Financial Sector Regulation: Partnering for Success

Head Table Guests

Charles S. Coffey, Executive Vice-President, Government and Community Affairs, The Royal Bank of Canada and Director, The Empire Club of Canada; Grant Kerr, Associate Minister, St. Paul's United Church, Brampton; Joanne De Laurentiis, President and CEO, Credit Union Central of Canada; The Hon. Howard Weston, ViceChairman, Ontario Securities Commission; Raymond J. Protti, President and CEO, Canadian Bankers Association; The Hon. Thomas Hockin, PC, President and CEO, The Investment Funds Institute of Canada and Director, The Empire Club of Canada; George D. Anderson, President and CEO, Insurance Bureau of Canada and Director, The Empire Club of Canada; Ronald Robertson, Chairman of the Board, Canada Deposit Insurance Corporation; Mark R. Daniels, President, Canadian Life and Health Insurance Association; and Bill Mitchell, Retired Partner, PricewaterhouseCoopers.

Introduction by Bill Laidlaw

The entire issue of the health of our financial institutions in Canada is one that remains permanently in our minds today. We are touched by these institutions every day. The average man and woman at times seem to be working for these organisations. I do at times.

Look at where the bulk of your paycheque goes to when you consider your monthly mortgage and Visa or MasterCard payments. Add to that your life insurance deduction and there is little else left. It is little wonder that all of us watch with keen interest the activities of these huge organisations and how they are managed.

When one considers the number of employees involved in keeping these institutions going and what would happen with a merger or failure, the results could be very major on our society.

Take out employees commuting to their places of work at a financial institution in downtown Toronto and there would be a lot fewer people down here.

Clearly the institutions included in our speaker's portfolio are very major players in our economy.

Today we are very fortunate to have as our guest the person responsible for financial institutions in Canada. He reports to the Minister of Finance.

Knowing his predecessor John Palmer quite well, I have a good idea of the challenges he faces in this job. Just contemplating the merger of the Royal and BMO would keep me up at nights.

Mr. Le Pan was appointed to his current position in September of last year, a very fateful month as you know.

Prior to this post he was appointed Deputy Superintendent of Financial Institutions, Office of the Superintendent of Financial Institutions (OSFI) in May 2001.

He also served in the office as Deputy Superintendent from 1997, his responsibilities being to oversee the supervision programme for banks, other deposit-taking institutions, life and general insurers, and federally regulated private pension plans.

In 1995 Mr. Le Pan joined OSFI as Deputy Superintendent Policy and was responsible for OSFI's input into legislative development, preparation of regulations and guidelines, precedents, identification and analysis of emerging issues as well as various international and Canadian regulatory co-ordination efforts.

In addition Mr. Le Pan served as Special Advisor to the Deputy Minister, Department of Finance leading a task force that finalised a government white paper on the supervisory, deposit insurance and policy holder protector regime and also pursued legislative implementation of the proposals.

Mr. Le Pan holds an Honours Bachelor of Arts degree in Economics from Carleton University and a Master of Arts degree in Economics from the University of Toronto.

It is my pleasure to introduce to you Mr. Nick Le Pan.

Nicholas Le Pan

Mr. Chairman, ladies and gentlemen: I am grateful to The Empire Club of Canada for the opportunity to talk about the Office of the Superintendent of Financial Institutions or OSFI as it is more affectionately known.

I use the word "affectionately" with some hesitation. I think there is a love-hate relationship between the regulator--OSFI--and the institutions we regulate and supervise.

Why is that? I'll get to the hate part later. The love part is because regulation benefits Canadian financial institutions.

A good supervisory system opens doors to Canadian institutions abroad and helps them at home.

Access to foreign markets is easier because host regulators have a high degree of confidence in our regulatory system. And Canadian financial institutions benefit, too, because counter-parties recognise that Canadian institutions are well regulated and well managed.

Good regulation is an important contributor to public confidence and public confidence is one key to financial institution success. Canadians have every reason to continue to have a high degree of confidence in our financial system.

Since becoming Superintendent I have been saying that we have to be highly interested in the success of institutions and their profitability. I have said that profitability is the first line of defence for an institution in managing stresses that come from adverse events--and as we know there are lots of adverse events to contend with in the world today.

I can't tell you the number of people who have commented to me that it is refreshing to hear a regulator say this. Why is that? Does it reflect the Canadian value system where profits are to be mistrusted? In my business, a long-term unprofitable institution is not a safe and sound institution.

I think it is important to challenge some of the perceptions out there about Canada, about regulators, and about our financial institutions.

I spend a lot of time dealing with regulators from other countries. I can tell you that, while Canada is a relatively small player in the world marketplace, we play a leadership role in international efforts to strengthen co-operation among financial regulators, improve global regulatory standards and promote sound regulatory practices internationally. And that benefits us in Canada.

Some of our Canadian values serve us well in this. We are seen as being quietly effective in helping international regulators reach agreement on difficult issues.

On top of that, we run a good system of prudential regulation and supervision.

In its latest report on Canada released two months ago, the International Monetary Fund said the same thing. It reported: "The financial system in Canada is among the most highly advanced and sound in the world, and it is supported by a well-developed regulatory and supervisory framework."

In the insurance world, we were a driving force around the enhanced effectiveness of the International Association of Insurance Supervisors, which brings together insurance supervisors from around the world to co-operate on common issues. The IAIS, as it is called, also allows representatives of financial institutions to attend as observers. I have had surprised CEOs come to me and say, "You know, Nick, I was at an international meeting and I was astonished at the high regard in which

Canadian supervisors are held." The love-hate relationship again.

These international efforts pay off. They help ensure that all institutions--no matter where they are locatedare playing by similar rules and standards. That's important for a country like Canada. Also, in our supervisory efforts we obviously don't limit our efforts to Canada, given the scope of many Canadian financial institutions--and there is often expertise elsewhere we can tap into so we aren't reinventing the wheel.

In addition, the more that foreign jurisdictions know about our system and the quality of our people, the more we help to advance the interests of Canadian institutions.

Canada also pushed the creation of the Financial Stability Forum, in the aftermath of the Asian and Russian financial crises in 1997-98. The forum brings together central bankers, finance ministries and financial supervisors to informally discuss potential vulnerabilities in the international financial system and ways to meet them. In early meetings, I am told that members of the forum were careful about sharing their anxieties. But in the three years since it was set up, this is changing, and the forum is turning out to be valuable.

A lot of the value that comes from such international work is the relationships that are developed. On September 11 and the days following, the ability to pick up the phone and talk to my counterparts in foreign countries was invaluable. The same goes for my counterparts, who were calling us to seek our views. This definitely strengthens the global financial system.

The Toronto International Leadership Centre for Financial Sector Supervision is another initiative with significant OSFI participation. In addition to funding from the Government of Canada, the centre also receives support from the IMF, the World Bank, and the Schulich School of Business. Founded in 1998, the centre is unique. Individuals with substantial experience in financial super vision from Canada and abroad help supervisors from around the world hone their leadership skills and build effective supervisory regimes in their countries. This centre of excellence in leadership is located here in Toronto. I'm pleased OSFI's supporting it.

OSFI is also creating a new programme to respond better to requests from foreign supervisors for assistance. We have been inundated with requests to help other countries that want to know more about the way we supervise institutions and more about what we think the keys to success are.

The level of assistance we provide as a result of this programme is expected to increase substantially this year. By helping emerging market economies to improve the stability of their financial systems, OSFI is making an important contribution to their economic development overall. And enhanced financial stability reduces the impact of shocks originating in other markets.

Let's look at another aspect. In the banking world, The Basel Committee on Banking Supervision, which includes supervisors from the most advanced countries, is in the process of completely updating the outmoded rules for setting the minimum required capital for international banks. The Basel Committee has asked Canada to lead the group overseeing the implementation of the new capital rules. This is quite an accomplishment.

And it is not just Canadian regulators who are playing a major role internationally in this regard. Canadian banks are intimately involved because they are often state-of-the-art in various risk-management techniques. So often are Canadian insurers. Canadian banks are well placed to benefit from a more risk-based set of capital rules. Having more risk-based rules is one key to more cost-effective regulation and supervision--and that's what OSFI is doing in a variety of areas. I am sometimes asked what my reaction will be if these new capital rules, once in place, produce less capital requirement than today. Within reason, and with appropriate margin for the fact that no model or set of models can be completely trusted, if the new rules indicate less capital is required for a successful, well-managed institution, my office will not stand in the way.

Now for the part you have been waiting for--the hate part of the relationship. Regulation has benefits--but it also imposes costs.

My job is to meet the mandate that Parliament has given OSFI--to protect depositors, policyholders and creditors from undue loss. That's public confidence. I have to ensure our cost and the way OSFI does business is justified in meeting that mandate. And increasingly we have to be concerned about compliance costs, not just the direct costs of our operation.

I think generally we do run an effective and efficient system. But I cannot say that and relax and go home and come back to work tomorrow complacent. Regulatory systems can become overwhelming.

How does regulation begin? First, problems arise that lead to regulation and the creation of regulatory bodies. These organisations then try to keep their rules up to date often by adding more rules, not removing rules. Exceptions and refinements are introduced and complexity increases.

Sometimes industry is complicit. Refinements are suggested by institutions to better deal with their special circumstances. Eventually, the system can turn into an economic liability. We cannot afford a top-heavy system. I have been saying that regulators need to increasingly focus on what matters.

So, if I hear that Canadian rules are a problem, I get concerned. Sometimes people don't have all the facts when they make their argument, but sometimes people have a point. Suggestions that costs and benefits of our regulatory system are out of whack concern me. This should concern any regulator, but I think it should particularly concern a Canadian regulator. Canada is a small country in world capital markets and we cannot afford an inefficient regulatory system.

International comparisons are a very important benchmark. That's why I've suggested to the insurance industry that we together do more work to compare how our capital rules stack up.

Because I lead OSFI, my focus is on trying to ensure that OSFI has the balance right. We do need rules and we do need to ask questions--uncomfortable questions at times--about the way institutions do things. We need to tell profit-maximising institutions that they can't cut corners in risk-management functions. Sometimes we need to just say no or to use the substantial powers we have been given, especially when safety and soundness is at stake. We sometimes need to add new rules in light of problems that we see. But we also need to remove rules sometimes or to look to other solutions.

Take corporate governance as an example. OSFI has thought about adding a lot of new guidance or rules. Our view was to tell boards what we expect, they will do it, and we will have a better system. Then we realised that we might be re-inventing the wheel. There is a lot written both domestically and internationally on leading-edge corporate governance practices especially for large complex corporations, and good boards take this seriously.

Instead of writing volumes of guidance for boards, OSFI may be able to achieve more, we think, by getting to know the boards of financial institutions better. We want to be a bit clearer about what we think are keys to the successful effectiveness of a board of a financial institution, and to increasingly work with boards when we see them falling short.

For me, effectiveness means directors' understanding their role, the institution and the business. It means their having appropriate interest in risk management and control issues and the views of regulators. It means demonstrating proactivity in dealing with issues that arise. And it means probing and pushing back in their relations with management and the external and internal control functions, including internal and external audit that boards rely on. Many board members are telling me that they think more dialogue with OSFI would be useful to them as well.

And that is as it should be because ultimately it is the job of the board of directors and of senior management to direct and run the institution. That is why OSFI is increasingly stressing strong internal controls and effective governance arrangements, because they help to achieve a cost-effective regulatory system.

There are still some who would say to supervisors, "You have never run anything, you have never been on a board, stick with your knitting." But there are others who recognise that we oversee some 450 institutions in Canada, and that we compare the practices we see. This gives us a perspective that few people have.

We must also be able to rely on other professionals with specific oversight responsibilities, including auditors, accountants and actuaries. As recent international examples illustrate, in the aftermath of business failures sometimes we find that the financial statements had failed to give a reasonable picture of the failed firm's operations and financial condition. Reporting, auditing, accounting and actuarial standards and their application need to reflect today's complex business organisations and sophisticated risk arrangements. And they must adapt more quickly to changes in the business environment and be applied faithfully. OSFI's reliance-based approach to supervision depends on it. The alternative is a much more intrusive and costly supervisory system.

Thus, you can bet that every regulator, including OSFI, is paying attention to Enron, as are a lot of boards and senior management whose job it is to continually reassess whether the procedures in place can be relied upon. We have looked at our rules for the pension plans regulated by OSFI. They don't permit that degree of related party investment. We take some comfort from the fact that our accounting standards are not as rules-based as in the U.S., but we are looking at whether our reliance-based system needs to be strengthened. I have already spoken about our approach to governance, but we will not respond in a knee-jerk way nor do I believe that there is any "silver-bullet" answer.

In closing, let me repeat:

Canada has a prudential regulatory system that is among the best in the world; this gives financial institutions a competitive advantage.

Success of institutions, as well as good internal controls, are important contributors to safety and soundness.

• The Canadian brand is recognised around the world as a quality brand; Canadians are punching above their weight in contributing to international financial stability.

• OSFI can't rest on its laurels and won't under my leadership.

Thank you.

The appreciation of the meeting was expressed by The Hon. Thomas Hockin, PC, President and CEO, The Investment Funds Institute of Canada and Director, The Empire Club of Canada.