Finance Committee on April 2nd, 2009

[The Chair, Conservative, James Rajotte]

I will call the Standing Committee on Finance to order. We are continuing our study pursuant to Standing Order 108(2), a study on measures to enhance credit availability and the stability of the Canadian financial system.

We have three organizations with us here this morning.

First of all, from the Investment Industry Association of Canada, we have Mr. Ian Russell, president and CEO, back before the committee.

From Credit Union Central of Canada, we have the president and CEO, Mr. David Phillips. We also have Mr. Ralph Luimes, the CEO of HALD-NOR Credit Union from Hamilton, I believe.

From the third organization, DBRS, we have co-president--and I'll try to pronounce the last name correctly--Mr. Peter Bethlenfalvy.

We can start. We'll go in that order. We'll start with the Investment Industry Association of Canada. We generally allow about five minutes for an opening statement. We may allow a little more time today because we have three witnesses, and then we'll go to questions from members.

We'll start with Mr. Russell, please.

[Ian Russell, President and Chief Executive Officer, Investment Industry Association of Canada]

Thank you very much, Mr. Rajotte.

Good morning to all committee members.

Good morning. My name is Ian Russell. I appreciate this opportunity this morning to appear before the House of Commons Standing Committee on Finance to participate in your discussion on an assessment of the measures taken to enhance credit availability in the capital markets.

I'll keep my opening remarks fairly brief, and I really look forward to questions on a full array of the subject matter, be it the credit availability questions or the regulatory reform that we're all embarked on, not just in Canada but globally.

It did not take long for the real economy to be affected. The financial impact and loss of confidence are being felt in every region and in every sector.

We've gone through a very difficult time in financial markets over the last six months, and it's unfolding quite dramatically in its impact on the real economy. Portfolio values are generally down about 20%, with equity investments down 30% to 40%. Real estate values in Canada are in the early stages of following global trends, unemployment rates are trending higher and are already at multi-year highs, and, as you're all aware, consumer spending has retrenched.

One of the areas that I wanted to touch on and elaborate on with this committee extends a bit beyond the measures we're seeing to really an assessment of the measures that were put in place during the budget.

I have to single out the efforts of the Bank of Canada really since the beginning of this crisis in the summer of 2007. Both the bank and the federal government, through its budget, have put in place very effective measures to improve the liquidity and functioning and credit capabilities within the capital markets, but there are still liquidity concerns in the marketplace.

Despite the success of some of the measures implemented to provide liquidity to the banks, such as the insured mortgage purchase program, for example, certain capital markets products have not been able to benefit from them.

Many corporate issuers still remain on the sidelines, and while the reasons are partially due to a general de-risking of investment by buyers, a significant factor in this development is a lack of robust market liquidity. Authorities must remain vigilant in monitoring and identifying the pockets of liquidity that may disrupt the normal functioning of important sub-markets, or the market as a whole, and continue to assess what must be done over and above the remedial measures that have already been taken to address these situations.

We applaud the government for following the recommendation made by the expert panel on securities regulation, and implementing a transition plan to create a Canadian securities regulator with willing provinces and territories.

I'll close with those remarks, Mr. Chair, and again look forward to questions covering that wide range of territory.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Russell.

We'll go to Mr. Phillips.

[David Phillips, President and Chief Executive Officer, Credit Union Central of Canada]

Thank you, Mr. Chairman.

I have about five minutes of opening remarks.

Mr. Chair, members of the committee, thank you for the opportunity to speak to you today.

I'm joined by Mr. Ralph Luimes, chief executive officer of HALD-NOR Credit Union, located in southwestern Ontario. Mr. Luimes is also the chair of the steering committee responsible for the Canadian business owner strategy, our system's initiative aimed at the small to medium-sized business market. But more on that later.

Before addressing the issue that brings us before you today, please allow me to begin by making a few preliminary remarks regarding the role of Canadian Central, my organization, and more generally the credit union system in Canada.

Canadian Central is a federally regulated financial institution that operates as the national trade association for its owners, the provincial credit union centrals, and through them for approximately 440 affiliated credit unions across Canada. With over 1,700 locations, serving more than 5 million members, 24,000 employees, and holding $114 billion in assets, credit unions represent an important component of the Canadian economy.

Credit unions in Canada come in all shapes and sizes and operate in almost every community, including large urban centres. Credit unions are the first choice of financial institution for many Canadians. In fact, one in three Canadians is a member of a credit union or a caisse populaire.

We believe these numbers reflect the system's strong cooperative values and commitment to the economic development of their communities in good times and bad. This commitment is illustrated by our continuing presence in more than 380 communities in Canada where a credit union is the only financial institution in town. Community involvement and commitment are also evidenced by the high level of the system's charitable donations, scholarships and bursaries, and employee participation in community development. In fact, in 2007 Canadian credit union community involvement reached $35.8 million.

Let us now turn to the topic that brings us before you here today: credit availability and the stability of the Canadian financial system. Let me first assure you that as member-owned institutions, credit unions are very much aware of the economic difficulties currently facing Canadians, and credit unions are working closely with their members and their communities to temper the impact of the crisis.

That said, certain reports have claimed that the availability of credit to businesses and consumers has, in recent months, shrunk. As a general observation, this may be true in that non-traditional lenders have retreated as financial market liquidity has grown tighter and the market for securitization has shrunk. However, the credit union system has not participated in this pullback from credit granting. Instead, we have pursued our more traditional relationship-based approach to lending, and credit unions continue to meet their members' demands.

In 2008, credit union loans grew by 7.2%. In the last quarter of 2008, our loans increased by 1.6%, which on an annualized rate amounts to a growth of 6.5%. Loans as a percentage of total deposits were 93.7% at the end of 2008, down slightly from 95.8% 12 months before, a reflection of strong growth in deposits in 2008. That stated, it's interesting to note that 10 years ago loans represented only 87% of total deposits.

Credit unions are committed to the small and medium-sized business market. Industry Canada statistics illustrate this as well. A comparison of Industry Canada SME lending data, looking at the chartered banks, foreign banks, and credit unions reveals that nationally, credit unions account for 18% of the SME lending market for authorizations $500,000 and under. In P.E.I. and Manitoba, this figure is 50%. In Saskatchewan it equals 62%, in Alberta 20%, and in B.C. 28%. This market is a key to credit union growth, and our system will not pull back from our SME members.

Our commitment to this important market is further demonstrated by the system's Canadian business owner strategy, more commonly known within our system as CBOS. Created in 2005 to enhance the competencies and capacities of credit unions to serve the business owner market as well as to raise awareness about credit unions with business owners, CBOS has actively engaged over 300 credit unions since the start of the program.

As for the matter of financial stability, I wish to highlight that the credit union system remains strong. Despite the economic downturn that began in the last quarter of 2008, the Canadian credit union system ended 2008 on solid financial ground. System assets, savings/deposits, and loans all recorded gains, maintaining the annual growth reported in previous quarters, although down somewhat from the rates reported in 2007.

By the end of 2008, the combined assets for affiliated credit unions and caisses populaires across Canada rose by 8.7% or $9.1 billion, to reach $113 billion. This is a 45% increase, or a $35.2 billion gain, over the last five years. Deposits and savings growth remained strong as total deposits with credit unions increased to $100.6 billion in the fourth quarter of 2008, up 9.5%, or $7 billion, from the previous year.

We believe the system is well positioned to face the challenges presented by the current economic situation and the opportunities to come in 2009 and beyond.

We wish to thank you once more for the opportunity to address you today. Mr. Luimes and I will be pleased to answer any questions you may have.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Phillips.

We'll go to Mr. Bethlenfalvy, please.

[Peter Bethlenfalvy, Co-President, DBRS]

Mr. Chair, members of the committee, my name is Peter Bethlenfalvy and I am Co-President of DBRS Ltd.

DBRS is pleased to have the opportunity to provide a statement of its views regarding this critical topic. My discussion will focus on the following areas: programs to enhance credit availability and stability in the Canadian financial system; and Canadian regulatory reform. I would like to begin by providing a brief overview of DBRS including our role in the market and our regulatory status.

DBRS is a Canadian credit rating agency established in 1976 and still privately owned by its founders. With a U.S. affiliate located in New York and Chicago, DBRS analyzes and rates a wide variety of issuers and instruments, including financial institutions, insurance companies, corporate issuers, issuers of government and municipal securities and various structured transactions. DBRS currently maintains ratings on more than 43,000 securities around the globe. DBRS rates approximately 100 of the largest banks in the world, including Canada’s major banks, insurance companies, credit unions and pension funds. This gives us a unique perspective on the functioning of Canadian financial markets from a global perspective. Since its inception over thirty years ago, DBRS has been widely recognized as a provider of timely, in-depth and impartial credit analysis, and makes its ratings available to the public free of charge.

Given its extensive role in the market, DBRS is committed to ensuring the objectivity and integrity of its ratings, the independence of its analytic staff, and the transparency of its operations. DBRS has adopted a business code of conduct in accordance with the International Organization of Securities Commissions, also known as the IOSCO code.

The IOSCO code is a globally recognized framework of practical measures designed to improve investor protection, the fairness, efficiency, and transparency of the securities market, and to reduce systemic risk.

An IOSCO review published on March 12, 2009, found that seven out of 21 global credit rating agencies, with DBRS being one of the seven, have implemented the 2008 IOSCO code on credit rating provisions. IOSCO noted that DBRS substantially incorporated the IOSCO credit rating agency code with few exceptions.

DBRS believes the IOSCO code continues to serve as an appropriate foundation for prudent regulatory oversight in all jurisdictions, and that globally consistent regimes are critical for well-functioning markets.

In addition, DBRS is registered with the SEC in the United States as a nationally recognized statistical rating organization, also known as an NRSRO, and has achieved global regulatory recognition, including recognition as an external credit institution in the United States, Canada, the European Union, and Switzerland.

With that context, let me now turn to our views on the programs to enhance credit availability and the stability of the Canadian financial system, while minimizing risks to the public.

The extraordinary financing framework introduced in January under the federal budget--much along Ian's comments--was a welcome move to improve access to financing for consumers and allow businesses to obtain the financing they need to grow and create new jobs.

In October 2008 the Bank of Canada introduced measures to provide exceptional liquidity to the financial system, as long as conditions warrant. Collectively, these programs are critical vehicles to stimulate liquidity and provide funding if and where necessary, or, as I like to put it--and I think this is a fundamental point for Canada--funding if necessary but not necessarily funding.

Investment grade corporations have been able to tap the public and private term markets, including the credit unions, that issue short-term commercial paper, as evidenced by a flurry of new issuance activity over the last few months. The commercial paper market continues to be robust, and many Canadian companies manage their liquidity prudently; however, securitization, in particular the term asset-backed market, remains frozen, unlike the asset-backed market, which continues to function and has approximately $50 billion outstanding.

DBRS appreciates the comprehensive consultation efforts regarding the Canadian Secured Credit Facility--the equivalent, I guess, of the TALF in the U.S., the Term Asset-Backed Securities Loan Facility; however, more needs to be done to stimulate this market. Term asset-backed issuance year to date has been just over $1 billion, versus $9.5 billion for the same period in 2008.

Depending on how rapidly these markets thaw and/or markets freeze again, additional programs may be necessary. DBRS is also supportive of quantitative easing should the need arise regarding this market, and it believes the Bank of Canada’s role as lender of last resort is fundamental.

This brings me to my second topic: Canadian regulatory reform. DBRS believes the Canadian approach to banking oversight has shown itself to work very well compared to other jurisdictions. The U.S. regulatory landscape has a patchwork of institutions that requires a significantly different response. A systemic view of risk is prudent and necessary. The U.S. proposal for a new super-oversight body for systemic management of exposures in the financial system is a good step forward.

In contrast to the U.S., DBRS believes that Canada has the right mechanisms in place to oversee systemic risk. At present, Canada has a Financial Institutions Supervisory Committee, chaired by Julie Dickson of the Office of the Superintendent of Financial Institutions, and includes, among others, the chairman of the Bank of Canada, and members from the Department of Finance, CDIC, and CMHC. They meet to discuss broad issues.

DBRS suggests that the Bank of Canada should continue its monitoring and liaison role to OSFI and as a lender of last resort, but not as a regulator. There is a necessary separate but integrative role for each of the Bank of Canada, OSFI, CDIC, a national securities regulator, and the Department of Finance.

Turning lastly to the global markets, the global credit crisis was caused by a super bubble of debt, but the lack of transparency and disclosure was the accelerant to its unwinding. DBRS believes that enhanced transparency and disclosure are key to normalizing credit markets, including greater international regulatory harmonization.

Over the last 18 months, DBRS has implemented a number of changes across this business, with particular focus on structured finance, to enhance the quality and transparency of its credit rating process and to help restore confidence in the credit-rating opinions.

In early 2008—my final comment—DBRS took the initiative to restructure its reporting to provide more timely and transparent disclosure on securitized asset-backed transactions, and this is a leading disclosure type among all asset-backed commercial paper markets in the world. In fact, DBRS will decline to rate asset-backed commercial paper programs when an appropriate transaction level of information is not forthcoming.

As a result, we believe DBRS and Canada are providing leadership to other jurisdictions in the area of transparency and disclosure.

DBRS has a long and proud history of playing a role in the Canadian and global capital markets. We take this role very seriously and are appreciative of being given the opportunity to share our insights with members of the committee.

I would be pleased to answer any questions you may have. Thank you.

[The Chair, Conservative, James Rajotte]

Thank you for you presentation.

We'll start with Mr. McCallum, please.

[John McCallum, Liberal, Markham—Unionville, ON]

My question is for Mr. Bethlenfalvy.

It's fair to say I think that you had a lot of egg on your face at the time of the asset-backed commercial paper crisis, where you were the only rating agency to give a triple-A rating. Is that a fair comment?

[Peter Bethlenfalvy]

We did rate a number of asset-backed conduits with the triple-A rating, yes.

[John McCallum, Liberal, Markham—Unionville, ON]

We had hearings following that, and we hadn't gotten to you until now, but I'm a little bit surprised that you come in and give your recommendations for improving stability and all of that without any comment whatsoever on the egg you had on your face and the essential role you played in that crisis.

Can you describe briefly what led you to that position and how much blame do you accept for yourself for what happened?

[Peter Bethlenfalvy]

We did, as I mentioned, rate 43,000 securities. The asset-backed is part of our ratings.

We focus very much on the credit quality of the programs. What we didn't anticipate was the global liquidity crisis. We focused on the credit quality. And in fact if we fast-forward through these 18 months, past the Montreal accord, the reissued notes have received a single-A rating from us.

[John McCallum, Liberal, Markham—Unionville, ON]

Yes, but at the time you gave a triple-A rating, and had you not done that we probably wouldn't have had this crisis, because no other rating agency was willing to do that. Is that not right?

[Peter Bethlenfalvy]

I'm not going to comment on the methodologies or the practices of the other rating agencies.

[John McCallum, Liberal, Markham—Unionville, ON]

No. I'm saying they didn't give a rating.

[Peter Bethlenfalvy]

They may not have been asked to give a rating, For a number of years, Canadian investors and regulators and market participants were quite happy with the market for asset-backed commercial paper.

It is true that we did not foresee the depth of the global liquidity crisis; we did not foresee credit spreads widening to levels not seen since 1932, and then beyond. I think it's a testament to some of the credit analysis we have done that the majority of the notes still maintain an investment grade rating, a number of firms continue to hold—

[John McCallum, Liberal, Markham—Unionville, ON]

I wold have thought you might have shown a little bit more humility and a little bit of willingness to accept at least a modicum of the blame for this, because so many Canadians, many of low income, had their assets frozen. It was a crisis at the time. Fortunately, it's been resolved in a satisfactory way...or reasonably satisfactory. It's a lot better than it was months ago. But the conventional wisdom seems to be that had you not taken this action on the triple-A ratings, this crisis probably would not have happened. So in that sense you're at the centre of it.

You seem to be saying very little about that and offering all sorts of advice, whereas I think what we would want to hear is how come you got it so wrong and what have you done so that we can have any confidence that you won't do such a thing again.

[Peter Bethlenfalvy]

There are many questions in there. Let me address the issue of contrition or our responsibility as a major participant in not just the Canadian capital markets but in global capital markets.

We accept our share of responsibility for the ratings, for all ratings that we provide. They are opinions. They're based on public methodologies. We're very public about how we got to those ratings. In fact, the day after we met with interested parties—investors, media, anyone—to talk about those ratings.

So we accept responsibility in the context of unforeseen events in the global market.

Since that time, we've taken a number of steps to improve our rating process. First of all, as I said in my remarks, our level of disclosure now for asset-backed commercial paper is the highest standard in the world, and we provide more disclosure on a transaction-by-transaction basis on what's in the portfolio, the type of assets. We provide that on a monthly basis.

Secondly, we've enhanced a number of our methodologies, based on some of the learnings we've had, not just in asset-backed but in a whole range of securities. The securitization market is a massive market, and asset-backed is just one part of it. So we've enhanced a number our methodologies. We're created a structured finance committee, which now approves any methodology or model from many areas of the firm, so that not one area can dominate its view. As I've said, we now follow, and fully subscribe to and have been approved by, the IOSCO code, which is securities commissions—Quebec, Ontario, and all the securities commissions, major ones, on the planet.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you.

I want to shift a little bit away from your rating agency to rating agencies in general. As we speak, the G-20 is meeting, and there's a big push among at least some countries in the G-20 to have much tougher regulation. When I read these reports, it seems there are three groups that are lumped together as in need of regulation: tax havens, rating agencies, and hedge funds. They are entities that have fundamental governance issues and therefore need to be brought under greater control.

In the case of rating agencies, one of the issues--and I'm not talking only about yours--is what some would regard as a fundamental conflict of interest, that the people you rate are the people who pay you. That causes a little bit of a conflict, not just for you, I hasten to repeat, but for rating agencies in general.

So my question is, would you concede that those countries, notably France, but not only France, I believe, that are pushing for far greater regulation of rating agencies at least have a point?

[Peter Bethlenfalvy]

Again, you have a number of questions there.

With regard to the point, we accept oversight, absolutely, and we subscribe to that oversight. In fact, the SEC has published its rules for regulating rating agencies, with which we're compliant. In fact, those rules come into effect on April 10 and we're fully compliant as of March 31.

With regard to the G-20, as you know, Canada is a co-chair of the working group, along with India, on regulatory reform, including credit rating agencies. Their communiqué on March 12, so only three weeks ago, talks about the G-20 finance ministers and central bank governors having agreed to regulatory oversight, including registration of all credit rating agencies whose ratings are used for regulatory purposes and comply with the IOSCO code.

So that's the G-20. France, Germany, the U.K., Canada--which is a key member, as I just mentioned--have subscribed to the IOSCO code of which we're one of seven that are compliant. And we are fully compliant with the SEC rules that were published in February and need to be followed in April.

[John McCallum, Liberal, Markham—Unionville, ON]

Okay. Thank you very much.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Monsieur Laforest.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Thank you, Mr. Chair.

Good morning to everyone.

Mr. Bethlenfalvy, I would like to know a little more about the mechanics of this. You were the only agency to grant a triple A rating to ABCP. The other credit rating agencies refused to rate those securities.

How does your financing work? Who pays you? Do you charge a fee every time you give securities a high rating or when someone buys them?

[Peter Bethlenfalvy]

Thank you for the question. If you do not mind, I will answer in English. Thank you.

Let me address the conflict of interest, because the honourable member raised that as well.

There's always a conflict, regardless of who pays you. The underwriters get paid by the issuer. The accountants get paid by the issuer. The lawyers who do an underwriting get paid by the issuer. So there's always conflict.

I think the key thing with regard to conflict of interest and who pays you is that you have separation between those who do the rating and the actual payment of the rating.

We at DBRS have long separated those two. In fact, we've taken it a step further. People who are on the analytical side don't even know if we get paid for the structure, or for the rating, or even how much. They're not even aware. So forget about negotiation. They're not involved in negotiation. They're not aware.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

I will re-phrase my question. When you rate a security, do you receive more money if more people buy that security?

[Peter Bethlenfalvy]

No, we do not. It's a flat fee. The structure is a flat fee. It doesn't matter how many people buy that security or the types of people who buy that security, we do get a--