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1. Introduction

(a) 1992 Reforms

The Government completed in 1992 far-reaching changes to the Bank Act, the Trust and Loan Companies Act, the Insurance Companies Act and the Cooperative Credit Associations Act. A new framework for competition was created by reducing barriers among the four financial pillars. Because of the scope of these reforms, it was decided that the federal legislative framework would be re-examined within five years rather then the usual ten, and sunset clauses require Parliament to enact new legislation by March 31, 1997.

(b) The Current Review

The Department of Finance began its current review by undertaking extensive consultations with the financial sector. On June 19, 1996, it released the White Paper entitled "1997 Review of Financial Sector Legislation: Proposals for Changes". The public was given until August 30, 1996 to make submissions. The House of Commons Finance Committee then held public hearings in Ottawa from September 19, 1996 through October 1, 1996. This Report is based on what we learned from the 35 witnesses who appeared before us, the 50 written submissions we received, and our own studies and consultations.

The Committee fully expects that our Report to Parliament will not be the final word on what the 1997 legislation should be. The Standing Senate Committee on Banking, Trade and Commerce will report on its hearings on the White Paper. We anticipate that our Report will generate further submissions to the Secretary of State for Financial Institutions, the Honourable Doug Peters, and our Committee. All those who have continuing concerns will be welcome partners with us in attempting to improve on our recommendations. Because of the complexity of the issues, the Committee recognizes that it is only with the active and ongoing collaboration of the financial sector and others that the best possible legislation will be crafted. The Committee welcomes continuing input regarding the 1997 legislation, both prior to its tabling in Parliament later this year or early in the next, as well as during the hearings before our Committee after the House of Commons will have passed second reading of the new bill.

(c) Summary of Changes to the White Paper

The Committee heard that major reforms of 1992 were working well and that the government was to be commended for the open and comprehensive process under which the 1997 reforms are being developed. The White Paper proposals were regarded generally with favour, as our report indicates. The Committee is, nevertheless, recommending a number of the changes to the White Paper proposals, the principal among which are the following:

(d) Future Reforms

The White Paper did not deal with a number of critical issues affecting the financial services industry. The budget of March, 1996 announced that the current review would not deal with the issue of whether banks could sell insurance through their branches. The Task Force on the Future of the Canadian Financial Services Sector will look at the structure of the industry and the roles played by its various members. Its task is to ensure that Canada has an efficient, secure and competitive financial sector for the 21st century, one that will promote growth, opportunities and jobs for Canadians. As well, it will receive recommendations from the Department of Finance Advisory Committee on Canada's Payments System, which will consider questions such as new members, access, competition and innovation.

The work of the Task Force along with that of the Advisory Committee, will help to set the stage for the next round of amendments to Canada's financial institution legislation, scheduled for no later than March 31, 2002. The Committee looks forward to the opportunity to participate with the government, financial services industry and Canadians in dealing with the complex but important issues that lie ahead.

2. Strengthening Consumer Protection

(a) Privacy Safeguards

Since financial institutions undertake such a wide range of services either directly or indirectly through their subsidiaries, they have access to a vast range of private information. They can have records of a client's income, wealth, debt, taxes, and investments. Records on precise expenditures can be obtained from credit cards and chequing accounts. Health records are part of life insurance, and insurers can now be owned by banks. As well, financial institutions which undertake data processing, document processing or payroll services for third parties have detailed information about individuals who are not even their direct clients. As financial institutions continue to expand their business activities, the greater becomes their access to information concerning each one of us.

The Government recognizes that the protection of personal information is of utmost importance. The White Paper states that "consumers must know why information is collected and how it will be used and stored". Consent is key if information is to be used for a new purpose or disclosed to outside parties. The Government also understands that consumers want access to information held about them, and rights of recourse if information is misused."

The Committee received no evidence involving the abuse of private information by a financial institution. The potential for abuse, however, is enormous and the need to deal with privacy concerns was unquestioned. For example, Mr. Jim Burnes of Power Financial Corporation pointed out that there is currently no legislative prohibition respecting the flow of customer information between a bank and its subsidiaries.

In dealing with this complex and important issue, the Government recently announced that it is developing proposals for a legislative framework to protect personal data. Meanwhile, it wishes to use this current review to implement regulations governing the collection, use, retention, and disclosure of customer information by federal financial institutions.

Two contrasting approaches emerged in testimony before our Committee. One was that put forward by Canada's Privacy Commissioner, Mr. Bruce Phillips, and the Consumers' Association of Canada. They urged that regulation should include a mechanism for enforceability, legislated sanctions for failure to comply, and oversight by an independent third party. The second was that put forward by the Government in the White Paper and supported by the financial industry, which recommends the CSA code as a minimum standard for institutions in formulating their own codes of conduct. The White Paper approach therefore involves a greater degree of self-regulation than does the first approach favoured by Mr. Phillips and the Consumers' Association of Canada.

The Canadian Bankers Association and the Insurance Bureau of Canada have already developed codes of conduct based on the Canadian Standards Association (CSA) model. The Consumers' Association of Canada applauded the White Paper's call for using the CSA model code as a minimum standard. The CSA code provides that information must be used only for the purpose for which it is collected. It stresses that customer consent be obtained for the collection, use, and transfer of information.

In meeting the challenges of protecting consumer privacy, the Committee does not have evidence of actual abuses before it sufficient to justify a full regulatory regime with prescribed penalties at this time, but does believe that the provisions in the White Paper for a self-regulated regime should be strengthened.

Accordingly, the Committee recommends, as set out in the White Paper, that the Government introduce regulations requiring all federally regulated financial institutions to:

Like the White Paper, the Committee recommends that financial institutions be encouraged to use the CSA code as a minimum standard in formulating their codes of conduct.

The Committee further recommends, however, that a Consumer Protection Bureau (CPB) be formed reporting to the Minister of Industry, who is responsible for consumer affairs. Customers who believe their complaints have not been dealt with adequately by the financial institution concerned shall be informed of their right to complain directly to the CPB and the CPB shall report to Parliament on such complaints. In the event the regulatory regime as proposed herein should prove inadequate to protect customer privacy, stronger measures should be considered, including the use of regulation making authority by the Government.

The Committee recommends that the above proposals to protect the privacy rights of financial institution customers be enacted immediately. The issue of the market power that financial institutions derive from the massive amount of data and information available to them is one that should be considered by the Task Force.

(b) The Cost of Basic Financial Services

Institutions charge different fees for financial services such as cheques, withdrawals, bill payments through ATMs, overdraft privileges, returned cheques, credit cards, etc., as well as a variety of "no frills" accounts. The Committee recognizes that such competition is beneficial to consumers, providing that they can readily compare the cost of the services they need, but this may often be difficult.

Accordingly, the Committee encourages the Government to work with banks and trust and loan companies, as well as with provincially regulated financial institutions, to simplify and improve the disclosure of fees to facilitate the dissemination of such information to customers.

(c) The Availability of Basic Financial Services

Some low-income individuals can have difficulty accessing basic financial services such as opening accounts and cashing cheques. L'Association coopérative d'économie familiale du Centre de Montréal testified that approximately three per cent of adult Canadians do not have a bank account and this number exceeds five per cent in British Columbia and the Maritimes. Eight per cent of adults living in households with annual income under $25,000 do not have basic accounts. They attribute this in part to the cost of banking services, but more importantly to identification requirements and to the fact that funds in bank accounts can be seized by creditors.

The Committee was offered no readily apparent solutions with respect to how financial institutions might verify the identity of individuals who may not have either a credit card or driver's license, nor with respect to the issue of whether welfare or other support payments should be exempt from seizure by certain creditors. While the latter issue is probably beyond the scope of federal jurisdiction, the Committee is confident that identification problems can be resolved in a way that allows better access to banking for low income Canadians and protects the institutions against fraud.

The financial services community is aware of these problems and discussions are being held to address them. Pilot projects have been undertaken in Toronto and Montreal involving the electronic deposit of welfare cheques in accounts tailored to the needs of low income individuals. If successful, these practices could be extended across Canada and perhaps expanded to include other support payments such as alimony and employment insurance.

Another aspect of access involves the need to have banks in smaller communities. Even with the new technologies, many individuals need someone "they can talk to". While the Committee believes that the presence of a bank branch or other such institution in every community is highly desirable, we recognize that unprofitable branches will be closed. Competition among two or more institutions in a community large enough to support only one may not necessarily be in the interest of either those institutions or their customers if the alternative is no institution.

The Committee recommends that the Government continue to work with consumer and community groups as well as financial institutions to develop and implement ways to improve access to financial services for low-income Canadians.

(d) Cost of Credit Disclosure

As part of the Internal Trade Initiative, the federal and provincial governments have reached an agreement on a harmonized regime for legislation dealing with the cost of credit for consumers. Once implemented, this regime will lead to enhanced and uniform disclosure practices across the country. These efforts were strongly supported by groups who appeared before us, including the Canadian Real Estate Association, the Consumers' Association of Canada, and l'Association coopérative d'économie familiale du Centre de Montréal.

The Committee recommends that harmonized disclosure practices should be continued and that they should include the actual annual interest rate on all lending contracts, including mortgages. In addition and as mentioned below, all mortgages should disclose whether prepayment is an option, and if so, the penalty entailed.

The Committee understands that the federal-provincial working group on the cost of credit disclosure considered legislating the format of disclosure, including whether certain items should be in large font or in bold. It was felt, however, that there are many important disclosure items and that it would be inappropriate to legislate that some must be more prominent than others. While the Committee bows to the experience of the working group, it still questions whether the interest rate and prepayment provisions might not be given greater prominence.

(e) Tied Selling

Tied selling occurs when a vendor requires a customer to purchase one product or service as a condition of purchasing another one. As the White Paper points out: "(c)oncerns have been raised that the special nature of the relationship between financial institutions and their customers renders their customers especially vulnerable to coercion and that market forces and the Competition Act may not provide sufficient safeguards for these consumers."

The Committee is concerned that tied selling must not be confused with cross selling. Cross selling, in essence, involves offering a lower price for a particular product or service if the customer agrees to purchase another product or service. Non-coercive cross selling may actually result in savings to customers who often find package sales attractive. As well, banks may find it worthwhile to make small business loans only if other services to that customer are part of a package, and the Committee does not wish to discourage lending to small business. It is not always a simple matter, however, to distinguish between tied selling and cross selling.

The Independent Investment Dealers Association brought three specific cases of alleged coercive tied selling by banks before the Senate Committee on Banking, Trade and Commerce. The Canadian Bankers Association has disputed that these cases involve tied selling. Without investigating the details of each case, the Committee cannot judge their merits. Suffice it to say, however, the Committee remains concerned about the possible abuse of power by not only banks but by all financial institutions and insists that their customers not be subjected to abusive practices involving tied selling.

The Competition Act currently prohibits tied selling by

The Committee does not believe that any of its concerns about the tied selling of financial services can be dealt with by the Competition Act prohibitions since undue pressure on an individual customer would not meet the test of substantially lessening competition in that market. Accordingly, arguments to the effect that the Competition Act can resolve this Committee's concerns about tied selling are specious.

In addition to the Competition Act prohibitions against tied selling, section 416(5) of the Bank Act states as follows:

The Committee received representations from both the Canadian Bankers Association (CBA) and the Independent Investment Dealers Association (IIDA) on this provision.

The IIDA asked that section 416(5) be amended to read as follows:

The CBA objects to the use of the word "pressure" as it currently applies, and to the expansion of its prohibition beyond "insurance for the security of the bank" to "any financial product or service".

The Committee shares the concerns of the CBA that the word "pressure" is not defined and that many aspects of selling can involve an element of pressure. As stated by the Consumers' Association of Canada, what is important is that the pressure not be undue or coercive. The Committee therefore recommends that section 416(5) of the Bank Act be reconsidered with a view to reflecting that it is not just any pressure, but only undue or coercive pressure, that amounts to unacceptable behaviour.

Secondly, the Committee recommends that the prohibition in section 416(5) of the Bank Act against undue or coercive pressure should apply to the provision of "any financial product or service" and not just "insurance for the security of the bank". There is no reason why such pressure should be permitted in any instance.

Thirdly, the Committee recommends that a provision similar to section 416(5) of the Bank Act as amended above apply to all federally-regulated financial institutions. Undue or coercive pressure should not be prohibited only among banks. Recognizing the possibility that constitutional issues might arise, the Committee recommends that the Government undertake discussions with the provinces with a view to obtaining this protection for customers of all financial institutions.

Fourthly, the Committee recommends that financial institutions would be required to:

Fifthly, the Committee recommends that customers who believe their complaints have not been dealt with adequately by the financial institution concerned shall be informed of their right to complain directly to the Consumer Protection Bureau (CPB) under the Minister of Industry, and the CPB shall report to Parliament on such complaints.

Sixthly, in the event the largely self-regulatory regime proposed herein proves inadequate to protect customers against undue or coercive pressure from tied selling, stronger measures should be undertaken.

Lastly, the Committee recommends that officials study the laws and jurisprudence in other jurisdictions to assist in determining more precisely the difference between tied selling and cross selling. For example, section 106 of the 1970 Bank Holding Company Act of the United States spells out in some detail the instances of activities of banks that are not considered to be tied selling and which are therefore presumably for the benefit of consumers. Various provincial laws dealing with this issue might also prove helpful.

(f) Right To Prepay Mortgages

The Interest Act provides that ordinary home mortgages with terms of over five years can be prepaid after five years with a penalty of three months' interest. CMHC insured mortgages of three or more years can be prepaid after three years, with a three month interest penalty.

A homeowner may wish to prepay a mortgage to try to take advantage of lower interest rates but may also be forced into this position because of changed circumstances such as insolvency, marital breakdown, or job relocation. As well, prepayment penalties vary widely among lending institutions.

The White Paper proposes consideration of legislating mortgage prepayment rights and maximum penalties. The Canadian Real Estate Association and the Consumers' Association of Canada are in favour of such legislation. The Canadian Bankers Association and the Canadian Life and Health Insurance Association object to any further legislated rights of prepayment according to a standardized formula. They assert that the mortgage market is currently highly competitive, and a standardized formula could lead to higher interest rates on mortgages and would make it more difficult for the lender to match the assets against their liabilities in a prudent fashion. The CBA suggested that the current legislated prepayment regime for mortgages over five years may result in higher interest rates than would otherwise be charged, fewer long-term mortgages, or both.

The main concern of the Committee is that a homeowner, when taking out a mortgage, may not realize that there is no right of prepayment and has no way of determining in advance what the penalties may be imposed. Accordingly, the Committee recommends that all future home mortgages contain a clause, prominently displayed, stating either that no prepayment right exists except on terms that may be agreed upon or else setting forth the terms on which prepayment will be possible. The presence or absence of a prepayment right will then be a question of negotiation between the lender and a hopefully informed borrower, and may mean that other terms such as the interest rate penalty can be the subject of competitive negotiation.

The Committee recognizes that mortgages without a prepayment provision may subject homeowners to hardship in cases such as moving, bankruptcy, or divorce. Hopefully, better disclosure might help avoid some such cases. The Committee does not consider, however, that it has sufficient information to recommend a legislated prepayment regime for mortgages with terms of less than five years at this time. It therefore recommends that the Government study this issue further with a view to protecting mortgagees, promoting competition among lenders, and ensuring fair rules for both lenders and borrowers.

3. Easing the Regulatory Burden

(a) Overlap and Duplication between Federal and Provincial Regulation

The White Paper specifically mentions three areas in which discussions are ongoing to reduce overlap and duplication between federal and provincial regulation of financial institutions.

The first area is with respect to the regulation of loan and trust companies. While discussions will continue, some progress has been made and the Government will amend the Trust and Loan Companies Act to include a harmonized definition of a "commercial loan". The Committee encourages further efforts with the provinces at harmonization.

The second area of ongoing efforts to harmonize is with respect to securities regulation. Securities are currently subject to thirteen regulatory jurisdictions, a ridiculous burden in a country of only thirty million people. The Committee encourages the Government to continue its efforts to work with interested provinces to develop a Canadian Securities Commission. While some provinces may not be willing to join in at this time, the benefits from even partial harmonization are substantial. It would help promote more efficient capital markets, reduce the cost of distributing securities, and enhance the competitiveness of Canadian companies.

Thirdly, the Government is prepared to explore with provincial governments the possibility of ending overlap and duplication in the field of credit unions. The federal Government currently regulates the Credit Union Central of Canada (CUCC), as well as six of the seven provincial credit union centrals registered under the Cooperative Credit Association Act. Quebec regulates the caisses populaires in Quebec. The federal Government indicated in the White Paper its willingness to withdraw from regulating the six provincial credit union centrals.

The CUCC appeared before the Committee and urged, however, that the federal Government continue its regulatory role in this area because federal withdrawal could, among other things, mean a loss of access by provincial centrals to the liquidity loans provided by the federal Government through CDIC. Accordingly, the Committee recommends that discussions continue, but that its withdrawal from regulation of provincial credit union centrals not be undertaken until such time as agreed to with the CUCC.

Property and casualty insurance brokers and agents are regulated and licensed provincially, subjecting them to twelve different regulatory regimes. They are also subject to privacy acts in Quebec and British Columbia. The Insurance Brokers Association of Canada (IBAC) proposes establishing a working group to attempt to harmonize the different provincial and federal laws. The Committee commends IBAC for its efforts at harmonization.

(b) Self-Dealing Regime

As financial institutions have been permitted to expand their powers and links to other institutions, the possibility of abuses arising from self-dealing among related parties has increased. The 1992 reforms regulated such behaviour requiring that each financial institution establish a Conduct Review Committee that must approve almost all transactions among related parties. The current definition of a related party (i.e. a person considered to be in a position of influence over the institution) is considered too broad since it may include several thousand individuals in a large institution. Accordingly, the Government has proposed to narrow the definition of related parties to include only the most senior officers, and to relax the rules with respect to subsidiary corporations.

The Canadian Life and Health Insurance Associations and Schedule II banks consider that the proposals would still leave the self-dealing regulations too onerous. As well, Deutsche Bank Canada asks that the proposed self-dealing regime be eased for dealings between Schedule II banks in Canada, their Canadian affiliates and their foreign parents. This would ease the regulatory burden if Deutsche Bank were no longer required to own its securities dealer affiliate directly, as is proposed below. The Committee encourages the Government to continue its discussions with these parties in an effort to ensure that while the abuses from self-dealing are proscribed, the regime is not unduly onerous. In addition, the Committee would welcome the advice of the Senate Standing Committee on Banking, Trade and Commerce, which has already undertaken significant studies in this field.

(c) Subsidiary Requirements

At present, financial institutions can engage in certain businesses only indirectly through subsidiaries. This requirement is to both separate core activities and to contain risks, but it causes unnecessary administrative burdens, including the management of tax losses.

The Committee agrees with The White Paper proposal and recommends that financial institutions be permitted to carry on venture capital financing for small business in-house. Administrative barriers to the undertaking of more venture capital activities should be removed, including the need to sell such investments within 10 years. The proposal to permit holdings for up to thirteen years is reasonable. As well, losses incurred through such operations should be deductible against other income for tax purposes.

The White Paper also proposed that financial institutions be permitted to do information processing in-house. The Committee agrees with this proposal, subject to its concerns about privacy rights as set forth above being respected. In-house information processing should not be a means for accessing information or data not otherwise available.

(d) Deposit Insurance Opt-Out

The Committee received no objections, and recommends that the Government proceed with the White Paper proposal "to allow financial institutions that do not take retail deposits to `opt out' of CDIC coverage, provided they are not affiliated with another CDIC member." Those institutions which would most likely seek exemption from CDIC are foreign banks.

The Committee agrees with the White Paper proposal that, in designing the exemption regime, the uninsured status of deposits with exempt institutions must be made clear and appropriate transitional measures be adopted.

The White Paper suggested that exemptions might be granted "on the basis of the size of the deposit (e.g., over $200,000); the type of depositor (e.g. corporation, non-resident) or some combination of these two criteria." Officials are currently discussing with interested parties what the precise terms for exemption from deposit insurance should be.

The Committee recommends that such discussions continue, and is confident that a regime for exemption can be arrived at which will protect those depositors who might otherwise look to the exempt institution for insured deposits.

Since CDIC membership is a requirement for membership in the Canadian Payments Association (CPA), opting out of CDIC would mean a loss of CPA membership. The Committee does not believe this result was intended, and consideration should be given to grandfathering CPA membership for those who do opt out of CDIC, or to allow CPA membership for those who, but for the opt-out, would be eligible for CDIC coverage.

(e) Foreign Bank Entry Regime

(i) Overall Regulatory Regime

The White Paper proposes to establish two types of regulatory regimes for foreign entities doing business in Canada namely, a fully regulated regime for foreign banks doing banking in Canada and a non-regulated regime for foreign non-bank entities whose Canadian financial activities do not involve the full range of banking activities ("near banks").

Regulated banks would include those foreign entities which are regulated as banks in their home jurisdiction and for whom banking services constitute a large portion of their operations. They would be permitted to provide services in Canada only through subsidiaries which are federally regulated financial institutions.

This means that they would be required to be federally regulated financial institutions as at present, incorporated in Canada, with a minimum capital of $10 million, and strict regulatory requirements including separate board committees, independent directors and reporting requirements.

Near banks would be those foreign entities which are not regulated as banks in their home jurisdiction, do not take deposits, do not resort to retail funding by taking deposits in Canada, but provide one or more banking-type services such as lending. They would not be federally regulated as financial institutions, but their initial entry into Canada would require federal regulatory approval.

At present, whether a foreign entity must become a federally regulated financial institution or not is determined on an ad hoc basis. Foreign banks are generally prohibited from carrying out banking activities in Canada, although they may undertake such activities by establishing a Schedule II bank. The Bank Act does, however, contain a number of provisions by which the general prohibition is subject to ministerial discretion. These have been used in the past to allow foreign banks to engage in limited activities in Canada. The White Paper removes these options.

The Committee agrees with the desirability of establishing a consistent legislative framework for dealing with regulated banks and near banks wishing to offer financial services in Canada. It also agrees, as proposed in the White Paper, that it is desirable to de-regulate the regime for near banks not in the deposit taking business. Where the Committee has concerns with the White Paper approach, however, is with the fineness of the net that has been cast, hauling into the regulatory hold many activities for which there is little or no rationale for such fate, including some activities carried on in Canada today which are quite properly not currently subject to full regulation.

The Committee heard testimony on specific examples of activities that would be brought under the regulatory regime, without any apparent rationale or need therefore. Each one of these cases involved an entity that was a bank or was owned directly or indirectly by a foreign bank, but which carried on only limited financial or other activities in Canada. If the "bank connection" were not there, they would have fallen under the non-regulated or near bank regime because the White Paper differentiates between regulated and non-regulated entities based on their ownership and not on the activities carried on in Canada.

Examples of such entities which cause the Committee difficulty in accepting the White Paper proposals were the following:

This U.S. bank wants to carry on in Canada the business of providing small business loans up to $75,000 at interest rates ranging from 1.75 to 8 percentage points over prime. These loans would be financed from U.S. sources and booked in the U.S. Under the White Paper proposals, it could not conduct such activities unless it were to establish a federally regulated financial institution in Canada.

All witnesses before the Committee agreed that competition in the provision of such financial services to Canadians was to be welcomed. The Committee does not believe it should be necessary, in most of these cases or similar examples, to require the limited Canadian financial activities to be carried out through a federally regulated financial institution that is subject to the full regulatory regime. Since no deposits are taken in Canada, there is no need to protect depositors.

As a result of these cases, the Committee believes that two options are open to the Government. One option would be to determine precisely what activities in Canada must be regulated and then deregulate all others, regardless of whether they are carried on directly or indirectly by a bank. A second option is to create a third category of foreign institutions, called "Limited Purpose Foreign Banks", which would lie between the regulated model applying to foreign banks that wish to provide a full range of financial services in Canada and take retail deposits and the deregulated system applying to foreign near banks.

The first option of dismantling the current regulatory regime based on ownership rather than the activities carried out in Canada would require a great deal more study. Would a new regime based on activities rather than ownership apply only to foreign banks or to domestic banks as well? Since the Committee believes that the five above mentioned entities as well as similar entities should be allowed to carry on their activities in Canada immediately without being brought under a full regulatory regime, would switching to a new regime based on activities rather than ownership delay their entry? Would such a new regime create unforeseen competitive disadvantages for Canadian institutions?

Given the time required to adequately study the first option based on function and activities, the Committee rejects it for now since the new regime must be enacted before March 31, 1997. This does not mean, however, that the Task Force could not revisit this issue. The Committee recommends, therefore, that the Government adopt the second option; namely, creation of a third category for the regulation of foreign banks that undertake only limited financing activities in Canada and do not take retail deposits. Because of their "foreign bank connection", entry into Canada would require administrative approval, but the Committee is not convinced that the case for regulation of these Limited Purpose Foreign Banks has been made. Barring compelling reasons to the contrary, they should be exempted from regulation. Otherwise, the government could require that such banks establish a federally regulated financial institution but develop a regime of limited regulation without the requirements for initial capitalization of $10 million and corporate governance that apply to other foreign banks. Other regulations might also be eased. The Committee's proposal to allow branching for certain types of foreign banks would also be a move in this direction and would also deal with the concerns of a number of the cases outlined above.

The Committee heard no testimony to the effect that, once approval for entry has been granted, further regulation of Limited Purpose Foreign Banks should be required. There would certainly be no need to protect retail depositors, which is the main concern of CDIC and OSFI.

Before implementing such a third regulatory category of "Limited Purpose Foreign Banks" for foreign entry to Canada, however, the Committee recognizes that this approach has not received full public comment and might possibly have unforeseen tax or other competitive consequences that could unfairly prejudice Canadian financial institutions. In addition, there might possibly be arguments for limited reporting requirements or assurances about corporate governance. Consumer-related issues such as tied selling, privacy and disclosure might also be factors to consider. Accordingly, while recommending this approach, it should not be implemented without the opportunity for further consultations. Such consultations should be undertaken immediately in order that the proposed regime can be in place by March 31, 1997.

(ii) Establishment in Canada

The White Paper did not address the issue of whether foreign entities carrying on a financial business in Canada should be required to have an establishment or some actual presence in Canada. This issue would apply to Wells Fargo, as well as to the provision of financial services through the Internet. The Committee's concern is whether issues such as legal recourse and disclosure for consumers, level playing field considerations for Canadian competitors, as well as others, can be adequately dealt with in the absence of an establishment in Canada.

The Committee's proposals to lessen the regulatory burden by allowing direct branching (as set out below) and having Limited Purpose Foreign Banks as above should make it easier to deal with these cases in the short term. The more fundamental issues raised by new technologies and new distribution systems will have to be studied by the Task Force on the future of the financial services industry.

(iii) Direct Branching

The White Paper did not deal with the issue of direct branching in Canada by foreign banks but it was nevertheless brought before the Committee by the Schedule II Foreign Banks Executive Committee of the CBA. Under their proposal, a foreign bank would be able to operate as a bank in Canada but without having to establish a separate Schedule II bank. Instead, they would be permitted to operate as a branch of a foreign bank. Canadian clients would deal with a foreign bank, not a Canadian subsidiary of a foreign bank.

Evidence received by the Committee was that the presence of foreign banks in Canada has declined from a peak of more than sixty to forty-five at present. The current requirement that they must operate through a Schedule II bank means that
they must have minimum initial capital of $10 million in Canada. If direct branching were permitted, the capital of the foreign bank could be used to support its activities in Canada instead of just the capital of the Canadian subsidiary as at present. As well, regulatory requirements aimed at protecting depositors are an unnecessary burden for those which do not take deposits.

We also heard testimony that Canada and Mexico are the only O.E.C.D. countries that do not allow foreign branching, and that were Canada to adopt it, Canadian companies would have greater access to world banking facilities than at present.

The Committee notes that while Canadian banks have been granted national treatment in the United States by virtue of the NAFTA, meaning that they are treated on the same basis as the U.S. banks in that market, they have not been granted treatment reciprocal to that of U.S. banks in Canada. The latter can still do things in Canada, such as establishing a national network of branches, that Canadian banks cannot do in the United States. While the proposal to allow foreign branching would give further rights to U.S. banks without anything in return, the Committee accepts the evidence before it that this potential lever would not have been important in any event in effecting a change in U.S. laws, which will come about only through pressures brought by the financial community in the United States.

We also sought the advice of the Canadian Bankers Association, whose members would seemingly have the most to lose from direct foreign branching, but were assured of their support, provided they are put on a level playing field with Canadian banks. The CBA commented that the principle activity of most foreign banks that opt for direct branching would be larger commercial loans as at present. While this may be true for the most part, the Committee is confident that direct branching will facilitate the entry into Canada of foreign banks to service individual customers and small businesses, and that more foreign banks will establish operations in Canada.

Based on the above considerations and the desire to both increase competition in the provision of financial services as well as cut unnecessary regulation, the Committee recommends that foreign banks be entitled to conduct their Canadian banking operations directly through branches. Foreign banks taking retail deposits will still be required to do so through Schedule II banks. To avoid problems with small under-capitalized foreign institutions spilling over into Canada, only foreign banks above some size threshold from countries where regulation is in line with international standards and acceptable to OSFI would be allowed to branch into Canada. Direct branching should be allowed as soon as possible, and not have to await the report of the Task Force.

Approval to conduct direct branching should be conditional upon the consent of federal regulatory authorities. That approval process would have to consider factors such as the financial state of the foreign bank and the adequacy of regulation in the home jurisdiction. Not every foreign bank would thus be entitled to operate as a branch, but only those that impose no undue regulatory burden on Canadian authorities.

While the Committee strongly recommends quick access to direct branching, we do not wish to provide foreign banks with an unfair competitive advantage over Canadian banks. Foreign bank branches must still be required to pay their fair share of taxes, including capital taxes. The regulatory regime should not give them competitive advantages over Canadian banks but, at the same time, should respect their special circumstances.

(iv) Retail Funding

The White Paper proposes that "near banks" remain unregulated provided they do not engage in "retail funding". The term "retail funding" is not defined, but discussions between officials and interested parties are ongoing.

OSFI currently obtains undertakings from near bank applicants that debt issues in Canada must be at least $200,000 and in denominations of at least $100,000. We were also told that provincially regulated financial institutions are permitted denominations of as low as $50,000, but that amounts vary among provinces. The Committee heard testimony that the above limits are unnecessarily restrictive and that lower denominations should be permitted.

The Committee recommends that discussions with officials continue. The paramount need is to protect unsophisticated investors who might otherwise believe that the issuer is regulated or that the debt is insured. The Committee recommends that the Government consider approaches to permit greater flexibility in the issue of debt by foreign near banks without them having to become regulated, but ensuring that purchasers of such debt will be made aware that the issuer is not regulated and that the security is not insured.

(v) Ownership of Subsidiaries

The White Paper proposes that "a regulated foreign bank which owns a Schedule II bank would no longer be required to hold other financial institution subsidiaries through the Schedule II bank." For example, a regulated foreign bank could control its Canadian securities dealer affiliate directly.

This proposal would, for example, allow foreign banks established in Canada which have investment dealer affiliates to ensure that only the Canadian capital rules as applicable to investment dealers apply to that operation, rather than the rules applicable to both dealers and bank parents, as is now the case. The problems this dual system causes were brought to the Committee's attention by some foreign banks. The Committee supports this proposal.

4. Fine-Tuning the Legislation

(a) Corporate Governance

(b) Joint Venture Arrangements

The White Paper proposes to allow more flexibility to financial institutions in entering joint venture agreements by removing the requirement that the eligible joint ventures be controlled in fact by a financial institution. The Senate Committee on Banking, Trade and Commerce indicated that the current joint venture rules inhibit competitiveness. Subject to further consideration by the Senate Committee, this Committee endorses such changes.

(c) Access to Capital for Mutual Companies

In 1992, mutual companies were permitted to issue preferred shares and small mutual life companies were allowed to "demutualize" or convert to stock companies. These measures were welcome but did perhaps not go far enough. The White Paper proposes that mutual insurance companies be permitted to issue participating shares and that all mutual life companies be allowed to demutualize. Having heard no objection to these proposals, the Committee assumes, subject to further evidence, that the government should proceed.

(d) Taking of Security Interest

There are inconsistencies between the Bank Act and provincial security legislation relating to the taking of security interest. A working group is looking at ways to address these differences. The Committee encourages these efforts to harmonize federal and provincial laws.

(e) Amendments to the Bank of Canada Act

The White Paper proposes a number of technical amendments to modernize the Bank of Canada Act, including the following: changes in the types of instruments the Bank may buy and sell; providing clarity regarding ancillary activities such as licensing anti-counterfeiting technology; and changing the threshold for unclaimed balances in deposit accounts which, having been inactive for more than 20 years, are sent to the Receiver General. The Committee heard no testimony against the changes being made, and assumes, subject to further evidence, that the government should proceed.

5. Reviewing the Canadian Payments System

The Canadian Payments Association

The Canadian Payments Association was created by an Act of Parliament in 1980 to "establish and operate a national clearings and settlements system and to plan the evolution of the national payments system". In doing so, the CPA makes rules and establishes procedures for payment, clearing and settlement.

CPA Governance

The Act stipulates that CPA member financial institutions must belong to one of the five following classes:

The CPA is governed by a board of eleven directors chaired by an officer of the Bank of Canada. The other ten directors are elected by their respective classes divided evenly between the banks and the non-banks. Membership of the CPA, currently at 143, includes virtually all deposit-taking institutions in Canada. About 60% of the members are non-banks and 30% are provincially regulated institutions, including the Caisse centrale Desjardins, the Fédérations des caisses populaires of Quebec, the Alberta Treasury Branches, and a number of local credit unions.

The CPA functions on a non-profit basis, with each member providing a financial contribution based on a percentage of the previous year's volume of payment items cleared through the system.

Clearing and Settlement

Clearing and settlement of payments is the main function administered by the CPA. Clearing is commonly defined as the processes used by individual deposit-taking institutions to obtain payment for items such as cheques and electronic transactions received by them in the course of the business day that were drawn on other member financial institutions. Settlement is the process whereby the net payment obligations relating to the clearing process are accounted for and adjusted through the accounts of the directly-clearing financial institutions which are held at the Bank of Canada.

Since 1984, all of the functions associated with the accounting, netting and reconciliation process relating to clearing and settlement have been processed through the Automated Clearing and Settlement System (ACSS). These functions include logging of payment items at seven regional settlement points across Canada, followed by the balancing, reconciling and reporting of such figures in order to achieve settlement through the Bank of Canada.

In addition to its role in the final settlement process, the Bank of Canada also makes lines of credit available to CPA member financial institutions in certain circumstances as a lender of last resort to further ensure the stability of the system.

Large Value Transfer System

In the past several years, the CPA has expended significant effort on developing an enhanced risk management system to augment the ACSS. This Large Value Transfer System (LVTS) which is expected to be operational in mid-1997 will give participating members access to same day certainty and finality of settlement for all transactions and will enable them to offer their customers finality of payment. The LVTS design contains mechanisms (including the requirement that individual participants be required to pledge collateral to secure the transactions that they enter into the system) to control "systemic risk". This is the risk that failure by one participant in the system to meet its obligations could spread to others and destabilize the financial system.

Technological Innovation

Every Canadian who enters into a paper payment transaction such as a cheque or an electronic transaction such as withdrawing money from an automated banking machine, is affected by CPA rules. Technological advances have enabled the electronic delivery of payments through such services as direct deposit, pre-authorized debits, automated banking machine transactions, point of sale payments and business-to-business payments through electronic data interchange. These advances have reduced the percentage of paper items cleared through the ACSS from over 91% in 1988 to just under 62% in 1995.

The CPA has been required to develop rules and procedures to address this transition from a paper-based to an increasingly electronic environment. Meeting the needs of third-party users while maintaining the overall integrity of the payments system has involved consultations leading to the establishment of a CPA Stakeholder Advisory Council which will hold its inaugural meeting on December 12, 1996.

The White Paper

The White Paper recognized that Canada has one of the best paper-based payments system in the world, but that changes need to be considered. Accordingly, it has announced that the Department of Finance will establish an Advisory Committee to recommend changes leading to greater opportunities for competition and innovation. Questions such as opening the payments system up to new players and allowing unregulated entities indirect access to payments system through CPA members by means of payable - through drafts are also to be considered.

The Committee supports establishment of the Advisory Committee on Canada's payments system. While these difficult issues have been put off for further study, the Committee nevertheless received a number of representations.

Trimark Investment Management Inc. was concerned about comments in the White Paper that payable through drafts, such as issued by Trimark, an unregulated entity, "could have negative implications for the financial system" and warned issuers against using them. Trimark wants to offer drafts to permit mutual fund holders with money market funds to have ready withdrawal privileges. The CPA Act allows such drafts but no member has made them available to Trimark or any other mutual fund. The Committee does not consider that such withdrawals could hurt the payments system, since such funds contain only short-term federal and provincial government securities and default is not an option. Accordingly, the Committee recommends that the White Paper should not be considered to ban payable through drafts which offer no security risks such as the above, prior to final resolution of this issue by the Advisory Committee. The Committee shares the government's concern, however, that the use of payable through drafts by financially insecure issuers could, in the event of default, "have negative implications for the payments system". The use of payable through drafts by unregulated entities could also raise issues of safety and soundness, consumer protection and disclosure, and level playing field concerns of other regulated institutions.

Both Trimark and members of the Canadian Life and Health Insurance Association (CLHIA) indicated that they intend to seek membership in the CPA. Trimark complained that it has tried unsuccessfully to make arrangements with two banks to offer chequing access to its money market mutual funds. CLHIA wants insurance companies to be able to hold insurance proceeds for beneficiaries and to offer withdrawal privileges. The Retail Council of Canada testified that the lack of competition in the supply of hardware for the making of electronic payments causes excessive costs to retailers.

The Committee recognizes that insurance companies and mutual funds have become increasingly important players in the financial services sector, and expects that their concerns, as well as those of the Retail Council of Canada, will be given full consideration by the Advisory Committee.

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