions and other financial services companies," and it also reports that its Canadian lease volumes increased by 46 per cent in 1997, while "decline in the U.S. and international retail and lease financing revenues from 1996 to 1997 was attributable to continued competitive pressures in these markets."
Then, the second background document points out that U.S. banks have held about a one-third share of the leasing markets since 1990 and that in the United States the combined share of the auto manufacturers' finance companies and the banks is about 80 per cent, which is approximately the same as the share of the auto manufacturers' finance companies alone in Canada.
I have trouble putting that together with the apocalyptic seven points that you raised in your opening statement; there seems to be a huge disconnection between the two. Can you explain to me how there is not such a disconnection, or alternatively, why Canada ought to be different from everybody else in the industrialized world?
Ms Kempston Darkes: There are significant differences in leasing in Canada versus other countries. First, I would point out that in the United States, there are approximately 10,000 banking institutions involved in leasing, compared to only six that would be involved in leasing in Canada.
In many of those countries that you reference, a lot of the vehicle leasing is really done to fleet customers who in turn lease to individual consumers. That is a very different type of transaction than what occurs in Canada. In those countries, 20 per cent of the vehicle business is done through leasing. In Canada today, over 50 per cent is leasing. So the enormity of the lease transactions for Canada far outweighs the relevance of those transactions in the United States or other countries.
Now, you talk about 80 per cent being controlled by the affiliated finance companies of the Big Three. That, in fact, drops over time as the Big Three's market share drops over time. In fact, there are over 20 affiliated finance companies working in this market today. There are other entities such as GE Capital, PH&H and others who also provide lease financing. So, again, the Canadian and American markets have very different natures.
The Chairman: I understand that the volumes are different, but it seems to me that essentially it is a difference of magnitude, not a difference of kind. I do not know why that is such a dramatic difference. To put it another way, if the leasing market in the United States were to follow the Canadian trend and get up to 40 per cent or 50 per cent or thereabouts, would the automobile manufacturers then argue that the banks ought to get out of auto leasing, that they ought to roll the clock back?
Ms Kempston Darkes: Well, I think that the United States has a far more competitive banking industry than we have in Canada, and when 10,000 institutions are involved, the cost-of-funds issues become very different. The huge advantage that banks enjoy in Canada is not a relevant factor as much in the United States, where the market for consumer deposits, et cetera is far more competitive. That is a key issue. In Canada, six banks literally are able to drive everybody else out of business, whereas in the United States that does not occur.
The Chairman: I do not want to argue with you, so I will turn to Senator Austin, but I just have to make one observation. I am not sure that there is a direct linkage between the 10,000 banks and a much higher competitive market. I say that in light of two facts. First, according to objective evidence, that is, evidence not from the banks, fees and service charges are 30 per cent to 35 per cent lower in Canada. Second, spreads on small-business loans, for example, are lower in Canada. I think, then, that one could argue that the very large number of banks in the United States makes economies of scale in that business very difficult to achieve and therefore may not, in fact, be in the consumers' interest.
Ms Kempston Darkes: Let me also say, Senator, that you need to look at the quality of the transactions going on in the United States and at consumer satisfaction with the leasing market in the United States. Several things come to mind.
It is not at all clear that consumers have been well served in the United States by having banks in leasing. Over time, we have seen banks withdraw from leasing in the United States as they have not been able to deal with the cyclical downturns that occur in that industry. There has also been abuse of consumers where banks pass on their mistakes to customers by literally forcing them to buy out vehicles which they otherwise would not do.
Again, it is not at all clear that having banks in leasing has been good for consumers. I will defer to some of my other panellists who may wish to comment further on that point.
Mr. Andrew L. Menzyk, President, Canadian Credit Operations, Ford Credit Canada Limited: Speaking from my U.S. experience, I would say that U.S. banks went into leasing very naively.
First, they were very aggressive on some of what we would call the lease-end values or residuals. They did not have complete expertise in the auto cycle. I am not talking about credit risk, but a manufacturer has privileged information regarding the plan of the product cycle, which vehicles are going away, which ones are staying, and so on.
At the end of a lease term, if a vehicle has been overpriced, the lessor has the option to absorb the loss. If the lessor happens to be a captive finance company, it will be concerned about keeping that customer, not just for the finance company, but also for the dealer network and for the manufacturer. That is the long-term view.
In the U.S., when faced with a potential loss of $1,000, $2,000, or $3,000 at the end of a lease product -- and about $500 tends to be the threshold -- the banks generally use a telemarketing program to point out to the consumer the excess wear and tear charges that a consumer is responsible for at the end of the lease. They use what I would call a pressure sales tactic, avoiding the dealer and going directly to the consumer and forcing them, if you will, to purchase the vehicle directly from the bank, albeit sometimes at a favourable rate. In other words, the banks avoid that residual loss.
According to independent studies by Moore Pace and by J.D. Powers, in the U.S. consumer satisfaction with the lease end process is 15 points to 30 points higher with captive automotive finance companies. I attribute that directly to the fact that a captive automotive finance company does not want to jeopardize the long-term nature of its customer relationships. For example, we at Ford Credit have Ford in our name; we are linked to the Ford dealer body and to the Ford Motor Company.
In the U.S., at least, the banks have not been willing to absorb that kind of economic loss during various points in the economic cycle.
Senator Austin: This is an area that gives me personally more trouble than many other areas in our review of the MacKay report's recommendations. One of the difficulties I have with your presentation and your comments is that none of the values that you present for manufacturer financing of automobiles would be lost in a competitive market, because you have the same corporate interests ensuring that there is financial liquidity for your dealer network. The banks might pirate some of the cream, but you are not getting out of the dealer financing or the consumer financing business. Do you care to comment on that observation?
Ms Kempston Darkes: Yes, senator. First of all, our affiliated finance companies work directly with the manufacturers to support a very solid auto market in the country. We are there for the long term and we are consistently there for the customer.
The fact of the matter is that our affiliated finance companies support the dealers through all types of transactions that banks have been unwilling to do. Whether it is equipment leasing at the dealership, major programs to redo dealerships and to bring higher levels of customer satisfaction, mortgages, whatever, our affiliated finance companies are there for our dealers and for our customers.
If we lose the leasing business, we will not have the same financial viability to continue to support all aspects of the dealers' operations and this is a critical factor for our dealers. If the banks cherry-pick one segment of the business they want to be in, it seriously lessens the financial viability of our affiliated finance companies to support our dealer network over the longer term. That is a huge issue for us.
You cannot turn vehicle leasing on and off like a water spigot. Banks have been getting out of leasing in the United States, and, as you know, two weeks ago Canada Trust pulled out of vehicle financing for everything west of Ontario. If banks are allowed to disrupt the market in the short-term and take our affiliated finance companies out of the market, our dealers will be seriously impacted by our inability to support all of their operations. The history of the banks in leasing shows that they are there for a period of time and then they pull back.
After the banks have been in leasing for a period of time and have created tremendous disruption in the market, it is very difficult for affiliated finance companies to sustain the dealer network over the longer term, and that is what we are there for. We are there for our dealers for the longer term of this business.
Senator Austin: Can you give us an idea of the return on equity that your lease financing has given you in Canada?
Mr. Menzyk: Again, that is very cyclical. I would say that over an economic cycle of 10 years or 12 years you are probably going to average something in the mid-teens. There will be some tremendous swings, depending on the state of the used car market at the time, to the point where you could be potentially in a loss position for a short period of time, perhaps a year or two.
Senator Austin: I was about to observe that your return on equity over a 10-year cycle is approximately the same as the bank's return on equity.
Where is the decision made as to how seriously the banks would compete with you? Where in the chain of transactions would the banks be most effective competing with you?
Mr. Menzyk: I should like to go back to a couple of points that you raised earlier. Because they are a domestic oligopoly, the banks' cost-of-funds advantage certainly would allow them basically to force out other competitors.
You made reference to the fact that they would buy the cream. That is another element of how a company can compete. Unless you are what the U.S. has found to be a growing market, which I call sub-prime and some people call non-prime, you cannot have an entire portfolio made up of the below-the-cream level. You need a spread of credit risk, and that is where the automotive finance companies, in support of the dealer body and in support of the manufacturer, buy a broader range of credit risk. That equation only works when you have a full spread of risk.
If you are always working with the marginal or lower end, it eventually forces you into a sub-prime company, which is certainly something that we do not want. You want to make credit available to marginal customers, but when I say "marginal customers", I do not necessarily mean customers who have bad credit. They may be customers who may have no credit, like young buyers. The level of marginal support you can provide is really dependent on how much of the cream business, as you put it, that you have.
Ms Kempston Darkes: The banks have basically enjoyed the majority of the business in the finance side. I think they would have maybe 90 per cent of that business. We only have 10 per cent of it through our affiliated finance companies and they are there supporting the more difficult risks in the business.
But, having said that, did you see one bank ad this summer for low-rate financing? That was probably the most competitive vehicle market we have ever been in. If you read the papers over the summer and into the fall, you saw finance rates of 2.9 per cent, 1.9 per cent, 0.9 per cent. There was not a single bank involved in that business. Not one came in to compete with those rates of finance.
Mr. Menzyk: I would also mention the rural markets. Because of geographic distance, it is often more costly to serve those markets and, generally, most banks and finance companies tend to have standard pricing throughout Canada, unlike the U.S. where it will vary at buy market. In general, the way it has been handled in Canada is just what Canada Trust did, which was to not provide service to that market. Obviously that has an impact on the small rural dealers and their customer buy.
Ms Kempston Darkes: As you know, many dealers run their own in-house lease financing. Here we have a situation where the banks are loaning to those dealers and at the same time want to compete for those dealers' customers. That is an inherent conflict of interest that will very much hurt dealers throughout this country.
Senator Austin: Let me ask you about a point that you made on the question of manufacturer finance company financing. To what extent is your competitive position improved by your ability to provide low-cost lending as a leader to sales? In other words, there is a whole set of accounts here from the manufacturer pricing to the dealer. It all raps up into a final number somewhere. Therefore, you have flexibility in the total price of the product as you deliver it to the consumer.
Ms Kempston Darkes: Leasing was developed by the auto manufacturers to address consumer affordability issues. Sales were falling dramatically as Canadians' disposable income was not rising and vehicles were becoming more complex with emission systems and other government-mandated controls required on the vehicle. How consumers could afford to purchase new vehicles became an issue, and that is why we developed vehicle leasing.
Clearly, we would not have the level of sales that we have today but for vehicle leasing. There was no doubt that sales of auto products in Canada were on a very dramatic downward trend because of affordability. We stepped in with leasing to try to maintain a solid industry in this country.
Now we compete with one another every day in the marketplace for that sale to the customer. Perhaps there is an industry in the world that is more competitive than vehicle leasing, but I do not think so.
I should like now to comment on an aspect of the affiliated finance companies. I know that you have heard from a vice-president of Toronto Dominion Bank who seemed to indicate that we were making money and just repatriating everything to the United States. Nothing could be further from the truth.
In the last 10 years, 85 per cent of the affiliated finance companies' profits in Canada have been reinvested in Canada. Over the last decade, 300 per cent of the Big Three's profits in Canada have been reinvested in Canada. So this discussion of the flight of capital is sheer nonsense.
Senator Austin: I think the problem I have with what you are saying is that you are giving me an increasing sense of confidence that you can maintain your competitiveness and your viability even against the banks. They will cherry-pick. They will try to take some of the cream, but how can they beat you in the delivery of the final financing product?
Ms Kempston Darkes: They can beat us because they have a 300 basis point to 400 basis point advantage in cost of funds that we cannot possibly equal, for one thing. They cherry-pick the business that they want.
Remember this, we are there for the total auto industry. We are there to support an industry in good times and in bad times and we cannot go in and out of that industry. We need to be there for the long-term support.
Senator Austin: I notice that you have not mentioned concerns with respect to tied selling and the access banks have to total information or a great deal of information about their customers. Do you feel that that is an issue, that the bank has the customer in a larger way than you do? You just get one crack at the customer. Is that a competitive issue as well?
Ms Kempston Darkes: Yes, it is very much a competitive issue for us. We believe that banks are interested in leasing as a loss leader and they do it simply to attract more customers into the bank and to sell them other services. We are in leasing because it is what supports the auto industry. Vehicle leasing can make the difference between success and failure for our dealers right across the country.
Banks want to get into leasing simply as another service to sell the customers and then add on to that service. We think tied selling is clearly an issue and it will be very difficult to control. Take, for example, a dealer sitting in any part of Canada. His lease inventories have been financed by the bank that now wants to compete with him for those very same customers. The bank literally has all the names and addresses and everything about his customers. Now, how could they not be successful with that kind of information and how could the dealer possibly compete with that?
Senator Austin: Do you think that if there were two banks in the country that had approximately 70 per cent of the retail deposit business in the country, it would make any difference to the competitiveness of your position if they were allowed to participate in light vehicle leasing? Would it improve, make no difference to, or worsen your position?
Mr. Menzyk: I would say the fewer banks that are in leasing, the fewer banks that exist. Being in leasing makes it much easier for a bank to control the market. There are some short-term actions that can be taken to preclude other competitors. I think that has two downsides: one, the fact that you do remove competitors; and two, should they stumble in that business, and if there are only one or two providers, then you have a situation where the banking industry itself has been put in jeopardy.
Senator Austin: If I understand correctly, your answer is that if there were two banks with approximately 70 per cent of the retail business in Canada, it would be an even more aggressive competitive presence to you.
Ms Kempston Darkes: Yes.
Senator Callbeck: Welcome. I have two or three questions I want to ask regarding the brief.
On page two, you talk about the services that are offered by the affiliated finance companies and you pose the question:
Would banks have a similar commitment to the industry during economic downturns?
In the next paragraph, referring to the affiliated finance companies you state:
They have acted as a lender of last resort for small business dealers whose financing needs have been rejected by banks.
I am wondering on what basis you make that statement. Do you have information that you can share with us?
Ms Kempston Darkes: It is an actual fact that we can demonstrate to you. Most banks today are reluctant to lend to smaller rural dealers. Those dealers really require our affiliated finance companies to get involved.
On single-purpose real estate mortgages, most banks are unprepared to lend up to the dealer's requirements and, again, the affiliated finance company has to come in with either the guarantee or the additional funding.
Most banks today are not interested in lending to the dealer for new equipment that he needs to service products and, in fact, we have seen on so many occasions that when dealers have reached their operating lines of credit the banks have indeed pulled back on that credit, and the dealers have to come to us to sustain them over the longer term. We can demonstrate that for you; we have numerous examples.
Senator Callbeck: Certainly, we hear stories of that but I have never seen any figures or any statistics.
Ms Kempston Darkes: The most recent case where the affiliate finance companies will have to come in and support the dealers is the withdrawal of Canada Trust from vehicle financing for everything west of Ontario.
Senator Callbeck: In your brief you mention that you do not want the federally regulated deposit-taking institutions to lease cars. You refer to the fact that credit unions do. May I assume that you have no problem with credit unions leasing cars?
Ms Kempston Darkes: First of all, that level of business at this point in time is relatively small and we have not seen the credit unions go through a major cyclical downturn. From that perspective, we do not know what the outcome will be. You have to be in this business through the good times and the bad, and we have not yet seen the impact of the bad times on the provincial institutions. However, I would be somewhat concerned if they became very heavily involved and the losses with residual values, et cetera, began to mount in the downturn. That could pose a risk to those provincial institutions. But, again, we will need to go through that period to see.
Senator Callbeck: I have one other question. On page 97, the MacKay report gives some statistics and says that one third of auto dealers own lease portfolios, and that this accounts for 10 per cent to 15 per cent of the light vehicle leasing market.
If the status quo were to continue, in other words, if banks were not able to lease cars, do you think that that 10 per cent to 15 per cent would go up? Do you see more dealers getting into this and owning?
Mr. Menzyk: I think it would be relatively flat. Dealers have been doing that leasing business for a number of years. For the smaller dealer, balancing that portfolio risk of what those vehicles are worth at the lease end is a bit more of a challenge.
In general, I would say that most of the customers that dealers have are customers that they know in their market that have special or personalized needs and they have tailored their service to those individuals.
However, with the subvented programs or competitive programs that the manufacturer offers, I do not see that as a growing segment for the dealers. I would say that it would stay pretty much status quo.
Mr. Brian D. Vasey, Vice-President and General Manager, Nissan Canada Finance Inc.: I should like to make just one point. When the dealers do their own in-house financing, of course, they have to set up a line of credit at the bank. Thus, the rates that they can pass on are dictated by whatever rates the bank charges them. At the end of the day, our subvented rates may be lower than that. That makes it easier for them to use the affiliated finance company programs.
Senator Di Nino: In your presentation you stated that the federally regulated deposit-taking institutions should be prohibited from offering leasing services on the smaller vehicles because obviously they are already leasing the large trucks, and so forth.
Please share with us why you think a distinction should be made, with respect to leasing, between federally regulated deposit-taking institutions and provincially regulated one like the credit unions and trust companies.
Ms Kempston Darkes: I think it has to do with the size of federally regulated institutions. We have only six banks in this country and they have enormous market power as it is. There is simply much less competition with federally regulated institutions.
As you mentioned, the banks have been in the business of leasing heavy equipment. But, as they have suffered losses, they have very quickly reduced their commitment to that business and very quickly pulled back. Therefore, there has not been any long-term benefit from the banks even being in that business.
On the provincial side, leasing is done on a much smaller scale. The caisses in Quebec are involved in it but on a much smaller scale. How viable leasing is for provincial institutions has to do with economic cycles.
Remember, leasing is the core of our business. We are there through the good times and the hard times. If there is a loss to be had in the business, we absorb it, because that is the whole essence of our business. We are there for the long term to sell cars and trucks and to support dealers. But it seems to me that, given the economic downturns that occur in this business, there is still some question as to how long the provincial institutions will be involved.
Mr. Menzyk: I would add that should a provincial institution fail, the auto captive finance companies should be able to absorb that amount of business in the short run and minimize any disruption to the dealer body and to the manufacturers. However, if a national bank was a major player and exited the market, it would be much more difficult to recover quickly and not have a major impact on the automotive lending side.
Senator Di Nino: Are you saying that if the provincially regulated institutions ever became large enough and had enough of a market, then you would also object?
Mr. Menzyk: There would be a similar concern.
Senator Kolber: If you could be perfectly objective, would you say that if the banks were allowed to lease small vehicles it would benefit the Canadian consumer?
Ms Kempston Darkes: Absolutely not, and I will tell you why. In the short term, there might be some pricing advantage for the consumer, but over the long term, as everyone else was driven out of business, there would be less competition and prices would rise.
Senator Kolber: Why would prices rise?
Ms Kempston Darkes: Because nobody else would be in the marketplace, with the cost of funds --
Senator Kolber: Are you saying that if the banks came in, you would all have to go out of it?
Ms Kempston Darkes: Basically, we cannot compete with the banks on the cost of funds. They have a 300 basis point to 400 basis point advantage in cost of funds that we cannot match.
If you are looking for objective evidence, let us compare lease rates in the United States and Canada.
The fact of the matter is that lease rates in Canada are about 1 per cent to 2 per cent lower than they are in the United States where all of the banks are in leasing. Here we have a very competitive market that benefits the consumer more than what exists in the United States today.
Senator Kolber: But I thought that in your opening presentation you talked about the advantage of having 10,000 banks down there.
Ms Kempston Darkes: That advantage has not been passed on to the consumer, because what we are seeing is that our rates in Canada are 1 per cent to 2 per cent lower for the consumer than they are in the U.S.
Senator Kolber: But that is true for the entire banking industry. Communal banks in the United States charge prime plus 3 per cent, 4 per cent, 5 per cent and 6 per cent, which is unheard of in Canada. However, that is not our major concern now.
Let me ask you this. Banks are in the leasing business. They lease airplanes. They lease boats. They lease heavy vehicles. Do you have any evidence that that activity has disrupted business in those areas?
Mr. Vasey: I guess it would be unfair for me to comment on that, because where I work we are not in that type of business. I might just add one point, though, with respect to the banks getting into leasing.
One of the concerns that we, as a smaller manufacturer in Canada representing Nissan, have with banks in leasing is that we have a lot of small dealers in small towns in rural Canada that today are struggling to survive. In many cases, the leasing business that they do now makes the difference between making it and breaking it. If that business were lost to them, they would be put in a very precarious position.
There is also the matter of those dealers having to compete with the same bankers they have to get an operating credit from in order to survive.
Senator Kolber: Are you saying that we have to balance the long-term viability of the automobile industry in Canada with allowing the banks to make some extra profit?
Ms Kempston Darkes: I think that maintaining a healthy auto industry in this country is essential. I think that maintaining a healthy dealer community that employs 100,000 people in this country is very important, yes.
Regarding your question about banks in heavy equipment leasing, you will notice that their rate of participation has fallen dramatically in that area. They have suffered losses and have withdrawn from that business as well. That is something we as an industry cannot do because we are there for the long term.
The Chairman: I should like to ask a supplementary question regarding your first answer to Senator Kolber when you talked about driving people out of business.
On page one of your brief, you state:
...banks have a history of capturing market share and driving out competitors in new markets through the use of loss leaders.
In the seven or eight years I have been on this committee I have heard similar statements. I have asked everybody if they can give me one element of proof, one or two examples that illustrate the validity of that statement. If you do not have examples at the moment, think about it and tell me what they are, because so far I cannot find the facts to back up that kind of statement.
Ms Kempston Darkes: In our industry, the banks have 90 per cent of the retail finance side of the business today. We only have 10 per cent of it and that is basically business that the banks have rejected.
Mr. Mark A. Nantais, President, Canadian Vehicle Manufacturers' Association: Mr. Chairman, perhaps I could add to that. Four years ago, the Senior Vice-President of the Bank of Nova Scotia, James O'Donnell, told the Consumer Bankers Association in the U.S. that the bank found that car loans were a great loss leader for other products offered in Canadian branches, such as mortgages, deposits, investment products, credit and debit cards, because the bank's approach now is more relationship banking in order to build a customer base with potential for cross-selling. The strategy, therefore, is not to actively pursue the indirect auto market but at the same time to take aim at any other indirect market that is available today.
The Chairman: I guess the question is: At what point is that in the consumers' interests or not in the consumers' interests?
Senator Oliver: Various people have different statistics. The Canadian Bankers Association did a study and came up with the following statistics that I should like you to comment on.
The Canadian Bankers Association said that in February and March of this year, Canadian interest rates on lease vehicles, an area where banks are not allowed to compete, averaged 1.2 per cent higher than U.S. rates. At the same time, rates on auto loans, where banks are allowed to compete, were 0.32 per cent lower than American rates.
Ms Kempston Darkes: I am glad you raised that because, quite frankly, we think that the study that was presented is seriously flawed for a number of reasons.
First of all, when they compared lease rates in the United States and Canada, they did not look at the subvented lease rates that were actually offered in the marketplace. They looked at a nominal rate only.
Second, that study was done in an environment in the United States that did not include full-disclosure leasing. As a result, those rates did not take into account all of the administration fees, termination fees, and so on that can be part of a lease. In Canada, on the other hand, the affiliated finance companies are under full-disclosure leasing. The Canadian rates would have looked higher because they included those charges that the U.S. institutions did not include because they did not have to disclose them.
Senator Oliver: Just because they did not have to disclose them does not mean that there were termination charges.
Ms Kempston Darkes: We know that there are termination charges.
Mr. Menzyk: In a bank lease, typically, there will be an acquisition fee paid at lease inception of somewhere between U.S.$350 and $500.
Senator Oliver: Is that credited at the end of the lease?
Mr. Menzyk: No. Generally, that is rolled into the capitalized cost of the vehicle.
Then, normally, the consumer will end up paying one of three fees when the vehicle is disposed of. There is a prepayment penalty of generally $250 should you terminate the lease early. If you return the vehicle there is a disposal fee of, again, generally $250, although some are as high as $400. In some cases, if you choose to purchase the vehicle at the end, there is a purchase option fee that is also normally in the $250 range. Occasionally, they will waive that $250 purchase option fee as an inducement to get the consumer to buy the vehicle if the lease end value is far below the real market value for that vehicle.
Senator Oliver: Do we have any of those three fees in Canadian leases today?
Mr. Menzyk: Some leases do include those fees today, but under full disclosure the impact on the interest rate is included. Where your normal interest rate is 7 per cent, let us say, if you have $500 worth of fees, your actual rate could be in the neighbourhood of 8 per cent to 9 per cent. Generally, the fees in the U.S. would add anywhere from one to two points to the rate.
The other point to make about the U.S. is that, although they talk about having disclosure in their leasing under regulation "M," that disclosure does not include rates. It is basically disclosure about the capitalized cost of the vehicle. It is the charges, the lease end value, and the monthly payment. But nowhere is a breakdown of the fees or the interest rates included. They will list what the fees are, but not necessarily itemized in such a way that the consumer can determine what the interest rate was in that particular lease.
Senator Oliver: Have you or your associations done a comparable chart and do you have other figures that you could submit to us to show us what you would say are the true differences?
Mr. Menzyk: Yes.
Senator Oliver: Could send those to our committee so we could read them?
Mr. Menzyk: Yes.
Ms Kempston Darkes: Again, senator, one of the other problems with that study is that it did not look at the subvented costs. All summer you saw 2.9 per cent lease financing, et cetera, because it is such a competitive market and we are trying to drive sales in the marketplace, but that study did not take that into account. When they compared rates, they did it on a very unfair basis and we could show you that.
Senator Oliver: On page 97, the MacKay report states that deposit-taking institutions were given the power to enter into leases in 1980 but that as a result of concerns expressed by auto dealers, it has been put off and put off. That was 18 years ago, and it seems like an awful long time to be waiting.
I also wanted to ask you to comment on some of the findings in the report that the MacKay task force asked DesRosiers Automotive Consultants Inc. to do. The report showed that residual values have become so high that a number of dealers in the business will soon come to a day of reckoning and find that they will be stuck with vehicles that they put too high a residual on.
Will this not level out the business in such a way that if the banks were there, they would help take some of this fall because there would be more competitors in the market?
Ms Kempston Darkes: Leasing is different from financing by the very fact that you own the vehicle and you have to accept the residual risk with it. When that situation occurs, the affiliated finance companies and the dealers will accept that cost, because that is part of our business.
In the United States, when banks in leasing have found themselves in that position, they have really passed those costs right back to the consumer by forcing the consumer to acquire the vehicle through their telemarketing system. Therefore, the consumer takes that residual risk. When that situation occurs in Canada, as it very well could, given the cyclical nature of our market, we bear that risk, not the customer.
Mr. Menzyk may want to comment on that.
Senator Oliver: The DesRosiers report suggests that the residuals have been so high in order to lure people into these leases and that it looks like you will be taking quite a loss on those very high residuals.
Mr. Menzyk: We have definitely taken losses on the leases, on the lease end value.
That brings me back to the point I made earlier about the U.S. experience with the banks. Like any captive finance company, Ford Credit must look at the consumer from a long-term perspective. We try to keep that consumer within the dealer network, within the manufacturer, and therefore we have absorbed that cost. Certainly it has been a very expensive cost in North America over the last two years. That is not to say that we have not made adjustments, but the point is that that kind of cost is not one that we felt you can push on to the consumer and still leave them with a positive feeling about the manufacturer and the dealer. To us, that positive feeling is critical. And that is something that the bank does not share. We are concerned about the auto industry. It is home for us.
Senator Joyal: Thank you. Your opening remarks refer to recommendation number 21, which deals with allowing the banks and the life insurance companies to lease. After that, your brief does not refer to life insurance again.
Do we have to conclude that you would accept having life insurance companies in the leasing business?
Ms Kempston Darkes: I do not think they have any interest in being in the vehicle leasing business to any great extent.
Mr. Menzyk: I think the concern would primarily be with the banks, just because of their size. Should an insurance company be able to control the market to any great degree, the concern would be equal. Unlike a bank or an insurance company, we will not withdraw from the auto industry should that business turn sour. We do need to make sure though that we are healthy to be there, however.
If an insurance company's magnitude were that of one of the major banks, our concern would be equal.
Senator Joyal: On page two of your brief, you have four points dealing with the conflict of interest situation between the local dealers and the lending institution, which is, I should say, a banking institution.
This is a situation that exists in the American market, so did you study exactly how the American auto dealers deal with the potential for -- or the reality of -- conflict of interest? Have you made any particular study in that area?
Mr. Menzyk: I think it is one of the most notable areas and, again, this is drawing from my U.S. experience.
In the U.S., dealer-owned leasing companies are maybe one-tenth the size that they are in Canada. When you talk about conflict of interest, as I pointed out earlier, the bank is controlling the rate at which they lend to the leasing company. If the banks have an avenue into direct or indirect leasing, then, it does put them at conflict with the dealer body. In the U.S. you do not see the same level of dealer leasing companies -- dealer-owned leasing companies.
Senator Joyal: On the second page of your brief you refer to the caisses populaires. As you remember, there was a strong reaction when the Government of Quebec allowed the caisses populaires to go into the leasing business. Have you been able to monitor the impact in the field since the caisses were allowed into that business? They are very spread out at the local level, which is where you fear the greatest negative impact would occur, if the banks were allowed into leasing in small and rural communities.
Mr. Menzyk: About a year ago, the caisses populaires came out with some very aggressive leasing plans. I cannot tell you why, but after about four or five months, they took a look at their pricing and retrenched. They came out with very aggressive residuals and very attractive rates, but that was relatively short-lived. I cannot tell you why they dropped their residuals and became much more selective in their credit decisions on leasing, though.
Senator Austin: I think the feature that has dominated our discussion this morning has been a view of the auto market as it exists today, and we really should take into account your vision of where the market will be in five years to 10 years.
I wonder whether you could see automobiles being sold on the Internet directly by the manufacturers or from large retailers, and whether all the financing could be booked on the Internet. Would that change the shape and nature of the business?
Ms Kempston Darkes: Let me take the first crack at that, Senator. There is no doubt that retailing will change over the years, and it will change to suit consumer needs. The one thing you must remember about a motor vehicle, however, is that you are selling both a product and a service. Buying the product is one thing, but making sure it has the appropriate service is something else.
Dealers are absolutely critical in that equation, however. We very much believe that auto dealers will have a role in the future, because they look after customers after they have purchased the vehicle. It is also essential that the customer derive a value from the product through being able to use it in every area of Canada, and rural dealers will thus continue to be very, very important indeed for us.
The Internet will certainly be a factor. In fact, you can visit any of our Web sites today, and you will see very extensive information about the vehicles that are for sale. Over time, yes, you will be able to apply for financing over the Internet, and you will perhaps be able to acquire a product over the Internet.
Our view is that that product will still be delivered through a dealer. The service side of the equation -- the customer care side of the equation -- must be very hands-on, and that is where dealers will continue to be absolutely vital to ensuring that the customer is well-serviced in the marketplace.
Senator Austin: We have seen the rise of service organizations that have nothing to do with selling cars, such as Canadian Tire and many, many others. According to some of them, the profit in on the service side, much more than it is on the retail side.
Competitiveness may move in the direction of direct sale by the manufacturer. The product may be delivered through some sort of delivery depot, but is the dealer really as critical a factor in the way the market may move?
Ms Kempston Darkes: We consider the dealer to be absolutely essential to the future market, because nothing will relieve the customer's desire for very high technology and very good care of his product.
If you take a look at vehicles today, manufacturers are very much focused on training in dealerships. At General Motors, I can tell you that we spend an inordinate amount of money training dealer-technicians. We are not prepared to leave servicing of the vehicle to just any organization. These are very high-tech products. They need to be well looked after, and they need to be looked after by people who truly know the business.
As vehicles become more and more complex, we believe that that requirement for training in dealerships will become ever more focused. The need for really good people at the retail end and in the customer side of the business -- the service side of the business -- will be even more important to our future success. Our reputation rests on how well a customer is looked after in the marketplace. For that, we will continue, I believe, to rely on our dealers.
Senator Austin: If the banks are allowed into the light vehicle leasing business, do you think the structure of automobile marketing will change? Do you see fixed price selling, for example, becoming a more dominant feature of automobile sales?
Ms Kempston Darkes: If banks are allowed in, we will see far fewer dealers being involved because, again, the profitability of those dealers will be suspect, and the smaller dealers will probably not continue to exist.
Leasing is a very important part of their total portfolio. I think we would see far fewer dealers, and I certainly would not see a continuing dealer presence in many, many rural communities in the country. That would be one key feature.
In terms of this fixed price selling, research has shown, Senator, that there are many people in the market today who just do not want to dicker over prices. They prefer to go into a dealership, see a price on a vehicle, and know that that is the price they will pay. Our Saturn dealerships operate that way. Each dealer sets his own price for a vehicle. It is on the car when the customer goes in, and that is the price that is paid.
We have experimented with things called "value pricing" where, basically, the price on the vehicle in the dealer showroom is what the customer will pay -- give or take $100 -- and that is the same price that is advertised in the paper. More and more customers want that kind of sales experience, and so the industry, in my belief, will migrate there. Clearly, each dealer will establish his or her own price in his or her own market. I think, however, that this whole question of whether or not you will continue to barter is one that may go away quite quickly, because customers are telling us that they prefer another system.
Senator Austin: It would not be driven by bank entry, then. It would be driven by customer preference.
Ms Kempston Darkes: My view is that customer preference will drive that decision, yes.
Senator Oliver: Senator Joyal asked you about the caisses populaires and credit unions. Those institutions, according to the MacKay report, were able to lease vehicles in all provinces except New Brunswick and Newfoundland. Further, provincial trust companies have leasing powers in most provinces.
The president of the National Bank appeared before us, and told us that he has a competitive disadvantage because in Quebec, the caisses -- his biggest competition -- can lease motor vehicles, and he cannot.
Mr. Menzyk: I am not certain what time period he was referring to. When they first started out a year or so ago, the caisses came out very aggressively. Since that time, our experience has been that they have pulled back significantly. They are not a significant player in the leasing market today, at least from our perspective.
Mr. Vasey: I would say the same thing about the caisses populaires; they have not caused a lot of problems. I cannot speak for the National Bank, but many of the banks are competing with us now, and we are not driving anybody out of business.
Senator Donald H. Oliver (Acting Chairman) in the Chair.
The Acting Chairman: Welcome, Mr. Cara. The floor is yours.
Mr. W.J. Cara, Private Investor: My name is Bill Cara. I am from Toronto, and I am here as a private investor. My prior affiliations include Dominion Securities, Dean Witter Canada, and Canaccord Capital, where I was the founder and chief executive of their Eastern Canada operations. I have been a member of the 10-person Ontario Government task force that reported on the unlisted securities market, which now is known as the CDN Market.
Eleven years ago I was honoured to be asked by the federal government to deliver a speech in the Far East region with the Senior Trade Commissioner for Canada in that region. Our speech was entitled "Trading With and Investing in Canada."
On April 23, this year, at the request of the Ontario Securities Commission, I delivered on behalf of the public of Canada -- at least in my eyes -- an independent and objective paper to the Provincial Securities Commissioners in the Public Forum Concerning Non-Self-Regulated Electronic Trading Systems and Market Fragmentation.
Here are my biases. I would like to see more fairness to the public consumer of our capital markets, and I believe that technology and globalization developments have overrun the capacity of existing market structures and regulatory systems to ensure that the public is fairly treated.
In this country, we need a federal-provincial agreement to legislate a national securities act, which would be administered by a federal securities commission. It is difficult to implement the very constructive recommendations of the MacKay report if the capital market system itself is quite flawed. To improve the financial services sector, which I think is basically a sound one, I think the Senate committee ought to be focused on infrastructure problems, and that is why I accepted the invitation to speak here today.
I have four points that I would like to go over. The MacKay report speaks to empowering consumers. My first point is that it would be helpful to Canadians if Canadian banks offered the same charges for precisely the same services in terms of trading securities -- apples to apples -- as they do for Americans.
My case in point, which I discussed with our provincial securities commissioners at the Forum on Market Fragmentation earlier this year, is TD's practice of charging Americans significantly lower commission costs. TD Greenline will charge you and I a CAN$95 discounted commission to buy or sell, as an example, 1,000 shares of Canadian Pacific stock. But TD Bank Waterhouse will charge Americans only CAN$25.50 -- US$17 -- for executing the same transaction. If you chose to trade those same shares through the Internet, TD Greenline WebBroker would charge you CAN$29, but TD Waterhouse WebBroker would charge Americans only CAN$17, or US$12.
My second point is that there is a need for a national electronic clearing system for securities, just as we have for cash funds. Securities are no longer maintained by financial institutions in the form of physical certificates. They are electronically stored and transferred. Without unnecessary cost and delay, which effectively negates my doing so, I cannot sell my 1,000 shares of CP at the more attractive price offered by a particular broker, if these shares are in an account at another broker. If I just want to margin the shares in Canadian Pacific to buy another bank's mutual fund, I cannot do that. I would like to have seen this issue addressed in the report's discussion of tied selling practices.
My third point is that the effects of advancing technology have surely changed the stock market paradigm in ways that benefit financial institutions more than they do consumers of capital markets. A system of multi-tiered markets now exists, and you may have heard the same thing this morning from the chairman of the Ontario Securities Commission.
Many of you may not be aware that more than 50 per cent of the volume of trades on the Toronto Stock Exchange is only reported to the Toronto Stock Exchange. That is, those trades are not executed through the facilities of the TSE, with full public access to them. They trades are made on what is called the "Upstairs Markets," which consist mostly of the big banks, and are merely reported after the fact on the Toronto Stock Exchange.
The public is particularly harmed by the existence of these upstairs markets, and by the private exchanges that are offered by so-called global brokers like Reuters Instinet and Bloomberg TradeBook.
At the public forum, I pointed out to the provincial securities commissioners that, at the close of the NYSE at 4:00 p.m. on April 15, a company called Cendant reported a situation involving some irregularities in accounting. Over the next several hours, when the public could not trade the securities, institutions around the world -- including our banks -- were trading 30,000,000 through Reuters Instinet. The price of the shares was cut in half, from $30 down to about $16. By the time you and I were allowed to trade, it was 11:04 the next morning, following which 107,000,000 Cendant shares were traded, which was a single-day, single-stock record on the NYSE.
There is definitely interest on the part of the public to trade securities at all times. If you want to empower the public, you will outlaw such extraordinary powers of institutions. Simply put, do not allow them to trade at times and on markets that are inaccessible to the public.
My final point is the most important, I think. The fact that the principal-agency conflict still exists in today's sophisticated capital markets is really outrageous. There is, as you know, a securities registration category called the broker-dealer. I ask you, is this entity a broker or is it a dealer? Each function represents different and opposing interests.
The fact that the broker-dealer can represent as many as three opposing interests in the same transaction is just as ludicrous as allowing the partners of the same law firm to represent opposing litigants. Even worse, it would be analogous to having yet another partner in that law firm be the trial judge. Such is the evolved self-regulatory capital markets system as we know it, and I think it has to change. The owners of capital should be the advantaged participants in capital markets. The financial services sector should be subservient, and that is not often the case.
I have given an example in my notes about the participation of banks in the capital markets, where they operate as dealers, principal traders, and agency brokers -- often in the same transaction. That is a flat-out conflict, and I think it has to be looked at.
Speaking as an individual, I think that the MacKay report was very constructive. I have a background on Bay Street, but I also have experience trying to finance small companies, and I find three recommendations that I really do support. They are: permitting securities firms to become members of the Canadian payment system; allowing credit unions to expand into traditional retail banking services; and eliminating so-called commission-free transactions by requiring full disclosure of the charges.
In terms of my own focus on trying to remove impediments to raising equity capital for growing small firms, my belief -- which is based on many years of experience -- is that the small corporate offering program in the United States is a particularly useful model. It was identified in the MacKay report. The vast majority of small enterprises in this country require capital raise-ups of less than US $1 million in a 12-month period of time.
With advances in technology and globalization, the best small Canadian firms could access risk-capital directly from the public without having to rely unnecessarily on the financial services sector. This could be done if -- and that is the operative word -- there were minimal registration and disclosure requirements, as with the SCOR program in the United States. That is not what Bay Street wants to see of course. The fact, however, is that, without some resolution of this matter, the majority of smaller Canadian firms will eventually take their cases directly to the Nasdaq and OTC markets in the United States.
In my case, I am chairman of a small New Brunswick company. It has 30,000 acres of forest, and a large sandstone quarry property in New Brunswick. The company banker is the Bank of New York. We recently incorporated a New Hampshire holding company that is currently filing SCOR documents with the SEC and the National Association of Security Dealers in the United States -- I have those in my briefcase, if you would like to go through them. Until about two weeks ago, I also served as chairman, president and CEO of a public Canadian health care company that is also listed exclusively in the markets in the United States. In both cases, we perceive that the task of raising capital in the U.S. markets because of the SCOR program itself would be easier than in Canada.
In summary, I can only stress the urgency of the matter. Our capital market structures and regulatory systems are flawed, and because of that, I believe, people are looking elsewhere for answers. Change is needed.
To conclude, although some of these remarks may appear to be negative, I assure you that I strongly support the MacKay report, and I congratulate the authors for their constructive work.
The Acting Chairman: Thank you very much for your presentation. You have raised three major points that no one else has mentioned to us.
Senator Austin: Mr. Cara, thank you for coming to us and telling us this story of your experience. A number of witnesses have talked to us about a national securities commission, and we have had a good deal of evidence about where it stands or does not stand.
This morning David Brown, from the Ontario Securities Commission, told us that, in effect, the Canadian securities regulators are creating a virtual national securities commission. As you have followed this industry so closely, do you have a comment on the cooperative relationship that has developed among the provinces in securities regulations?
Mr. Cara: I was really most impressed at the conference to which I referred earlier. The speakers from the various stock exchanges in Canada did express an indication of their willingness to cooperate. Politically, however, I think that there are just too many differences -- the Quebec versus Ontario situation, for example. In the west, right now we have the Alberta Stock Exchange going into Vancouver and marketing new listings.
In practice, there really is not that much competition. I would like to see the politicians really get behind this and push them into having it, though. It comes down to the fact that people want to protect their jobs, but it is the investors, the shareholders, and the publicly listed companies that go to these exchanges to raise capital that will suffer, however.
Senator Austin: We have heard from Mr. Brown from Ontario; Mr. Hindman from B.C.; Mr. Hess from Alberta; and Mr. Martel from the Quebec Securities Commission. What they have told is that they are cooperating very well, and that they believe that cooperation is lowering the costs of raising funds from the public through their securities process. They have adopted the lead regulator process. Essentially it seems to be based on what is a national offering. In other words, a national offering based on the lead regulator being from the province of the head office or corporate control of the entity.
You feel that their comments with respect to cooperation are not realistic, however?
Mr. Cara: The individuals that you just mentioned are basically from government agencies. Those are the people I found to be most cooperative. They are the individuals in senior management of the stock exchanges. This is private sector. And these are the people that are most concerned about saving their jobs, and about their own political empires.
Senator Austin: What are your comments with respect to the possibility of the TSE privatizing itself and offering shares to the public in the profit stream, if any, that it earns?
Mr. Cara: I spoke about that earlier this year at that public forum. My comments were not treated as though they had much credibility. Last May your committee was told that the stock exchanges across Canada should go public, and that they should ultimately amalgamate and offer one national electronic market system. That is the future, but it is also the necessity.
I think that the Toronto Stock Exchange has taken absolutely the correct step, the first step. I also think that it does not require politics between the Ontario-Quebec border to stop that process from continuing. A public company is a public company.
From what I observed at the public forum earlier this year, the people from the Montreal Stock Exchange and the commissioners from the Quebec Securities Commission were most impressed with the process of cooperation. I cannot see why we could not see a publicly traded company being between the Montreal exchange, the Toronto exchange, and the exchanges in the west.
Senator Austin: Would this single exchange be sensitive to regional conditions? For example, Alberta was able to create its junior capital pool, but it might not have been able to do that if it had had to have a dialogue and get the approval of Ontario, Quebec and even British Columbia. In Alberta, at least, they believe that to be a successful vehicle.
Mr. Cara: An exchange is really a marketing, educational, facilitation type of an operation. There is no reason why a public company could not have a small office in Edmonton, Calgary, Winnipeg, Halifax, et cetera.
There is no reason why the offices in Alberta, for example, could not be doing the listings for the oil companies -- the junior oil companies, and some of the other locally economic-based companies. In the same way, forest products or fisheries in other parts of the country could not have their listings started up from those offices of the national exchange.
Senator Austin: Our history has been to let our regions do their own thing in their own way. I come from Vancouver and we have this -- perhaps unwarranted -- belief that Toronto does not know everything it needs to know about the rest of Canada. I am willing to enter into a dialogue with the senator from Toronto over the subject, but only if he is willing to get up early in the morning.
I am addressing the issue of stock exchanges and the way in which stock exchanges administer the market. That market creates the liquidity, which creates the investment capital, and the regulatory side we have discussed. I doubt, however, that a uniform market would have produced the specialization that has given rise to capital formation, for example, in British Columbia in mining; in Alberta in oil and gas. Those two markets are now also fostering junior high-tech companies. Remember, Toronto drove junior mining off the Toronto Stock Exchange. So the idea of one single exchange is one I would be sceptical of.
Mr. Cara: What the TSE did was to drive out the promoters that were operating illegally out west. What technology is doing right now, however, is driving the best quality promoters down to the United States. They are now residing in places like California, Arizona, and Florida, and they are using the SCOR program and the easy way of taking their companies public and raising capital in the United States. These are not people that operated illegally.
If we were to have a uniform program across Canada that was able to appeal to these promoters and the best small companies, they would stay there. People would then work in Vancouver or Halifax, because that is where they are from.
Senator Austin: You have given us three examples of issues in the securities industry itself. This industry, as you well know, is subject to provincial regulation, and I take it that the examples that you have given us are outside the current scope of federal supervision.
Mr. Cara: But they should not be.
Senator Austin: They should not be. Please give us your view on that.
Mr. Cara: In the past five years, I have spent approximately four years in the Bahamas -- not full time, but more or less full time. I created the member regulations for the Bahamian stock exchange, and I did have discussions with the CDN Market and Toronto Stock Exchange regarding the use of the CDN Market -- the Ontario unlisted market -- to expand it into a national unlisted market.
This indicated to me that, if I could put together a method of listing companies on the Bahamas Stock Exchange -- companies that wanted to drop off the exchanges on which they were listed and go to the unlisted market in Ontario -- this would give them an option. Those that wanted to go to the unlisted market in Ontario could do so if they filed on the Bahamas Stock Exchange, and then duly listed on the Ontario unlisted market.
The problem, of course, is that, if you are a B.C. company, you do not have to follow the rules and the laws of Ontario. I think that we may need to get away from having these small provincial corporations. I think if a company is public, it will have shareholders from across Canada.
Perhaps one of the things you should examine is having these companies have a federal charter, because you will find shareholders all over this country. I invest in Quebec or New Brunswick corporations to some extent, probably as much as the next person from those provinces.
Senator Di Nino: I was intrigued by your comments, and I think Senator Austin covered it quite well. Would a single entity market for all of Canada not affect competition?
Mr. Cara: In my mind it would not. In fact, in my mind you could take it a step further. You could throw out all of the stock exchanges in Canada. You could invite the Nasdaq market to Canada and have them operate a listing -- a process for Canadians to trade.
Senator Di Nino: You are saying that we should create the competition by inviting foreign markets to come in?
Mr. Cara: No, not at all. I am just saying that you are putting too much emphasis on what an exchange is. If you really look at what an exchange does, it is marketing, education, and facilitation of training. It is getting into the minds of the investors and shareholders, and helping them to make good decisions. It is helping the listed companies raise capital. The technology of the marketplace is only a computer, and that computer can be in Halifax or it can be in Victoria. It can be in New York City.
Senator Di Nino: The decisions are still made by one body, however, and any product's availability would be dictated by that one body, instead of creating a competitive force. That competitive force, as Senator Austin suggested, would create a different market, specific to an area or areas that the one body situated in a central part of Canada might not wish to offer.
Mr. Cara: Let us suppose that there are offices for marketing and education facilitation in each of the major cities across Canada. Each may have only a few people, and the office in Alberta, say, is doing the listing and the marketing for the small energy companies. It is up to those individuals to market properly for that listed company, and to show the shareholders right across Canada that these are good, small, growing companies, and that there is value here. It is up to these companies to do the job. It is not just up to the individual companies themselves. They do need a stock exchange behind them.
Senator Di Nino: You are suggesting that one avenue for raising capital would be the SCOR program that exists in the U.S. I believe your paper refers to the fact that there would be less need for disclosure -- a "minimal registration and disclosure requirement."
How does that serve the needs of the investing public?
Mr. Cara: If you go through the SCOR document itself, you will find that it is not a simple document. It is a very complex document. In my case, the latest one that I filed is 32 pages long. It has a series of complex questions -- this one has approximately 50 -- and these questions obtain information similar to a prospectus. This is, in fact, a prospectus filing.
Senator Di Nino: I am using your words, though, Mr. Cara. You say in your presentation:
There is minimal registration and disclosure requirements as with the SCOR program in the U.S.
So you are saying then, that this may not be correct?
Mr. Cara: No. It is correct. I can do this filing for approximately $10,000 in cost for my corporation. Those are legal costs. I do not have to use a broker.
In Canada, to raise capital, I have to go to a broker. I have to go through their legal process and due diligence, and what have you. It will cost me perhaps $150,000 to raise $150,000 or $200,000. I do not think that is fair.
Senator Di Nino: You believe that the SCOR program would safeguard the interests of the investing public or the investor from the standpoint of issues such as disclosure and regulatory requirements?
Mr. Cara: Very much so. The statements, the representations, the warranties, and the covenants in the document that is filed with the Securities and Exchange Commission are subject to it. This is a filing process, but it is a very simple filing process.
The Acting Chairman: One of the three things you said you liked about the MacKay report is that it recommends allowing credit unions to expand into traditional retail banking services.
Do you have any concerns or any caution for this committee about the impact on safety and soundness -- which is so much a part of our financial system -- if that were to occur?
Mr. Cara: I was not thinking so much about the financial integrity of some of the smallest of the credit unions as I was about the importance of negotiating face-to-face with the consumer. A person who needs some help or some assistance financially needs to be able to sit down with somebody in his or her community. The importance of that cannot be stressed enough.
The Acting Chairman: A number of witnesses have reached the same conclusions that you have. Thank you very much for coming today.
The committee adjourned.