ORGANIZATIONAL FLEXIBILITY
1. Ownership Rules
2.
Widely-Held Rules Satisfied by Co-operative or Mutual Form of Ownership
3.
Transition Ownership and Takeover Rules for Demutualized Life Insurance Companies
4.
Approval of Acquisition of a Widely-Held Institution by a Foreign Purchaser
5.
Recategorization of a Schedule I Bank To Be No Longer Widely-Held
6.
Grandfathering of Institutions Not Conforming to New Ownership Rules
SECTION B
ORGANIZATIONAL FLEXIBILITY
Background
Current ownership policy is different for banks and other federally regulated financial institutions. In general, Canadian banks must be widely held, which under the current rules means that no individual can own more than 10 per cent of any class of shares. Schedule II banks are exceptions to this rule and there are three categories of exception. The first is for foreign banks that are widely held, which can own 100 per cent of a Canadian bank subsidiary. The second exception is that a bank may have a controlling shareholder for up to 10 years after it is chartered, as a transition measure to becoming a Schedule I bank. The third exception, which was introduced in 1992, is that any widely held and regulated Canadian financial institution can own 100 per cent of a bank. Schedule I and Schedule II banks have virtually identical powers; the only difference between them is in the ownership structure permitted. (Task Force Report pages 77-78)
There is no widely-held rule for federally regulated trust companies or insurance companies owned by shareholders. For these companies, as is the case for Schedule II banks, the Minister of Finance must approve any shareholding in excess of 10 per cent, but there are no legislative restrictions or directions on the exercise of this authority. Since 1992, there has been a legislated requirement that when trust companies, insurance companies or Schedule II banks reach a size where they have more than $750 million in shareholders’ equity, they must have a public float of at least 35 per cent of voting shares. Insurance companies can also be mutual companies, owned by policy holders rather than shareholders. Mutual companies are widely held by definition. Four of the five largest life insurance companies in Canada are mutual companies, but each has announced its intention to demutualize and become shareholder-owned.
There are two main reasons why public policy has required the banks to be widely held.
The first is that the absence of a controlling shareholder facilitates continued Canadian control of banks, regardless of ownership. It used to be the case that foreigners could hold no more than 25 per cent of the shares of federally regulated financial institutions, but successive international trade agreements have resulted in the elimination of this restriction. As capital markets become more global and economies become more integrated, all major Canadian banks have sought to raise capital in foreign markets and most have listed their shares on U. S. stock exchanges. Foreign ownership of Schedule I banks has increased in recent years. However, the 10 per cent restriction, together with certain requirements in the Bank Act, ensure that the mind, management, and principal location of economic activity of our Canadian chartered banks remains in Canada.
For insurance companies, the mutual form of ownership has ensured Canadian control of companies accounting for a major share of industry activity.
There are a number of reasons why Canadian control of our major financial institutions is important. Strong domestic financial institutions provide benefits to communities through philanthropic contributions and community leadership. They also provide the basis for domestic financial centres that can offer higher-quality, skilled jobs to Canadians, and can result in greater taxation revenue for Canadian governments. Canadian institutions are also felt to be more sensitive to domestic market situations ¾ particularly in an economic downturn ¾ than foreign-controlled institutions might be.
The second reason for requiring wide ownership is that the absence of a controlling shareholder facilitates the separation of financial and commercial activity. Those responsible for the safety and soundness of banks have long been concerned that dominant shareholders with commercial interests could influence a bank to make lending decisions that were not in the best interests of depositors or other shareholders. The failure of many trust companies owned by dominant shareholders in the 1980s and early 1990s lent credence to this view. This concern led to the introduction of much more restrictive related-party transaction rules in the 1992 legislation; it was also a factor in requiring the 35 per cent public float for larger trust companies and shareholder-owned insurance companies, introduced at the same time.
In the June 1997 Discussion Paper it was stated that "ownership of a regulated financial institution is a privilege, not a right." In this report, this view is reaffirmed.
Further, it is argued that "as the functions of institutions continue to converge … distinct ownership regimes for banks, trust companies and insurance companies will become increasingly anachronistic. … Second, … current ownership regimes are unnecessarily inflexible, particularly with respect to ownership of a bank."
Second, the Task Force believes that the current ownership restrictions are unnecessarily inflexible, particularly with respect to the ownership of banks. The current 10 per cent restriction can preclude the use of stock as acquisition currency for potential transactions that might require the granting of a position in excess of 10 per cent to a major shareholder in the target company. In a world where consolidations are increasingly commonplace, and where many transactions are consummated through share exchanges, this inflexibility can seriously constrain the range of potential strategies that our domestic banks can consider. Indeed, it is one factor that may force them to look at domestic consolidation rather than international acquisitions.
A further consequence of the wide-ownership provision is that it seriously constrains the potential for new entrants into banking. It is theoretically possible for anyone to start a bank in Canada but, after 10 years, regardless of how well the bank was doing, the owner would have to divest enough shares to come within the 10 per cent restriction. There are many regulatory barriers facing new entrants. These include federal and provincial capital taxes and the requirement for a minimum of $10 million in capital, both of which requirements we recommend be relaxed. But, in the view of the Task Force, the most significant regulatory barrier to entry is the inability of entrepreneurs to enjoy the fruits of their investment. The Task Force argues that if competition is to be encouraged, those willing to take risks should be permitted to reap the rewards when they are successful.
The Task Force recognises that allowing commercial interests to own banks is a major departure from current policy. It believes that the separation of commercial and financial interests does provide additional assurance that institutions will be managed and governed in the best interests of depositors and policy holders and, in its recommendations, … such separation for the largest of our institutions is called for. But if we are to enjoy the benefits of increased competition in our marketplace we need to encourage the entry of additional institutions, and the most effective way to do this is to relax the current restriction on commercial and financial separation for smaller banks.
It may well be the case that as new entrants emerge and competition intensifies some of the smaller institutions will fail, despite the best efforts of OSFI to supervise them. This should be regarded as a normal consequence of the workings of a dynamic and competitive system.
In designing a new ownership policy, the starting principle is that there should be a common ownership regime for all federally regulated financial institutions. It should balance prudential concerns with the desirability of enhancing competition through encouraging alliances and new entrants. In practical terms, this means that it should vary by size of institution rather than type of institution, with heavier weighting toward prudential considerations for larger institutions.
Task Force Recommendations
3)Canadian public policy should continue to support the Canadian control of large regulated financial institutions carrying on business in Canada. Specifically:
(a) There should be a redefined widely-held rule applicable to all large federally regulated financial institutions, designed to foster continuing Canadian control of a significant part of the financial services sector.
(b) The other existing legislative requirements designed to achieve Canadian control should be maintained.
(c) The legislation should be strengthened by a provision to make it clear that the principal executive functions of widely held, federally regulated financial institutions are required to be carried out in Canada.
6) Ownership rules should be revised as described under the heading "Ownership Rules and Enhanced Competition" to permit the establishment of new closely held banks and co-operative banks.
29)The ownership rules should be designed to foster:
(a) entrepreneurship and competition;
(b) the safety and soundness of the system; and
(c) the preservation of Canadian control of substantial parts of the financial services sector.
30) In respect of large financial institutions, the maintenance of Canadian control and the better assurance of safety and soundness by the separation of commercial and financial interests are key principles underlying the ownership rules. For those reasons, large financial institutions should be widely held, as defined in Recommendation 33. It is important to foster entrepreneurship and competition in the start-up and growth of new financial institutions; accordingly, smaller financial institutions should not be required to be widely held.
31)Any holding of more than 10 percent of any class of shares in a federally regulated financial institution by a person or group of persons acting jointly or in concert should continue to require the prior approval of the Minister of Finance, on a "fit and proper person" test.
32) There should be a single ownership regime, consistent across the financial services sector, which is based on the size of the institution measured by its shareholders’ equity. The essential parameters of the ownership regime would be as follows:
(a) In order to foster start-ups and competition, institutions with less than $1 billion in shareholders’ equity would be able to be closely held, including sole ownership by one person or company.
(b) In order to provide enhanced corporate governance in the interest of safety and soundness for growing institutions, financial institutions with more than $1 billion but less than $5 billion in shareholders’ equity would be required to have at least 35 percent of their voting participating shares widely held and publicly traded.
(c) The Minister of Finance would have the authority to exempt a subsidiary of a foreign financial institution from the requirement to have a 35 percent public float.
(d) The largest financial institutions, those with shareholders’ equity in excess of $5 billion, would be required to be widely held as described in Recommendation 33.
(e) A widely held, regulated financial institution that is incorporated in Canada should be able to hold up to 100 percent of the shares of another regulated financial institution, regardless of size.
(f) Where a single owner or group of related owners has effective control of more than one regulated financial institution, the applicable ownership rule will be determined on the basis of the combined shareholders’ equity of the controlled financial institutions.
33) Large financial institutions, i.e., those with shareholders’ equity in excess of $5 billion, would be subject to the following widely-held requirements:
(a) As described in Recommendation 31, no person, or group of persons acting jointly or in concert, would be allowed to own or control more than 10 percent of any class of shares without the approval of the Minister of Finance.
(b) The Minister of Finance should have discretion to permit ownership positions in any class of shares in excess of 10 percent and up to 20 percent. Shareholders permitted by Ministerial order to own more than 10 percent should not collectively own or control more than 45 percent of any class of shares.
(c) The Minister of Finance should also have the discretion to permit a shareholding, on a temporary basis, in excess of the 20 percent limit, subject to the Minister’s approving a plan from the shareholder to divest to an agreed percentage (not to exceed 20 percent) within a fixed time period. The Minister should be empowered to obtain and enforce undertakings from any person holding such an excess shareholding, both to confirm the agreement in respect of the divestiture of the shares and to assure that voting rights will not be exercised on the shares in excess of 20 percent during the period prior to disposition.
34)Although the discretion of the Minister of Finance to permit a shareholding in excess of 10 percent for institutions that must be widely held should not be constrained by statute:
(a) The discretion should be exercised when the Minister concludes that the excess shareholdings would:
(i) enhance competition or competitiveness in the financial services sector;
(ii) enhance the safety and soundness of the Canadian financial services system; or
(iii) foster the growth of the Canadian financial services industry by, for example, facilitating a business alliance or an acquisition by a Canadian financial institution.
(b) The increased shareholding limit should not be generally available for passive investments in which the excess shareholding would add no value to the business beyond the investment of the shareholder.
(c) The Minister should issue guidelines to identify the circumstances in which the Minister would be prepared to consider an application to exercise the discretion.
35) An institution which reaches the $1 billion and $5 billion thresholds, and which therefore becomes subject to new ownership criteria, should have a reasonable period of time, to be determined with the approval of the Minister, to comply with the applicable requirements of the ownership regime.
37)In respect of financial institution holding companies, the ownership rules should apply to the holding company on the basis of the combined shareholders’ equity of the regulated financial institutions controlled by the holding company.
Views of Witnesses
Witnesses who addressed this issue were generally in favour of the Task Force recommendations. The CEO of the Royal Bank stated:
The report's proposals relating to ownership policy provide a pragmatic and sensible direction. The wide ownership rules faced by Canada's Schedule I banks have had the twin objectives of ensuring a separation between commerce and finance and ensuring domestic control. While these may well be justified government objectives, there have been four undesirable consequences. The report attempts to correct these.
First, by applying only to banks, the policy is open to being undermined by the non-bank sector. In addressing this issue, the report proposes extending the wide ownership rules to all financial institutions, not just banks.
Second, since ownership rules may act as barriers for new bank start-ups, as it is practically difficult to have dispersed ownership in small institutions, the report provides for exceptions to the rule for small institutions.
Third, since the strict 10 per cent rule may limit the use of bank shares for a merger and acquisitions strategy, where the partner may not be as widely held as a Canadian bank, the report suggests that the 10 per cent limit be allowed to rise to 20 per cent, with ministerial discretion.
Finally, since the ownership regime prevents outright takeovers, it can be a barrier to effective foreign competition. In addressing this, the report recommends allowing outright takeovers of widely held, large institutions by large, widely held foreign institutions under exceptional circumstances, where it is clearly in the interest of Canadians to do so. (John Cleghorn, September 29, 1998)
The CEO of the Bank of Montreal provided comments on the Task Force recommendations from two different points of view, that of a businessman and that of a policymaker.
I think MacKay got around a delicate issue with some skill. If you read our submission to the MacKay task force, you will see that I said something very controversial. I said, "Drop the 10-per-cent rule." I was asked at one committee — and I cannot remember which committee because I have appeared before so many — if I favoured the elimination of the 10-per-cent rule. I answered the question and it caused all kinds of confusion in the media.
I answered the question as a businessman, a CEO responsible for advancing the interests of his shareholders. Any restrictions on the saleability or value of my stock is bad news. Therefore, as a businessman, my view would be to take away the 10-per-cent rule.
I had a second reason for wanting the 10-per-cent rule gone. I am tired of hearing critics say that it has provided us with some kind of wonderful protection that none of us want. If people think that the 10-per-cent rule is protection, then take it away. Now, that is a businessman speaking.
If I were the Minister of Finance and were asked if I would drop the 10-per-cent rule, I would then say to myself: Do I want to lose sovereignty over my banks? Banks are the engines of the economy.
I have been approached three times by American banks for a takeover. They know nothing about the 10-per-cent rule. We would be in play in 10 minutes.
It would be great for my shareholders.
By the way, Canada is not uniquely protectionist in that regard. Many people do not have 10-per-cent rules, but try to buy a clearing bank in Germany, France or even in the United States. We can buy Harris. If I took a run at Chase, I might get caught up in that vortex for 50 years before I got approval.
Most countries still worry about credit allocation decisions. A fundamental role and mission of the financial industry — in particular of the banks within it — is the mobilization of pools of savings and investments in the country, followed by the diversion of those pools into financing risk-taking in the economy. If you move the policy making on risk appetite outside the country, then the country may not be as well served as it currently is by players who feel an obligation to finance activities that they might not finance from abroad.
I guess what MacKay said is "I understand the dilemma. The dilemma is how to ease up on the 10-per-cent rule to allow some takeovers of foreign institutions by widely held institutions," which I think is fine, "and not allow the other?" I think he found a way around it. It is not a bad finesse. Frankly, if there were a way of eliminating the 10-per-cent rule domestically, I would do it and keep it internationally, but then you get into national treatment problems on NAFTA. I think he tried to skate around that as best he could. (Matthew Barrett, October 8, 1998)
One witness argued in favour of allowing more concentrated ownership for smaller banks.
The ability to start new banks would be one major factor. It should be made easier to start a new bank — perhaps with higher percentage ownership by certain groups initially, and becoming more widely held over the longer term.
We are seeing a shift into more specialization in financial services. A company with expertise in a particular financial services field starts a bank that would focus on that area. It would be helpful if that company could, for example, own 50 per cent of that specialised financial institution initially, and later on reduce that percentage ownership to 25 per cent or maybe even 10 per cent. It is difficult to get a bank started without a significant backer today. (Terry Norman, October 20, 1998)
The CEO of the Canadian Western Bank expressed similar views.
On ownership rules there is a lot of merit to concentrated ownership for small financial institutions because you might have a very strong parent that can supply capital, can assist in the ratings. It might be a parent or a major shareholder could be a major commercial entity in a region that thinks that region could or should have a financial institution. The process would have to be very closely monitored. I think starting up small institutions you have management risks and you have capital risks and you have all kinds of risks that could take place that may not be apparent at the outset. It may strengthen small banks if the ownership is concentrated because you will have those perceivably strong institutions, like maybe a life company might own a piece of a bank that can supply capital, direction and systems support. Access to capital will be improved significantly. All you have to do is look at the Hongkong Bank in Canada. It can gear its capital almost precisely to the right levels because its parent lends the correct amount of money to keep the ROE up as high as they can and the right mix of tier one and tier two. They can operate very efficiently by having a very strong parent. (Larry Pollock, October 28, 1998)
The CEO of the Laurentian Bank also favoured the flexible ownership rules proposed by the Task Force.
One of the positive aspects of the MacKay report is flexibility. The members of the task force have one major objective — to create more competition — and they realize that, in order for this to happen, they must do some non-standard things. I have some sympathy with that. We cannot have it all.
We have a small market. If we wish to keep it Canadian, yet we want a more competitive market, there must be some compromises. If everyone is alike, it will not happen. This is one of the big problems with the Bank Act; everyone is alike.
What MacKay is saying is that you can have more flexibility on the ownership of small players — the second tier. It does make sense, and it does create more dynamics in the system. I feel it would make sense if you were to do the other thing too. If you were only to do this, I would have a problem. What I like about MacKay is that if you want more dynamics in the small market, again, you cannot have it all. You must compromise, and that flexibility is good. (Henri-Paul Rousseau, October 23, 1998)
Others expressed reservations about varying the ownership requirements with the size of institution.
These three differing ownership requirements, based on size, will add costly complexity and leave in doubt what happens when a company moves either up or down one or more size categories. The regulatory framework should focus on fostering strong, agile, competitive financial institutions which can respond quickly to a fast-changing marketplace and not set up rules which will require difficult interpretation.
I have difficulty when you have step cliff stages because what happens when you move up or down. Some companies get smaller over time, some get larger. Now, are you forever grandfathered which will create quite a mishmash of corporate structures in Canada.
I believe really that, subject to fit and proper ownership of a financial institution, there should not be a widely held criterion. (David Nield, November 2, 1998)
Some expressed reservations about ministerial flexibility with respect to the ownership rules.
Overall, I am also in agreement with most of the provisions covering ownership, including priority given to Canadian ownership, maintenance of the principle of largely distributed ownership for large institutions, and openness vis-à-vis groups and holding companies. Nevertheless, I must express certain reservations, particularly regarding the evolution of the 10-per-cent rule.
I am concerned that the flexibility introduced will erode that rule to the extent that it will ultimately be eliminated entirely. I support the idea of allowing 100 per cent ownership of institutions with less than $1 billion in capital. I also endorse the concept of a transition class for institutions that have between $1 billion and $5 billion in capital. However, I propose that this class be split in two; 65 per cent ownership should be permitted only for capital of less than $2.5 billion. For the segment between $2.5 billion and $5 billion, the ownership limit should be lowered to 35 per cent.
According to the task force's "Background Paper No.2," there are currently four financial institutions with federal charters that fall into the $1 billion to $5 billion capitalisation range. … they are identified as the National Bank, CT Financial, Canada Life, and Mutual Life. I do not approve of the idea that a single shareholder could take legal control of those institutions. A position of 35 per cent would be sufficient to ensure that the principal shareholder could exert significant control over these companies.
The reason I take this position is that it is very difficult to analyze the effect of concentration in Canada. I very much look forward to the report of the Competition Bureau, but my guess is that by now they must have a really hard time coming to a global conclusion, because in some areas it is clearly very competitive and in other areas it is probably less so.
The great virtue of the 10 per cent rule is that it ensures that if, and I underline "if," there are oligopoly profits or profits coming from concentration, they are redistributed. If we take away this rule then we allow those excess profits to be concentrated in one shareholder.
Furthermore, I somewhat oppose the flexibility measures proposed by the task force for the class of institutions that hold over $5 billion in capital. In my opinion, the 10 per cent rule has very interesting advantages and it is important that this rule be maintained with sufficient rigour. Moreover, it is also true that it entails disadvantages, such as granting more power to managers vis-à-vis a fragmented group of shareholders. I am consequently slightly disappointed that the task force does not devote more attention to this problem and that it has not examined in greater detail the antidote represented by cumulative voting, which perhaps should be imposed on large institutions. (Jean Martel, October 23, 1998)
The CEO of the Mouvement Desjardins argued in favour of the widely held rule for all sizes of chartered banks.
In terms of competition and competitiveness in the Canadian market, we believe that the limit of 10 per cent ownership should continue to apply to all Canadian chartered banks. In the Canadian context, these institutions are often regional banks when we talk about the smaller banks. The report discusses businesses that have capital of less than $5 billion. In the Canadian context, these institutions are often significant regional banks that have an important impact in one or two provinces.
Allowing excessive holding by a shareholder could lead to adverse impacts for the region if the shareholder's interests do not coincide with the economic development of that region of the country.
On the other hand we are in favour of the idea of allowing a greater number of participants in the Canadian market. That would give Canadian consumers more choice and allow them to be better served at a better cost.
… we do not see the advantage in allowing a group to hold up to 65 per cent ownership of a bank of smaller size, especially since these banks often do business either in one province or two provinces. We therefore find it a little risky to allow a group, which can often be a commercial or industrial group, to become the owner of a bank, to all extents and purposes, even if it has only $5 billion in capital, it is still — It is $100 billion that allow one to acquire that wealth and use it for one's own ends without being interested in the development of the environment in that province, but rather in the development of one's industry or commercial group.
One can imagine that today there are groups that would be very interested in operating in parallel with a bank that could be found in a similar business. In that sense, we do not understand the nuance made in the MacKay report saying that for banks that have between one and five billion in assets we could allow up to 65-per-cent ownership. It is a proposal we have difficulty understanding. (Claude Béland, October 23, 1998)
One member of the Committee pursued the difference between a 10 per cent and a 20 per cent widely-held rule.
One other question on the widely-held provision, which I think there is a fair amount of agreement we have heard on the 10 per cent rule, although we have heard some people suggest that it be increased to 20 per cent, I think on the grounds, if I am paraphrasing their reasons for support accurately, is that you would have a more substantial, a more important, a more influential shareholder at 20 per cent than 10, and perhaps more importantly, I am no accountant, that once you get 20 per cent, you can then equity account. Could you comment on that argument?
The CEO of Manulife responded.
Yes. I think with respect to the 20 per cent in terms of the equity accounting that you mentioned, it is only significant if the investee, the investor rather, is an institution that needs to tabulate earnings on a quarterly basis. If it is an individual, whether they have a 20 per cent interest or 19 or 21, that does not matter. It is an accounting consideration.
I think more importantly than that, I think that, and my reasoning goes something like this: We have in Canada a very concentrated economy already, and the idea that maybe a 20 per cent ownership limit in a widely-held company, you know, in many companies that is control. I do not think the Ford family, for example, has more than 20 per cent of the Ford Motor Company. Yet you can see the name of the young man that just became — of course, he is probably very brilliant, but it could be that his name is Ford has something to do with the fact he is now the chairman of the company.
So I think that you would want to be careful to not have your deposit-takers, frankly, fall under the control of anybody. I mean, I think this argument that in the absence of a strong, controlling interest they are going to misbehave, I mean, that is maybe for the old days. I think that the institutions that own stock in these companies up to the 10 per cent limit and so on, institutional investors, analysts and so on, rating agencies, everybody is very vigilant and they are held to a standard of performance as every bit as high as if they would be if they had a 20 per cent owner.
Now, I agree with the Task Force's recommendation that there be a flexibility allowed in order to accommodate transactions that could only be possible if you expand the ownership limit from 10 to 20 per cent for a temporary period of time. I agree with that. (Dominic D’Alessandro, November 4, 1998)
The witness from Power Corporation argued against the proposed ownership rules.
The position we find ourselves in is that there are really only two players of size in Canada that do not fit into widely held or the 10 per cent rule. Power Corporation and its subsidiaries is one, and the other would be Canada Trust.
In our case, insofar as the demutualization is concerned, they have come up with a rule that says the Manufacturers Life or the Sun Life could buy you, because they are widely held, but you could not buy them. We find it very difficult to understand who dreamed that up. A chartered bank could buy a Great West or London Life, but we could not buy a chartered bank.
If there continues to be rationalization in the industry, and I am not saying there is, but if there is, the terms that have been put out there effectively discriminate against us because of our size. We do not find that either fair or equitable.
…
In 1992, the acts of the day determined that there must be a 35 per cent widely held tranche in a regulated financial institution. That was arrived at after a great deal of debate back and forth. We find it hard to believe now that they will create another ownership regime, made in Canada, since 65-35 pretty well dictates that there will not be any hanky-panky. You have a 10 per cent regime that applies to the banks. You can see why it is there. It is there to keep the foreigners out. What is the purpose of having a 10 per cent regime in the life companies?
The 10 per cent rule existed for any Minister of Finance in our country over the last 40 or 50 years. It is there to maintain the status of our major chartered banks, which is very important. Because of the concentration, they are the overwhelmingly important instrument of the federal government. I do not think you are terribly interested in seeing that run out of Amsterdam or Frankfurt or New York. The 10 per cent is there for that reason. Despite our wish that it will go away, to be practical about it, I suspect it will probably stay for the banks.
When there is something that concerns the banks, because of their overwhelming importance in the financial fabric of the country it is transferred over to the life insurance industry. Why does that happen? The way things are going, the food distribution business will be run by three companies. I think food is more important to most people than life insurance. They do not have a 10 per cent rule on grocery chains, although that is a significant part of everyone's budget. How far do you want to take this thing? (Jim Burns, November 5, 1998)
This witness argued that controlling shareholders, such as Power, have played a positive role in the financial services sector and that the widely-held ownership rule clearly discriminates against them. To accomplish the objective of Canadian control of large regulated financial institutions, alternatives to this rule should be sought. His views were echoed by the CEO of Great West Life, a Power owned company.
This recommendation on widely-held ownership, if implemented, would discriminate against Great-West/London Life in that it would prevent us from growing in the future by way of making a substantial acquisition.
If Great West/London Life is foreclosed from pursuing major acquisitions, this lofty goal of encouraging strong competition with the banks will almost certainly be thwarted. The result will be that the banks will become the only buyers of large financial institutions. (Raymond McFeeters, October 6, 1998)
With respect to the definition of widely-held, the CEO of Manulife cautioned moving from 10 per cent to 20 per cent.
I think with respect to the 20 per cent in terms of the equity accounting that you mentioned, it is only significant if the investee, the investor rather, is an institution that needs to tabulate earnings on a quarterly basis. If it is an individual, whether they have a 20 per cent interest or 19 or 21, that does not matter. It is an accounting consideration.
I think more importantly than that, I think that, and my reasoning goes something like this: We have in Canada a very concentrated economy already, and the idea that maybe a 20 per cent ownership limit in a widely-held company, you know, in many companies that is control. I do not think the Ford family, for example, has more than 20 per cent of the Ford Motor Company. Yet you can see the name of the young man that just became — of course, he is probably very brilliant, but it could be that his name is Ford has something to do with the fact he is now the chairman of the company.
So I think that you would want to be careful to not have your deposit-takers, frankly, fall under the control of anybody. I mean, I think this argument that in the absence of a strong, controlling interest they are going to misbehave, I mean, that is maybe for the old days. I think that the institutions that own stock in these companies up to the 10 per cent limit and so on, institutional investors, analysts and so on, rating agencies, everybody is very vigilant and they are held to a standard of performance as every bit as high as if they would be if they had a 20 per cent owner. (Dominic D’Alessandro, November 4, 1998)
Finally, questions were raised about the definition of widely-held and about the threshold level for a big institution. The CEO of Laurentian Bank supported changing the definition of widely-held from 10 per cent to 20 per cent.
Once you have that 20 percent, it will give all of us, everybody in the industry, the capacity to attract new capital and then enhance competition because of that.
I would go for the 20 percent vote because of the equity accounting: it will bring in new capital through these new players. (Henri-Paul Rousseau, October 22, 1998)
With respect to the threshold level for a "big" institution, the CEO of Canada Life argued that this level should be raised:
Relative to size, in defining what size constitutes a large financial institution, the report uses a $5 billion shareholders' equity criterion. Ownership rules and public review of mergers are then related to this figure.
Five billion dollars is too low a definition of large. Five billion dollars in shareholders' equity would not put a company in the top tier globally and it is still much lower than that of major banks. I suggest a minimum of at least $10 billion.
Obviously, there is a limit, and I suggested $10 billion. Part of the problem is a company like my own that is international in outlook and has been for over a hundred years. So I am naturally conditioned by, not only the domestic market, but what goes on elsewhere. $5 billion Canadian is less than three and a half billion dollars U.S. these days and that is a pretty tiny institution when you look around the world.
So that was the reason why I believe the $5 billion is too small. $10 billion I believe starts taking the enterprise into a larger category, whether it be by U.S. dollars or Canadian. (David Nield, November 2, 1998)
Conclusions
The Committee agrees in principle with the Task Force recommendations on ownership rules; that is the Committee favours Canadian control of large regulated financial institutions carrying on business in Canada. Further, there should be a single ownership regime across the regulated financial services sector.
The Committee agrees that there should be three class sizes of institutions: small, medium and large. Small institutions can be closely held, medium-sized institutions must have at least 35 per cent public float. Large institutions must be widely held.
This analysis must also consider criteria for size other than shareholder equity. For example, it may well be that market share of retail deposits for deposit taking institutions, and annual premiums for life insurance companies, is a more appropriate and effective description of class size than shareholder equity.
With respect to the thresholds that define the size groups, however, under $1 billion being small and over $5 billion being large, the Committee heard little evidence. It is, therefore, the view of the Committee that the government develop a clear set of criteria to classify institutions by size.
Further, with respect to the definition of widely-held, while the Task Force gives the Minister the discretion to permit an individual, or group of individuals acting together to own up to 20 per cent of voting shares, the Committee recommends that widely-held mean that no individual or group of individuals acting together, or group of individuals acting together, shall control more than 20 per cent of the voting shares, and shall not own more than 30 per cent of the equity.
The Committee is, therefore, distinguishing between ownership and control and is increasing the percentage of outstanding shares that an individual, or group of individuals acting together, may control. It is, in addition, the view of the Committee that the Task Force recommendations involve excessive use of Ministerial discretion, which creates unnecessary uncertainty in the financial services sector with respect to ownership of regulated financial institutions.
It is the view of the Committee that the 20 per cent threshold will encourage larger shareholders to more closely monitor management, enable 20 per cent shareholders to take advantage of equity accounting rules, and provide added flexibility for mergers and acquisitions, as explained fully in the Task Force report.
2. Widely-Held Rules Satisfied by Co-operative or Mutual Form of Ownership
Background
Canada is almost alone among developed countries in the absence of strong second-tier institutions that can compete with the major banks. The credit unions and caisses populaires are effective competitors in some provinces, but not all. The Task Force believes it is vitally important to encourage strong second-tier institutions. To ensure that the co-operative sector has every opportunity to grow, the Task Force recommends that provision be made for co-operative ownership for deposit-taking institutions, similar to the mutual form of organisation now used for insurance companies. The co-operative form of ownership would allow the formation of new member-owned banks or trust companies. But the Task Force also sees this provision as enabling existing credit unions or credit union centrals, with permission from their incorporating province, to be continued as banks or trust companies. (Report of the Task Force, p. 84)
Task Force Recommendations
36)Businesses organized in the co-operative or mutual form of ownership should be deemed to comply with the widely-held rules by definition and without the need for special exemption, whatever their size.
Views of Witnesses
What little testimony the Committee received on this recommendation was favourable. For example, the CEO of Credit Union Central of Canada, stated that:
In this recommendation, the "widely-held" will allow us greater flexibility in terms of our system responding at the national level and federal jurisdiction in order to operate across the country. (William Knight, October 8, 1998)
Conclusions
The Committee supports the Task Force recommendation.
3. Transition Ownership and Takeover Rules for Demutualized Life Insurance Companies
Background
After demutualization it may take some time for a newly demutualized company and its management team to adjust to the reality of life as a listed public corporation. It may also take some time for the company’s shares to attain full market recognition of value. Many insurance companies that have demutualized in other countries have been granted a transition period during which they have been immune from takeover.
The Task Force believes that the four demutualizing companies provide an important platform to enhance competition in the Canadian marketplace for financial services, particularly with an expanded power to offer payments services. Accordingly, it does not wish to totally constrain business alliances and restructurings during any transition period. It would not, however, like to see any of these companies swallowed up in the early stages of their life as public companies, while their market values may still be adjusting to full recognition of worth. (Task Force Report, p. 85)
Task Force Recommendations
38) In respect of demutualized life insurance companies, they should become subject to the general, size-based ownership regime after a transition period of three years from the date of demutualization. Demutualized companies with shareholders’ equity in excess of $5 billion would have to be widely held and remain so from the date of demutualization. Transition guidelines for the three-year period should assure that all demutualized companies, as a matter of principle, are not subjected to hostile takeover bids or amalgamation proposals. The guidelines should therefore provide that the smaller demutualizing companies should also be widely held for the three-year transition period. The transition guidelines should also provide that, in the normal course, the Minister of Finance should not approve any proposal for merger or acquisition of any newly demutualized company. However, should any demutualized company and its board of directors propose a transaction that, in the opinion of the Minister, is clearly in the public interest and desirable to conclude within the three-year transition period, it should be allowed to proceed.
Views of Witnesses
Witnesses from the mutual life insurance companies supported the transition period. The CEO of Canada Life stated:
I think in the case of mutual companies because we are moving from quite a different corporate structure to a public structure, we do need a time frame to make the move from one to the other for proper value to be determined but, after that, I believe the market should govern. (David Nield, November 2, 1998)
The CEO of Sun Life agreed:
In terms of potential demutualization for a corporation presently operating in a number of markets with 127 years of tradition, demutualization could be viewed as a seismic event and will take some very considerable time to accomplish and to work through. We see the ability to accomplish that successfully as an important short-term reality, where some form of ownership protection will result in avoiding the potential for the policyholders not achieving full value for their policies. (Don Stewart, October 6, 1998)
The CEO of Mutual Life agreed but added that friendly transactions should also be prohibited during the transition period.
The reason that I have argued that the three-year period should prohibit both unfriendly takeover offers or hostile takeover offers and what I would call friendly transactions is because a friendly transaction, a supposedly friendly transaction, can put the directors in a very difficult position, because even though it says the transactions would have to be friendly, if a proposal is put in front of the directors in private that says, If you agree to support this transaction, then we will make public an offer for all of your shares at "X" premium, whatever that might be, and depending on the state of the markets at that particular time and whether or not the markets had recognised the potential value of the company as it was moving to establish itself, the directors could be put in an extremely difficult position. They would be consulting all of the best lawyers to find out what their personal liability was in that circumstance.
So the notion of friendly and unfriendly is, I think, a distinction that is not in fact borne out in practice. So that is why we have come to that view. We have said, we at Mutual have said right from the beginning that we did not believe that the policyholders, who would become the shareholders, should be denied, if you will, the opportunity for the company to enhance the value of its shares through performance or through any alliances or indeed, ultimately takeover offers in the fullness of time.
It was our view, that three years was a reasonable period of time for the shares to reach full value and for the company to find its way and get on its feet, if you will. So that is why we have said right from day one that we did not believe that longer term a converted mutual company should be exempt from the normal rules of the market. That is our obligation as a management team, is to create value for our new shareholders who will start out being the policyholders. So that has been our view.
In the case of MacKay, he has said essentially that, that three years is the transition period. Then after that, the normal rules that apply to all financial institutions should be in place. (Robert Astley, November 4, 1998)
The CEO of Manulife argued for a longer transition period for hostile takeovers but no transition period for friendly mergers among demutualised companies.
In Manulife's case, given the quality of our franchises and the strong potential of our businesses around the world, the reality is that, once demutualized, we — and I believe demutualizing companies — would represent very attractive takeover targets.
The Task Force has recognised that this transformation will require great effort and has recommended a three-year transition period free of hostile takeovers and merger proposals.
However, it is Manulife's view that that is too brief and that a five-year period is required. This would be a more realistic timeframe in which to establish ourselves as a strong, stand-alone public company.
The Task Force further recommends that the ban on merger transactions should not extend to friendly transactions among the demutualized companies themselves. It is believed that a prohibition of such mergers would unnecessarily restrict the industry's ability to consolidate.
Manulife agrees with the Task Force and strongly recommends that mergers between "consenting" demutualized life insurance companies be permitted during any transition period.
At the same time, it should be noted that after the transition period, the Task Force recommendations would allow the takeover of a large demutualized life company by a chartered bank and indeed, the acquisition of one or all of our demutualized companies is easy to predict.
It could be argued that such takeovers would be counter to the vision put forward by the Task Force of independent life insurance industries competing vigorously with the large established banks.
Our idea is quite simple, is that for a period of time post demutualization, and the situation post demutualization is the following, is the day after you demutualize a company like Manulife that is owned by 700,000 people around the world, who did not know that they owned the company, their loyalty to the company, their ability to assess the value of the enterprise, to put a proper price on it, our profile in the investment markets and institutional markets has yet to be created. So we are sitting targets, frankly, for someone who would came along and want to make an offer.
So what we have asked for is that there should be a period of time during which the nearly demutualized company gets a chance to prove itself. We have asked for a five-year period, but beyond a five-year period, after the five-year period, if we have not grown or developed a capability or a franchise that can stand on its own, we are not saying that, no, we should not be part of another institution.
I just wanted to add one other thing to that term. The five-year period that we are asking for is not inconsistent with what is being accorded to other demutualizing entities in other jurisdictions.
Now, let us say we all demutualize and it is three years down the road and all of us are demutualized companies. Right? I mean, the banks have signalled their intention. You will recall that the Royal Bank did make an offer to buy London Life, and if you will bear with me a minute, the reason they did that is because Great West Life was not available and the other four companies could not be bought because they are mutuals, but now they are not mutuals.
So do you think that their appetite for owning an insurance company will disappear? I do not think so. So there will be four potential entities there for them to buy. Our strategy calls for us — I use the Royal Bank, but it could be any bank — our strategy calls for us to buy to a size where maybe we have an opportunity to be autonomous and to be someone who is delivering service to Canadians and competing around the world and competing well. (Dominic D’Alessandro, November 4, 1998)
Conclusions
The Committee is on record as supporting demutualization in a number of previous reports. Further, it has urged the government to act in a timely fashion, which the government has not done. The Committee is hopeful that, with the Task Force recommendations and the support of others such as this Committee, the demutualization process will finally reach a satisfactory conclusion.
Demutualization can only benefit consumers of financial services as the demutualized companies gain the same access to capital markets as other publicly traded companies. This access to capital will enable them to compete much more effectively with other regulated financial institutions in providing expanded offerings to the Canadian consumer at competitive prices.
In addition, participating policyholders will receive shares in the demutualized companies, an unexpected, but no doubt welcome, addition to their stock of assets.
4. Approval of Acquisition of a Widely-Held Institution by a Foreign Purchaser
Background
This is a time of rapid change in the financial services business and it is simply not possible to foresee all scenarios. It is possible to imagine circumstances in which additional flexibility in the ownership policy might be desirable to achieve important national policy interests.
One example might be where a major Canadian financial institution faces financial difficulty that gives rise to serious concerns about its continuing viability. One option would be the combination, by merger or takeover, of that institution with another large Canadian financial institution. That, however, would increase still further the concentration in Canada’s financial sector. In such a circumstance, the Minister of Finance should have the statutory authority to look beyond Canadian financial institutions to find a "white knight," weighing the various objectives of the ownership policy and the need for a competitive marketplace.
Another scenario could be that a Canadian financial institution might be unable, for reasons of capital or other business constraints, to pursue an expansion of its business in Canada even though it might add a vitally important competitive force to Canada’s financial services market. Such an institution might be an attractive candidate for acquisition or significant investment by a widely held financial institution based outside Canada that is interested in expanding operations in Canada. Such an acquisition or investment could be offside the ownership rules proposed above.
In either of these cases, the Minister would want to know if a transaction can be crafted that maintains the benefits of a Canadian controlled financial sector, while furthering objectives of safety and soundness or enhanced competition. We believe the ownership policy should allow such flexibility. (Task Force Report, p. 87)
Task Force Recommendations
39) The Government should have the power, to be used only in exceptional cases, to approve the acquisition of a large widely held Canadian financial institution by a foreign purchaser, free from the impact of the widely-held rules. Any such transaction should be subject to:
(a) the completion of the usual processes for merger approval (i.e., review by the Competition Bureau and OSFI, and Ministerial approval following the completion of the Public Interest Review Process); and
(b) the following additional criteria being met:
(i) the buyer should be a widely held, regulated financial institution approved by OSFI;
(ii) the acquisition should be approved by the Governor-in-Council on the recommendation of the Minister of Finance that the acquisition would be in the Canadian public interest by enhancing competition or competitiveness in the financial services sector or by enhancing the safety and soundness of the Canadian financial services system; and
(iii) enforceable undertakings should be provided by the buyer to the Minister to ensure that the transaction provides its intended benefits to Canada.
Views of Witnesses
There was no comment on this issue and recommendation.
Conclusions
The Committee supports the recommendation of the Task Force.
5. Recategorization of a Schedule I Bank To Be No Longer Widely-Held
Background
The special circumstances of the smaller existing Schedule I banks will also have to be considered. There are three such institutions which are currently subject to the 10 per cent rule but do not have shareholders’ equity in excess of $5 billion, namely the Canadian Western Bank, the Laurentian Bank and the National Bank. The Task Force proposes that these institutions would, in the first instance, become subject to the new widely-held regime (i.e., shareholdings could be increased to the 20 per cent limit with Ministerial approval). However, the Task Force also recognises that these institutions may consider that their business interests would best be served by reverting to the ownership rule that would otherwise apply to them by reason of their size. This would, for example, permit such institutions to pursue business strategies, including alliances with prospective partners, of a different nature and scope than would be the case if they remained widely held.
These somewhat smaller Canadian institutions are promising platforms upon which to build stronger and even more competitive financial service businesses, firmly rooted in Canada. As a result, it is critical that they should have the greatest available flexibility as they consider how and when to reshape themselves. The ownership proposals of the Task Force would, for example, permit one of these institutions to develop a cross-ownership relationship with a commercial entity or foreign institution, or to take advantage of the proposed holding company regime to form an alliance with other mid-sized players in the Canadian financial services sector. They cannot take advantage of these options if they are widely-held. (Task Force Report, Background Paper #2 p. 36).
Task Force Recommendations
40) A Schedule I bank which is subject to the present 10 per cent rule but which would not, by reason of its size, be subject to the new size-based, widely-held regime would initially be subject to the new widely-held rule but would have the right to be recategorized into the class of financial institution, with the resulting ownership rules, which would apply by reason of its shareholders’ equity. This recategorization would require the approval of the board of directors of the bank, confirmed by a special resolution of the shareholders and the approval of the Minister of Finance.
Views of Witnesses
This recommendation received very little comment from witnesses.
The CEO of the National Bank, one of the banks to which this recommendation applies, welcomed the flexibility.
Today, the flexible structure that is proposed, both in terms of structuring the bank and structuring the ownership, could be useful eventually, depending on how events unfold. (Léon Courville, September 29, 1998)
Conclusions
The Committee supports the recommendation of the Task Force.
6. Grandfathering of Institutions Not Conforming to New Ownership Rules
Background
Some institutions currently have share structures and ownership patterns that do not fully comply with the regime proposed by the Task Force for institutions of their size. It would be unreasonable to require those institutions, as a condition of continued participation in the Canadian market, to reshape themselves. Accordingly, it is proposed that in such cases, which are expected to be few in number, the present ownership structures would be grandfathered in terms to be resolved in the enabling legislation. The objective of the grandfathering policy should be to ensure that the present economic value of those institutions and their shareholders is not lessened by the new policy but that, in the long term, steps would be taken so that the institutions would be onside. (Task Force Report, Background Paper #2, p. 34)
Task Force Recommendations
41) A company with share ownership not conforming to the new ownership rules at the time of their introduction should be permitted to continue business without altering its ownership structure, subject to the Minister being satisfied with the quality and substance of the undertakings provided by any controlling shareholder in respect of prudential issues. Such a company should not be permitted by reason of its grandfathered status to acquire an institution that, by virtue of its size, must be widely held. There would be no requirement for the dilution of the share ownership of the control block, whatever the shareholders’ equity of the financial institution might be at any time. A regime should be adopted so that, over time, the nonconforming institution would come into compliance with the ownership regime. Particulars of options which the Task Force suggests should be available to the controlling shareholder follow:
A controlling shareholder wishing to sell its control would have the following options:
1) Subject to Ministerial approval based on the "fit and proper" test, the owners of non-conforming control blocks would be permitted to sell to a single purchaser or group of purchasers even if the transaction did not bring the institution into compliance with (a) the 35 per cent float requirement if it has $1 to $5 billion in shareholders’ equity, or (b) the widely-held requirement if shareholders’ equity exceeds $5 billion. Any subsequent disposition of the control block would be in accordance with one of the mechanisms in paragraph 2 below.
2) In addition to option 1, the controlling shareholder, or a purchaser pursuant to the single transaction exemption contemplated in option 1, could dispose of the control block in any of the following ways:
¨ Share issue to dilute the control block.
¨ Sale to multiple purchasers, which would result in compliance with the applicable ownership principles. As with any other transaction, Ministerial approval would be required for any shareholder to own more than 10 per cent of the shares.
¨ Sale to a foreign or domestic widely held financial institution which is approved by the Minister on the basis that it is a "fit and proper" owner (and without any requirement for the purchaser to provide the undertaking described in option 1).
¨ Sale to a purchaser that has provided a divestiture plan acceptable to the Minister to achieve compliance with the ownership regime.
As a result of these transition provisions, owners of existing control blocks would have a number of ways to maximize the value of their shares in the long term, including the important option of selling to widely held financial institutions which are not Canadian controlled.
Views of Witnesses
To the extent that witnesses commented on this recommendation, they were supportive. The CEO of Canada Trust, however, expressed some reservations.
Experience makes you worry when you try to translate this into legislation. When you try to have general legislation that prevents new players that are not widely held from coming in, but grandfathers others, the devil is in the detail, as the previous speaker said. In the end, you do not provide the degree of certainty about the ownership rules that allows the actors to continue in place.
As I think everyone is aware, investors do not like uncertainty. They leave markets where there is uncertainty. We have a fear that we will not get the kind of grandfathering that would allow Canada Trust and Power to stay in the game. (Ed Clark, October 7, 1998)
Conclusions
The Committee supports the principle of grandfathering those institutions with non-conforming ownership structures, but with a different approach than the Task Force has taken. It is the view of the Committee that an institution should be grandfathered under its current ownership structure for as long as it remains in its current size class. Once it moves into a larger size class, it must conform to the rules of that class. If, for example, Canada Trust or Canada Life were to move from medium-sized financial institutions, to large institutions, they would have to become widely-held.
Further, the Committee recommends that the exemption apply to the existing owner only. The Task Force recommends the exemption be extended to one subsequent buyer. It is the view of the Committee that this compromise introduces unnecessary complexity and adds little value.
Finally, the Committee recommends that the current owner, only, of a financial institution be permitted to exercise all powers granted to other financial institutions in the same size classification, regardless of their ownership
The Committee recognises that profit-oriented financial institutions will adjust to whatever legislative and regulatory regime governs their behaviour. In so doing, they will attempt to maximize the value of their enterprises, given the environment in which they operate. Whenever the environment changes – either because of technological change, demographic change, changes in the preferences of consumers, or changes in legislation or regulations, either domestically or abroad – there will be an impact on the business strategy of the institution and an impact its value.
The fact that all institutions are not identical means that legislative and regulatory change will have an uneven impact on existing financial institutions. Each institution has a unique history which is a reflection of the legislative and regulatory regime in which it was established. Changes in that regime can affect each in a different way.
With respect to the treatment of existing institutions, there are a number of options for policymakers when changes to a regime are to be introduced. One option is simply to require all institutions to conform to the new rules by some given date. This ensures that from that date forward all institutions are treated equally. This practice, however, imposes costs on the institutions affected.
With respect to insurance companies, for example, the new ownership policy could require all existing (non-mutual) large institutions to be widely held by a certain date. Great West, for example, would then be forced to become a widely held institution by that date. This will clearly have a negative impact on the value of that company It would require Great West to undertake a public offering of shares to meet this requirement and "big buyers" would not be among the potential buyers.
Another option is to grandfather existing institutions forever with the respect to the rules and regulations they are currently working under. This can create considerable economic value for the grandfathered institution. In the example just given, it would mean that Great West could continue to have a controlling shareholder forever. Hence, if the current owners are interested in selling their equity, they would have access to a complete range of potential buyers, large and small. This creates an inequity with respect to other companies that do not have access to this option.
There are "compromise" options such as the Task Force has used, giving the current owners the opportunity to sell their equity to a controlling shareholder. This option requires the buyers to respect the widely-held rules should they, subsequently, want to sell their equity. This may reduce the value of the equity to the buyer, and the proceeds of the sale to the existing owners, but by less than option one, which forces immediate conversion to wide ownership. On the other hand, it introduces unnecessary complexity.
As long as institutions are not identical there will always be anomalies in the system that must be dealt with. The task of the policymaker is to ensure that the intent of policy changes are realised without creating unacceptable inequities in the system. Those institutions granted exemptions must balance the net benefits from their exemption with the net benefits they would receive from giving up the exemption.
The Committee’s recommendations strike the appropriate balance.