5 Improving the Regulatory Environment
Highlights The government is acting to make sure that the regulatory environment responds to the evolution of the sector by:
- Improving the governance of the payments system.
- Reducing the reporting burden relating to Canada Deposit Insurance Corporation standards.
- Providing the Superintendent of Financial Institutions with new powers to deal with the potential risks arising from increased competition.
- Streamlining the Office of the Superintendent of Financial Institutions' regulatory approvals process.
Effective prudential regulation protects consumers and minimizes the risk to the financial system. Canada has developed an international reputation for having a safe and sound financial system. In its 1997 Global Competitiveness survey, the World Economic Forum ranked Canada first in terms of the soundness of its banking system.
Canada's regulatory structure is up to date
In order to keep pace with a changing financial sector, the government updated its regulatory regime in successive reviews in 1992, 1996 and 1997. In 1992, cross-pillar ownership was permitted and new in-house and subsidiary powers were conferred on financial institutions. In 1996, OSFI was provided with a legislated mandate, early intervention rules were put in place and the regulatory system was made more transparent. Additional measures to ease the regulatory burden were introduced in 1997. Taken as a whole, these reviews served to significantly lessen the regulatory burden on the sector in order to reap the benefits of increased competition.
Nevertheless, in this era of rapid change and global competition, the government must continually consider what regulatory changes are needed to ensure soundness and increase effectiveness. This is a complex exercise because, while pursuing enhanced competition, innovation and the protection of consumers, the government must never lose sight of the need to maintain the safety and soundness of the financial system.
To that end, the government will make changes in a number of areas. The governance of the payments system will be improved, regulatory overlap will be reduced, regulation will be adjusted to adapt to an environment in which the importance of competition has increased, and application processes will be streamlined.
Governance of the Payments System
An important aspect of the 1996 payments system review was the governance of the Canadian Payments Association (CPA) and other private payments system such as Interac, credit card and electronic cash systems.
Currently, the members of the CPA are responsible for the Association's day-to-day decision making. With the exception of the Board's chairperson, who is a senior official of the Bank of Canada, CPA directors are elected by the membership. The government's oversight is limited to the approval of its by-laws. The Bank of Canada has oversight responsibilities and enforcement powers over systems that it designates under the Payment Clearing and Settlement Act, such as the Large Value Transfer System operated by the CPA. The oversight and its associated enforcement powers require the Bank of Canada to ensure that appropriate arrangements are in place in these systems to contain systemic risk. Payment card associations such as debit card service providers, credit card service providers and electronic money providers are not currently subject to direct oversight by a financial regulator. However, Interac operates under a Consent Order of the Competition Bureau.
In the course of the payments system review, it emerged that the CPA suffered from a perception that it was a closed group of financial institutions, not necessarily guided by broad public interest considerations but by the interests of its members. That is, the CPA did not take into account the public policy objectives of efficiency, safety and the consideration of consumer interests. The government believes that this issue can be resolved in part by expanding access to the payments system as proposed, and also with increased public input into the system, through an improved governance structure.
In order to improve the governance structure of the payments system, the government will make a number of changes:
The payments system should evolve in a manner that takes the broader public interest into account
The CPA Act requires the CPA to "establish and operate a national clearings and settlements system and to plan the evolution of the national payments system."1 The mandate will be clarified to better define the Association's role in the payments system and to establish its responsibility to advance the public interest. Moreover, the CPA will be required to facilitate rather than plan the evolution of the payments system.
- The CPA Board will be expanded from 11 to 15 members. The Board will consist of 11 CPA members (5 bank, 6 non-bank), 3 independent directors and 1 director from the Bank of Canada.
Independent directors will be appointed by the Governor in Council on the recommendation of the Minister of Finance. In order to provide a balance between Direct and Indirect Clearers, while recognizing their different roles in the payments system, the government is proposing that there be no more than four Direct Clearers on the Board from each of the bank and non-bank groups. In total, Direct Clearers other than the Bank of Canada can hold a maximum of 8 of the 15 positions on the Board. As is now the case, the director appointed by the Bank of Canada will serve as Chair of the CPA.
- The Stakeholder Advisory Council (SAC) will be enshrined in the CPA Act.
The CPA established SAC in 1996 as an 18-member group to advise the Board on the payments system from the perspectives of a variety of interest groups. All but 3 members are drawn from outside the CPA. While this voluntary forum has been very useful, it could be enhanced if it were supported by a legislative requirement within the Act.
- The Minister of Finance will have a maximum of 30 days following receipt of a new or amended CPA rule to disapprove it, if it is found contrary to the public interest.
The Superintendent of Financial Institutions is responsible for making examinations of and enquiries into the business and affairs of the CPA, and for reporting annually to the Minister of Finance on whether the Association is operating in conformity with its Act and by-laws. Based on a review of this role and the governance regime proposed in this document, this examination would no longer be necessary.
Therefore, the Superintendent will no longer be required to perform an examination of and report annually on CPA activities.
- The use of electronic payments systems is growing rapidly. This provides benefits to Canadian consumers and businesses. However, should these new systems evolve in a manner or to an extent that they become a critical element of the payments system, and a broader public interest arises, then some oversight responsibility would be appropriate.
Therefore, the Minister of Finance will be given the authority to designate other payments systems for oversight.
- The Minister of Finance will have the power to issue a directive to the CPA and other designated systems to require a change in a by-law, rule or operating practice which the Minister determines to be contrary to the public interest. New by-laws, or changes to existing by-laws, that result from a directive would be subject to Governor in Council approval.
Such a directive power would ensure that the policies, by-laws and rules of the CPA and other designated systems are consistent with public policy objectives.
These changes will address the public interest issues raised during the review process while ensuring that Canada's payments system maintains its dynamism.
Consumer Compensation Plans for Deposits and Insurance Policies
The Canada Deposit Insurance Corporation (CDIC) is a government-backed consumer compensation scheme for federally and provincially regulated deposit-taking institutions. The Canadian Life and Health Insurance Compensation Corporation (CompCorp), the consumer compensation scheme for life insurers, does not have government backing. The life insurance industry has recommended that government backing be extended to CompCorp as a way of levelling the playing field. The Task Force reviewed this issue as well and recommended that CDIC and CompCorp be placed on an equal footing.
CDIC and Compcorp The Canada Deposit Insurance Corporation (CDIC) insures deposits at banks, other federally incorporated deposit-taking institutions and some provincial trust companies. CDIC's board comprises several senior public servants and private sector members appointed by the Governor in Council. The Corporation has the power to inspect its members and, in some circumstances, to take control or acquire the assets of a member institution. As a Crown corporation, CDIC obligations are guaranteed by the government. Since 1996, a credit enhancement fee has been applied to any new borrowings to bring CDIC's cost of debt in line with that of a private sector organization.
In contrast, the Canadian Life and Health Insurance Compensation Corporation (CompCorp) is a private, non-profit corporation established by the life insurance industry to protect life insurance policyholders against the loss of benefits in the event of insolvency. Its board is composed solely of independent directors. It has no regulatory responsibilities and no power to step in over a troubled member institution. CompCorp can borrow from the private sector and from member life insurance companies, but it cannot borrow from the federal treasury.
The government has reviewed this issue on a number of occasions and continues to be of the view that the extent of government backing for compensation schemes of the deposit-taking and life insurance industries does not need to be identical. Deposit insurance is provided to protect the general public against systemic risk. Although life insurance companies may increasingly offer products that compete directly with deposits, only deposit-taking institutions are subject to developments that could lead to system risk issues.
Streamlining Canada Deposit Insurance Corporation Standards
CDIC standards will be updated and streamlined
The Public Accounts Committee, industry groups and others have called for a clarification in the respective roles of CDIC and OSFI to avoid unwarranted duplication in the regulatory system. As the deposit insurer, CDIC engages in a broad range of activities in order to minimize its exposure to loss. Some of these activities may overlap with those undertaken by OSFI. The Task Force focused on CDIC's Standards of Sound Business and Financial Practices, and proposed that the regulatory regime would be more streamlined if the application of these standards were the responsibility of OSFI.
CDIC's Role CDIC's mandate is to provide deposit insurance, promote standards of sound business and financial practice, and to contribute to the stability of the financial system, for the benefit of depositors while minimizing its exposure to loss. To that end, CDIC annually requires its members to attest, through a self-assessment report filed with CDIC, that they comply with the Standards of Sound Business and Financial Practices in CDIC's by-laws. Currently, there are eight standards, published in 1993, which relate to management of liquidity, interest rate risk, credit risk, real estate appraisals, foreign exchange risk, securities portfolio, capital and internal controls. CDIC provides its members with a booklet of commentary and guidelines on each by-law.
CDIC's standards have been in place for six years, and it is timely to review their role and impact. CDIC and OSFI are consulting with the industry on the possibilities for streamlining the standards.
In addition, CDIC commissioned the Regulatory Advisory Services Group at PricewaterhouseCoopers to assess the effectiveness of the CDIC standards and make recommendations in response to the Task Force. The report indicates that the standards are universally recognized as an effective tool and should continue to be set and administered by CDIC.
The PricewaterhouseCoopers report concluded that there is little or no overlap between CDIC standards and OSFI guidelines, although they may deal with similar subjects. However, the report also concluded that some of the standards need to be modernized and the process for reporting on compliance could be made less burdensome.
The standards by-laws will remain at CDIC and will be updated. A number of changes will be put in place to streamline the associated administrative processes. For example:
- The standards will be reviewed to align more closely with current concepts of risk management.
- The frequency and detail with which compliance must be reported will be reduced in many cases. Institutions that are highly rated for supervisory and deposit insurance purposes will generally not be required to file comprehensive reports every year. For all institutions, it will be made clear that compliance is to be assessed relative to the broad principles in the standards by-laws, and that the booklets are intended to be a source of commentary and guidance, not a detailed code.
- CDIC's opinion on whether an institution is following the standards should take into account the significance of any deficiencies, and non-material deficiencies should not necessarily be viewed as non-compliance. The statutory requirement imposed on examiners (OSFI for federal companies) to provide CDIC with standards compliance reports (section 29 of the CDICAct) will be amended to address this materiality concept.
- CDIC and OSFI will enhance their co-ordination and information-sharing in order to reduce the reporting burden on institutions.
In addition to the legislative change required to implement these initiatives, most of the revisions to administrative mechanisms will be put in place by December 31, 1999.
Preserving Safety and Soundness in the New Environment
In striking a balance between increased competition and the potential for greater risk in the financial services sector, an efficient supervisory and regulatory framework should provide appropriate incentives for financial institutions to manage their risks prudently.
In 1996, the government introduced an early intervention policy with three main components: 1) a legislated mandate for OSFI that recognizes the need for prompt action by the supervisor and by the institution to resolve problems; 2) Guides to Intervention that make clear to institutions the actions the supervisor will take if the financial condition of an institution deteriorates; and 3) the power to close a troubled institution while its capital is still positive, i.e. before it becomes insolvent. The government is committed to the principal of early intervention as a means of preserving the safety and soundness of the financial services sector.
In support of the initiatives to promote greater competition in the financial sector, the Superintendent of Financial Institutions will have additional supervisory powers to deal with the potential for increased risk in the system.
There is a balance to be struck between increased competition and the potential for greater risk
These powers would increase the consequences for any institution that fails to meet certain regulatory or supervisory requirements. In particular, the following measures are proposed:
A new authority that would allow the Superintendent to remove directors and senior officers from office in certain circumstances, such as instances of misconduct. A system of administrative money penalties for financial institutions and individuals that fail to comply with undertakings and cease and desist orders, or violate financial institution legislation and regulations. Measures to enhance the Superintendent's power to deal with related party transactions of financial institutions. These measures will support the early intervention regime, the thrust of which is to prevent undue losses to policyholders and depositors.
Streamlining Regulatory Approvals
Federal financial institutions are required to obtain approval from the Minister of Finance or the Superintendent of Financial Institutions before they can complete certain transactions and business undertakings. This approval process helps to maintain the safety and soundness of the financial system and ensures that the activities of the financial institutions are in the public's best interest.
The government is aware that this approval process can be burdensome, which is why several legislative changes have been made over the past few years in an effort to streamline this process. In 1992, financial institutions were provided with broader in-house and subsidiary powers. In 1996, OSFI was provided with a legislated mandate, the entire regulatory system was made more transparent and an early intervention regime was established. In 1997, the regulatory burden was further eased and consumer protection was improved.
New streamlining opportunities are continually being explored and, as part of this ongoing initiative, OSFI will introduce a new notice-based approval process for many of those transactions currently requiring the approval of the Superintendent.
Under this process, instead of applying for regulatory approval, institutions will file a standard notice with OSFI. There will be a maximum 30-day period for the Superintendent to raise concerns, seek further information or indicate that there will be a delay. If none of these actions are taken, the transaction will automatically proceed. This change is intended to reduce the burden associated with smaller transactions that do not raise prudential concerns.
In addition, in some cases, institutions will need to obtain several approvals under the various financial institution acts in order to complete a single transaction. Mechanisms to permit blanket approvals in such circumstances will be developed in order to streamline the regulatory process.
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