Finance Committee on May 17th, 2006

[The Chair, Conservative, Brian Pallister]

Welcome to members of the committee and to our guest, Monsieur Le Pan.

Members, pursuant to Standing Order 81(4), we are here to deal with vote 35 of main estimates 2006-07, under the Office of the Superintendent of Financial Institutions, referred to the committee on Tuesday, April 25, 2006.

Before I invite Monsieur Le Pan to proceed with his presentation, I will mention to the committee that we will be dealing with Madam Wasylycia-Leis' motion after discussion and questions with Monsieur Le Pan. After that, I would ask members of the steering committee to remain so that we may have a further discussion in lieu of another separate meeting.

Yes, Mr. Pacetti.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

I have a point of order, Mr. Chair. Mrs. Wasylycia-Leis' motion is not on the orders of the day, and I don't have a copy of the motion. I don't know if we were supposed to discuss it, and I don't know if we need to discuss to it, but I'd like to have a copy of it.

[The Chair, Conservative, Brian Pallister]

In a previous discussion, Mr. Pacetti, Madam Wasylycia-Leis expressed to me that she has met the requirements of notice. The motion will be distributed. She's expressed a desire to bring it forward today. I'm anticipating that she'll be doing this following discussion rather than prior to Mr. Le Pan's presentation.

I hope that meets with the approval of committee.

I'll ask Mr. Le Pan to proceed with his remarks.

Thank you, sir.

[Nicholas Le Pan, Superintendent of Financial Institutions, Office of the Superintendent of Financial Institutions Canada]

Thank you, Mr. Chair.

After my short opening statement, I'd be prepared to answer questions on anything you'd like to ask about the office and the operations of the office.

Fundamentally, we are very fortunate, I think, to possess in Canada one of the strongest financial systems in the world. It contributes to the strength and innovation of the economy and protects the savings of individual Canadians. The environment in which OSFI operates, both domestically and internationally, is fluid and at times unpredictable. Maintaining a high level of confidence in the safety of money entrusted to financial institutions and remaining a world-class regulator is very important in our plans and priorities.

We are a prudential regulator, and I want to emphasize the word “prudential”. We focus on safety and soundness, not on so-called market conduct issues of how financial institutions deal with customers.

We've had a legislated mandate from Parliament since 1996. Under the legislation, our mandate has four main elements. These are laid out in the material.

The first part is to supervise federally regulated financial institutions and private pension plans to determine whether they are in sound financial condition, meeting minimum funding requirements, and complying with their governing law and supervisory requirements.

The second part is that if there are material deficiencies, we are to advise institutions and take, ourselves, or require management to take, necessary corrective actions. This includes management, boards of directors, or plan administrators. That's the so-called early intervention part of our mandate, common to many prudential regulators in Canada and around the world.

The third part of our mandate is to advance and administer a regulatory framework that promotes the adoption of policies and procedures by regulated institutions designed to control and manage risk. We do that directly ourselves, through guidelines and so on. We also work with our partners in the Department of Finance and other agencies with respect to the federal legislative framework, and we work with other partners--for example, in the auditing, accounting, and actuarial professions, or internationally--who are developing rules and frameworks applying to these organizations.

Last, we are charged with the monitoring of system-wide or sectoral issues that may impact financial institutions negatively, in pursuit of our overall mandate to protect depositors and policyholders. We contribute to public confidence--that's what our statute says we're supposed to be doing--by pursuing our mandate. Our legislative mandate also explicitly acknowledges the need to allow financial institutions to compete effectively and take reasonable risks. That means for a variety of our activities we're in the business of balancing.

Our mandate recognizes that management and boards of directors and pension plan administrators are ultimately responsible for the operation of their entities, and that financial institutions and pension plans can fail. A well-run system in which Canadians and people outside Canada can have a high degree of confidence is very important, of course, for economic performance, so our priorities are generally pretty broadly aligned with broader government priorities.

We have a variety of partner organizations within government and the private sector. We are involved, of course, pursuant to our mandate, in risk assessment and intervention, in setting rules and guidelines, and in approvals under the various pieces of legislation.

In terms of our budget, our spending in the main estimates is $85 million for fiscal year 2006-07. Virtually all of our operating costs--except for $768,000, which is in relation to the Office of the Chief Actuary--are recovered and paid by the financial institutions and pension plans that we regulate and supervise. That's why you see the net number of $768,000 that's in the votes.

Most of the costs of the Office of the Chief Actuary, which deals with the Canada Pension Plan, with pension plans for members of the public service, pension plans for members of Parliament, judges, and so on, are also recovered from the pension plans or departments for which the Chief Actuary provides valuations or other services. The rest of about $768,000 is recovered out of general revenues.

Our financial statements, which we publish annually, are prepared according to generally accepted accounting principles and are audited annually by the Auditor General.

The following gives a little perspective on our costs. About $73 million of the $85 million relates to financial institutions, $5 million relates to private pension plans, and about $4.7 million to the Office of the Chief Actuary.

As I said, we charge back virtually all of our costs to the financial institutions and pension plans or to other government departments. For financial institutions, for a large bank or an insurer, our charges would amount to about $4 million to $5 million a year, depending on the size of the institution. For a smaller or middle-sized depositing institution, we would charge back about $100,000 a year.

Our costs on a main estimates basis rose approximately 1% between 2005-06 and 2006-07. That's largely because of a variety of re-engineering initiatives we put in place to look at how we were doing our basic supervisory activities and other activities, and to keep our costs under control.

It is planned that our costs on a main estimates basis will rise in future at around 4% a year, though the increase will be faster in the pension area where we're adding resources because of the deteriorating condition in that area. They will be less than that in the other areas. That increase is basically reflective of normal inflationary growth for human resource costs and some ongoing investments in enabling technology.

Some of the increase is also due to additional resources we've put into anti-money laundering and anti-terrorism financing. Our planned staff complement is about 460 employees, and this is relatively static, though we cut it back between 2005-06 and 2006-07 as part of our re-engineering exercise.

Our priorities in the coming year include contributing to ongoing international and domestic efforts to strengthen capital rules, continuing to monitor and take action vis-à-vis the state of federally regulated pension plans, and increasing attention, as I've said, to anti-money laundering and counterterrorism financing issues. That's really in support of efforts being led by other departments--FINTRAC, the RCMP, and so on.

We report publicly on our website, and provide extensive information on aspects of our performance measures, including confidential surveys we undertake of the people we deal with, regulate, and supervise.

While we operate largely behind the scenes, I feel the high-quality work we do is acknowledged every time Canadians put their trust in a federally regulated institution or pension plan.

I look forward to your questions.

[The Chair, Conservative, Brian Pallister]

Thank you for your presentation, Mr. Le Pan.

To start us off, you have seven minutes, Mr. McKay.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you, Chair. Thank you, Mr. Le Pan.

An issue that has been in the news and that I know was of great concern to the previous government was that of the deficits in some of the private pension...or public pension plans, I suppose. I noticed there was a proposal in the budget with respect to certain funding measures. I wonder if you might expand on that as to how you would take moneys out of the federal government's budget and distribute them into plans that are federally regulated but essentially private.

[Nicholas Le Pan]

I'm not sure which initiative you're referring to. The budget has two initiatives related to pension plans.

One initiative, which relates to private pension plans and which I believe is very important given the deteriorating condition, is further flexibility in the funding requirements for private pension plans. The budget announces the government's intention to put in place regulations to provide for the possibility of private pension plans funding their deficits over ten years rather than five, with appropriate safeguards related to information being provided to plan members and safeguards for what I've called, on various occasions, “downside protection”, because there is potentially some more risk in a longer funding period.

I have been on record for a while now indicating that the funding situation of private plans was deteriorating. The number of plans operating at a deficit has increased. I believe the situation is manageable, but it requires, as I have said, active management. Part of that active management—and I think it is a very important contribution, which I have been on record as supporting for a while—is further flexibility on a temporary basis for funding of plans' deficits. Often, further flexibility will make a difference in allowing private sector sponsors to maintain defined benefit pension plans, and I think that's to the benefit of plan members, provided there are important safeguards, which I've talked about.

This does not involve anything to do with public moneys; it is a change in the funding regulation. My understanding is that the details of that regulation are likely to be pre-published for consultation very shortly. A number of groups over the past year or two have spoken in favour of more funding flexibility.

The second initiative, which you may be referring to, is the budget initiative around the Canada Pension Plan. Really, I'm not in a very good position to speak about that in any degree of detail. The government has announced its intention to put additional moneys into the Canada Pension Plan. The office of the chief actuary, who is independent from me in his actuarial evaluations, will be involved in determining what the impact of that is on the contribution rate, for example. But this is a policy decision the federal government has made, and it's an issue officials from the Department of Finance—the Chief Actuary, if you want, at some point—can come to talk about: what the impacts may be, and the rationale.

But neither of those is putting public money into private sector plans.

[John McKay, Liberal, Scarborough—Guildwood, ON]

I appreciate that clarification, because I think there was some confusion around this.

With respect to private plans, effectively you are proposing, subject to what your paper might say, some regulatory changes in terms of letters of credit, ten years versus five years, and that sort of thing, in order to be able to move deficits into some level of stability, then.

There is a question here, though, as to how the deficits get to that point. We've had a pretty vigorous market, and a lot of the pension plans are invested heavily in the equities market. But simultaneously we've had low interest rates, so it's kind of a catch-22 situation. Are you proposing a difference in the mix of equities and debt?

[Nicholas Le Pan]

There are really several questions there. How did the situation arise? What other actions are then appropriate in order to deal with it?

First of all, as key background, the legislation federally, as in many other jurisdictions in Canada and abroad, deliberately permits defined benefit pension plans to operate at a deficit. It does that because it's highly unlikely that sponsors would otherwise be willing to put in place defined benefit arrangements, given the fluctuations in asset markets, and so on. The regulations currently provide, and this is similar to most other jurisdictions, that so-called solvency gaps, once identified, need to be funded over a five-year time period.

The increase in the deficit position of defined benefit plans arose from several factors, as you said, and a couple of others that you didn't mention.

One, there initially was a pullback in equity markets, if we go back a couple of years. This did not come about over the last six months. It's something that's been developing over the past couple of years, and its something that we at OSFI have been talking about enacting for the last couple of years. Equity markets pulled back a bit; there's been some move back, of course, which has helped.

Secondly, long-term interest rates significantly declined, and long-term interest rates are what go into the actuarial valuation of the liabilities. The lowered long-term interest rates have significantly increased the value of the liabilities, when you do the evaluation of the plan.

There have also been some changes in actuarial rules on how you value these kinds of liabilities. The rules are not set by the government or by OSFI. They're set by the Canadian Institute of Actuaries. In particular, the Canadian Institute of Actuaries changed the rules about how fast you recognize declines in interest rates. Over the last nine months, that has contributed to quite a significant change in the deficit position of a number of plans.

There were also certain plans that took contribution holidays, and there were certain plans that had benefit improvements. They cut into surpluses and perhaps left less room. That's permitted under the rules and regulations, but it may have left less of a cushion to deal with the downturn.

Fundamentally, we have a variety of tools at OSFI, and those were enhanced in the mid-1990s, to allow us to intervene when we think the situation is likely to be too detrimental to pension plan members. We've been very actively using those tools for the past couple of years, certainly since the decline in solvency positions started.

[The Chair, Conservative, Brian Pallister]

I'm sorry to intervene, but as you know, we have a certain amount of time available for each questioner. Mr. McKay's question will have to be answered by way of another question.

Thank you.

Mr. Loubier, a follow-up, please.

[Yvan Loubier, Bloc, Saint-Hyacinthe—Bagot, QC]

Thank you, Mr. Chairman.

Welcome, Mr. Le Pan. It is always a pleasure to see you here and also to listen to you.

I have a few questions to ask you regarding the bill, which—at least in part—is intended to allow for an opening up of the mortgage loan insurance sector.

My colleague attended a briefing with officials. He asked certain questions to which he was not given satisfactory responses. Amongst other things, he asked why Genworth is the only private insurer in this sector. How is it that this situation has come about? We put the question to officials from the Department of Finance, but were unable to get an answer. Perhaps you are more aware of the privilege that Genworth enjoys.

[Nicholas Le Pan]

As far as I know, that company is the only company that has applied to OSFI over the course of several years, until quite recently, to offer this kind of business. At OSFI we regulate mortgage insurers, and we would certainly have been open to receiving applications from other mortgage insurers if there'd been interest. I can't comment on why we haven't got applications. It may have been a business decision on the applicants' parts, but our system and our framework were open to receiving applications for doing this business by other insurers.

We now have before us an application from somebody else who wants to get into the business, and that's public knowledge. We're processing that application as we would any other application, giving it the consideration it needs, and we'll make a recommendation to the minister in due course.

[Yvan Loubier, Bloc, Saint-Hyacinthe—Bagot, QC]

Mr. Le Pan, given that more and more private businesses are interested in this sector, do you believe that the cost of mortgage loan insurance will have a tendency to go down, as has happened in the other sectors of the economy?

Moreover, given that the mortgage loan insurance sector is becoming lucrative—perhaps more so than in previous years—do you think that the private sector will take the best clients and leave the others to the Canada Mortgage and Housing Corporation? If that is the case, taxpayers will assume more of the cost of bad debt in the private sector.

[Nicholas Le Pan]

As I understand it, government policy for a while has been designed to have a degree of competition in this marketplace. We're responsible for administering at OSFI our part of the system, which is applications from anyone who would want to enter the market to do this business. As I said in my introduction, our mandate requires us to take account of the need for allowing institutions to compete effectively. So if a financial institution comes to us to set up in the mortgage insurance business, we'll assess, on a broad basis, the viability of their business plan, assuming it's reasonably viable, and their capitalization and so on, but we're then going to, in all likelihood, recommend that entity be licensed to offer the business to consumers.

There are lots of aspects of the marketplace that will affect the availability of mortgage insurance and all those kinds of things that you asked about, one of which is how many competitors there are. But there are lots of other aspects that will affect this, including capital rules, and the nature of the guarantee that's provided to private insurers, which was provided in the first place in order to provide a reasonably level playing field so private insurers could compete with public insurers, with CMHC. Without that system, banks and other financial institutions would get a break on their capital if they dealt with a government guaranteed institution, CMHC, but would not get a break if they dealt with a private insurer, and this is what the guarantee that was put in place was designed to, in part, correct.

So I think there are a lot of aspects that would affect availability of insurance, and so on, and I understand the committee wants to have perhaps a broader discussion of that. I'm certainly happy to contribute, from our perspective, as to what our role is, but our role is fairly minimal in this. We'll make an assessment of the viability and solvency of any new applicant. We'll take account of the fact that we are supposed to allow institutions to compete effectively. So we're not going to impose our business judgment on institutions' judgment. If somebody thinks they can do the business profitably and contribute, in competitive terms, we're not going to say no to that. If their plan is clearly crazy or something, which is highly unlikely, but occasionally we see applications for new institutions that are very ill-developed plans...but assuming that's not likely the case, we have a set of capital rules that will apply to protect safety, soundness, and solvency, and we'll proceed.

Again, please don't take that as any comment on an application specifically in front of us; that's our framework, and I think that framework has served the system in a lot of kinds of markets pretty well over the last couple of years.

[The Chair, Conservative, Brian Pallister]

Monsieur St-Cyr, to continue for just a minute, sir.

[Thierry St-Cyr, Bloc, Jeanne-Le Ber, QC]

If I understand correctly, the criteria you use to draft your recommendation for a given application deal mainly with the issue of viability; you ask yourself if there is sufficient capitalization. Do you also take repercussions on consumers and on the market into account? There is a great deal of concern that new players could concentrate on low-risk borrowers and leave the higher-risk ones to a public company like Canada Mortgage and Housing.

Do you take these concerns into account in your analysis or do you limit yourselves to analyzing the viability of the business?

[The Chair, Conservative, Brian Pallister]

Could you give just a brief answer, Mr. Le Pan? Mr. St-Cyr will have another opportunity to question you.

[Nicholas Le Pan]

The criteria we use are set out in our governing legislation. They do not explicitly include impact on consumers. They do include the viability of the overall business, which obviously has to take some of those factors into account. In addition, the minister has a role in these approvals, assessing the impact on the overall financial system. That might be something that would be applied elsewhere.

Against the policy framework that's now in place, we look at the criteria in the legislation.

[The Chair, Conservative, Brian Pallister]

Thank you, Mr. Le Pan.

To continue, we have Madam Ablonczy.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

Thank you, Mr. Le Pan.

As someone new to the file, and having met with a number of the players in the finance field, I can tell you that you have a lot of fans out there, sir. That must be scary.

[Nicholas Le Pan]

Not always. When we walk into these institutions, we're not always there to bring good news.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

We know that.

Speaking of news, we've just had a budget introduced into the House. Would you tell the committee a little bit about your view of the budget, in terms of improving concerns that have arisen in OSFI?

[Nicholas Le Pan]

I'm not really sure what you're talking about.

A couple of things in the budget are, I think, very important. The one most directly important in terms of OSFI's business is the issue of the funding relief for private pension plans. That's the biggest immediate impact on the most important and most problematic part of our business. As I said, I think that's very positive.

Beyond that, obviously a number of other things in the budget affect the overall financial and economic conditions. One of the things we--and safety and soundness--have benefited from over the past few years has been very sound economic performance. Our economic environment has been very supportive of success in the financial institutions sphere; success is very important for safety and soundness, so things that keep those economic conditions in good shape are pretty welcome from my side.

[Diane Ablonczy, Conservative, Calgary Nose Hill, AB]

I was particularly interested in the suggestion in the budget that any surpluses could be applied to the CPP and the QPP. I wonder if you could give us your opinion as to the advisability of that, should the opportunity arise.

[Nicholas Le Pan]

Unfortunately, Ms. Ablonczy, I don't really think I could give you my opinion on that.

Part of my office has an important role in the CPP system. The Office of the Chief Actuary, which accounts for part of my office, has a very explicit role in the evaluation of the Canada Pension Plan. As you know, it produces a report triennially--every three years--on the long-term health of the CPP and on the required funding rate to meet the target and so forth. I really do not want to get into actuarial evaluations, and indeed it would be inappropriate for me to do so.