Evidence of meeting #50 for Finance in the 39th Parliament, 2nd Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was bank.
A recording is available from Parliament.
3:30 p.m.
Conservative
The Chair Conservative Rob Merrifield
I'd like to call the meeting to order. This is pursuant to a committee resolution that we had on April 2, 2008. These are briefings on the asset-backed commercial paper in Canada.
We have with us, from the Office of the Superintendent of Financial Institutions Canada, Julie Dickson, superintendent. We want to thank her for coming.
Ms. Dickson, the floor is yours.
3:30 p.m.
Julie Dickson Superintendent, Office of the Superintendent of Financial Institutions Canada
Thank you.
Mr. Chairman, members of the committee, I am pleased to appear before you today to discuss this very important issue. There were many factors at play that caused the problems which occurred in the asset-backed commercial paper, also called ABCT, market, and I believe a full discussion and review are vitally important.
Before I speak to some of the questions related to the ABCP issue, let me touch briefly on OSFI's role in the Canadian system.
The Office of the Superintendent of Financial Institutions Act notes that OSFI shall strive to
protect the rights and interests of depositors, policyholders and creditors of financial institutions, having due regard to the need to allow financial institutions to compete effectively and take reasonable risks
Institutions under OSFI's regulatory oversight include banks, federally registered trust and loan companies, property and casualty insurance companies, life insurance companies, and federally regulated private pension plans. Thus for banks, OSFI's primary role or job is to protect the interests of depositors. This is important, since banks hold the life savings of many Canadians.
Because OSFI was created to help contribute to public confidence in the financial system, some have assumed this means we are responsible for public confidence in the financial system. However, our act makes it clear that our role in contributing to public confidence in the financial system is concentrated on the banks' safety and soundness.
Today I would like to focus on what OSFI is doing as a result of the non-bank ABCP issue. Before doing that, I would like to reiterate a few key points regarding the non-bank ABCP market.
First, OSFI's capital rules are designed to help protect the safety and soundness of Canadian banks in the interest of depositors. The capital rules that apply to Canadian banks did not drive the widespread adoption of general market disruption liquidity lines by non-bank firms in Canada. This topic is covered at length in an OSFI backgrounder dated April 22, 2008, copies of which were provided to you on Friday.
Second, there was no consensus that the ABCP market posed a significant risk to investors. Indeed, the market had worked very well for the previous 17 years. Further, some developments had occurred and were reported on that were seen as being positive, such as DBRS's decision to change its rating methodology in January 2007.
Third, much more is known today than before about the factors that were important for investor safety. For example, after the events of last August, it became apparent that the strength of the sponsor—in other words, whether the conduit was set up by a bank or non-bank—was extremely important.
OSFI has taken a number of actions in response to the ABCP issue. First, we assessed early on the impact of the turmoil in the ABCP markets on all federally regulated institutions that we oversee. Very few of the institutions we oversee had material exposure to non-bank ABCP. It's important to note that financial institutions are considered to be sophisticated investors. The private pension plans that OSFI oversees had virtually no exposure.
We also began a review of guideline B-5, which requires Canadian banks to delineate their roles and responsibilities in creating ABCP vehicles, as well as capital requirements for loans to such vehicles. We are focusing on the roles and responsibilities of banks, especially when they deal with ABCP conduits created by unregulated entities like Coventree. We are looking at whether bank involvement with such conduits can create the impression that ABCP issued by unregulated entities is sponsored by banks.
Third, we are focusing on how banks determine which products they add to their approved product list for ultimate sale. Our focus is on risk that may result in large, unexpected payouts or losses by a bank. From our perspective, Canadian banks are at risk if they unexpectedly repurchase products they had sold to clients. We want to determine best practices in developing approved product lists, so that the likelihood of future losses is minimized.
Fourth, OSFI has been very involved in the work of the Financial Stability Forum to assess the causes of the turmoil and to formulate recommendations to enhance system resilience. I've worked with international colleagues to draft the FSF report on enhancing market and institutional resilience. The report includes more than 60 recommendations that have been accepted by G-7 finance ministers and covers key issues, such as capital and liquidity for banks, as well as the need for more transparency in ABCP conduits, and various changes that should be made by rating agencies.
This is the reason I have to leave at 4:30. There is an FSF working group meeting tomorrow in Europe.
Lastly, OSFI, as well as our international counterparts via the Basel Committee, are increasing capital charges for liquidity lines to support ABCP. This will further enhance bank safety and soundness.
The freezing of the non-bank ABCP market has rightfully led to a lot of questions, and it is important to identify and understand what happened. OSFI fully supports the efforts being made by all parties in this regard and will continue to provide input into these deliberations.
I would be pleased to take your questions.
3:35 p.m.
Liberal
John McCallum Liberal Markham—Unionville, ON
Thank you for your testimony. My first question has to do with the market disruption liquidity lines, which I gather have been terminated. Does that imply, at least with the benefit of hindsight, that it would have been better had they never existed?
3:35 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
The first thing to note, just so that everyone is clear, is that the general market disruption liquidity lines, B-5, which set out a zero capital requirement, did not apply to Coventree or the non-banks at the heart of this issue.
What we talked about in our background was that in 1988 or so, regulators around the world had set a zero capital charge for any type of liquidity line under one year. When OSFI saw securitization start to grow rapidly, we became very concerned about the fact that no capital was being—
3:35 p.m.
Liberal
John McCallum Liberal Markham—Unionville, ON
Excuse me. I have read your document.
Would you agree with my proposition that with the benefit of hindsight it would have been better had those kinds of lines not existed?
3:35 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
That would not be true from a bank regulator's perspective. From a bank regulator's perspective, you have to have capital if you take risk. The banks were not taking much risk with those liquidity lines. When you look at what happened globally, asset-backed commercial paper vehicles globally started to have a problem even with global lines.
From our perspective, the Canadian banking system is not having the kinds of problems that some other banking systems are having, because they were not taking risks without capital.
3:35 p.m.
Liberal
John McCallum Liberal Markham—Unionville, ON
But isn't it true that you've recently adopted a broader risk management framework, which would look at banks in their capacity as investment dealers and reputation risk and things of that kind? In that broader context, is it not the case that those lines inappropriately transferred risk from institutions to individuals?
3:35 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
We have said we are going to revise guideline B-5. We are working on that now. We are going to our international colleagues and we're saying that a zero percent capital charge is inappropriate for any liquidity line. That is because we have seen that banks bought back or started to support their vehicles. If you are going to be supporting your vehicles, you must have capital.
The whole theory had been that risk was being transferred to investors. That was the theory around the world. But what we've seen in the last nine months is that the risk that banks thought they had transferred actually hasn't been transferred, because banks stepped in and bought the transferred product back.
While we had legal and accounting opinions that the risk had been transferred to investors, we began to realize, as did every other regulator, how important reputation risk was. Once transferred, they would bring it back. They will have to hold capital for any liquidity line going forward.
3:35 p.m.
Liberal
John McCallum Liberal Markham—Unionville, ON
There have been rumours that one or more financial institutions regulated by OSFI may have had inside knowledge of declining asset quality and possibly ordered these assets to be sold without informing clients.
Is OSFI examining tapes or trading behaviour in the period leading up to the freeze in August of 2007?
3:35 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
That would be the responsibility of the Securities Commission and of the Investment Dealers Association.
3:35 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
Yes. Most of the stuff was sold through dealers. Product was being sold by either the dealer, mostly the dealer, or by the bank directly. We are looking to the Securities Commissions and the IDA to do work. The IDA has indicated they are doing work.
3:40 p.m.
Liberal
John McCallum Liberal Markham—Unionville, ON
It seems to me there were a number of red flags that went up that OSFI seems to have ignored. For example, only one domestic rating agency gave a rating and the larger international ones did not. One Canadian bank, the TD Bank, decided it wouldn't have anything to do with that kind of asset. The international standard was very different from the Canadian standard.
My question is, weren't there warning signs that occurred along the path that would have caused OSFI to take action faster than it did and play more of a leadership role in this fiasco?
3:40 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
I think when you look at the 17 years preceding August, this market had worked extremely well. We knew there was a debate, and that was a very public debate. We've seen the reports that various rating agencies prepared and issued. DBRS was issuing reports. Other reports were being done. Even the Bank of Canada did a very good report in June 2007, and they talked about the fact that we had a unique market. Then they talked a lot about other features of the market.
Because we had general market disruption liquidity lines, the credit enhancement was greater. For example, you'd put more assets into the vehicle than commercial paper issued. While the liquidity lines were not what you saw internationally, the structures were believed to be more robust, with more assets in the structures. From our perspective, this was known. We had sophisticated investors who are heavily involved in the market presumably knowing about those reports.
It's not a market that we oversee. We've spoken in the past about the kind of work we do, which is focused solely on bank safety and soundness. We would put investor alerts on our website if we saw someone saying it was a bank and taking money from Canadians when it's not really a bank. There would be an investor alert on that. But when you're talking about asset-backed commercial paper and the fact that the market was different from what existed elsewhere, we would look more to other agencies that have responsibility for investor protection.
We were out at conferences explaining that we were not telling banks what type of liquidity line to offer. It was something the market was deciding and investors were deciding.
3:40 p.m.
Conservative
The Chair Conservative Rob Merrifield
Your time is gone. We have to move on to other questioners.
Monsieur Crête.
3:40 p.m.
Bloc
Paul Crête Bloc Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC
Thank you, Mr. Chairman.
Ms. Dickson, as far as asset-backed commercial paper in Canada is concerned, do you agree that, beyond the financial crisis, we came close to a major economic catastrophe because of the lack of control at each stage of securitization? When securitization was created, a process whereby many financial products containing good and rotten apples are bundled together, this is what led to the major catastrophe we are experiencing today. How should the system be changed so that this type of situation does not happen again?
Let me give you a concrete example I am familiar with. A bank sells one of these products, knowing full well that this product is not reliable, to people who have short-term needs, but who, three days later, will have lost $20 million.
What has to be done so this type of situation does not happen again? What has to be done at each stage of the process by the credit rating agencies, by your organization or others, including the Bank of Canada, so that does not happen again? What is your position on this?
3:45 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
I know the securities regulators across Canada are looking at the operation of the exempt market as it pertains to asset-backed commercial paper. The big issue here is that asset-backed commercial paper was sold without a prospectus because it was in the exempt market. The security regulators are looking at that and whether anything needs to change in that regard.
One of the issues in this market is that it evolved quickly over time. For a long time it stayed the same and the product stayed the same--the asset-backed commercial paper. Indeed, the asset-backed commercial paper vehicles that banks themselves set up tended to be plain vanilla. But the asset-backed commercial paper conduits that were being set up by the unregulated players tended to be much more complex and aggressive. I think you always have to be concerned if a product changes over time and you don't see it.
I noted that we were looking at the approved product list processes--
3:45 p.m.
Bloc
Paul Crête Bloc Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC
In your opinion, did the credit rating agencies do their job well?
3:45 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
Are the rating agencies playing a role?
3:45 p.m.
Bloc
Paul Crête Bloc Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC
Are they still doing their job well?
3:45 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
I think DBRS should talk about exactly what it did. I noted in all of my speeches and backgrounders that they believed the risks were balanced because they had a general market disruption liquidity line, but they had better enhancement in the vehicles. That's what they've said, but they could give you more information on that.
3:45 p.m.
Bloc
Paul Crête Bloc Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC
In Canada, the banks generally have a good reputation in the eyes of the public. However, in this context, some banks offered a product which turned out to be of extremely bad quality. The ones who did so really put their credibility on the line.
Should there be better controls over banks selling this type of product?
3:45 p.m.
Superintendent, Office of the Superintendent of Financial Institutions Canada
There are a lot of things here. Not only banks sold the products; we know that. I don't know all the details here, but banks can act in different ways as fiduciaries, in which case they have an obligation, if they are giving advice, to know the product and the client. That is what the securities commissions and the IDA would be looking at.
Banks can also act as order desks. The phone rings, you pick it up, and someone says, “I want the product.” Banks would have tapes, etc., of that.
It's hard to make generalizations. If anyone is giving advice to buy a product, there is a regulator involved. It's not me, but there is a regulator and they're looking at that.