Finance Committee on May 18th, 2016

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Thank you.

That's it, Mr. Chair.

[The Chair, Liberal, Wayne Easter]

Mr. Caron is next, and then Mr. Albas.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Good afternoon, Mr. Campbell. Thank you for joining us. At our last meeting, we began a discussion that we could unfortunately not finish. So I will put some questions to you that I felt were rather important.

On either side of the political spectrum, there are many people who are worried by such legislation because they draw parallels with what happened in Cyprus, where small depositors' money was seized and used to bail out failing banks or financial institutions.

I know that's not what the bill provides for, and I want to use your presence to reassure our audience. However, I am worried by the fact that the bill does not establish a definition of what constitutes a long-term debt that would be converted into shares when a bank is failing. That will only be defined through the regulations, but regulations can be amended, since Parliament is sovereign, as Mr. Champagne said, and since the executive makes that decision within a sovereign Parliament.

Could you explain to us the mechanism through which a bank would be bailed out, and explain what that implies, especially in terms of converting certain elements into shares? What safeguards are there to prevent a government from amending regulations in order to use, for instance, clients' deposits?

[Glenn Campbell]

Thank you for the question.

Let me step back to explain. What is in the proposed amendments is the legislative framework for setting out how the conversion process would work and the authorities under the Minister of Finance, the Superintendent of Financial Institutions, as well as the CDIC.

The whole concept here is around long-term debt securities. The nature of long-term debt securities, which are what would be bailed in under that scenario, can shift over time, so you're quite right that the definition could be adjusted over time.

The purpose of putting them in regulations and not in legislation is twofold. First, we need to consult with the industry precisely on the definition of what constitutes a long-term debt security—the nature of a debt security going over 400 days, the type of composition—and make sure that we have it stated in legislation precisely enough to capture what banks are going to have to do under contract law to issue these new securities. It needs to be quite precise.

We'll also need to have the certainty under which they can issue these, and that will come from legislation and regulations. Banks currently issue non-viability contingent capital, that instrument being under contract law. The industry is looking for more certainty, which is being provided by the act and by the regulations.

Deposits are not referenced in the legislation because they're not contemplated. Really, the framework here is long-term debt securities.

As we mentioned in our last discussion, the whole premise here is to keep a bank operating, to keep customers protected, and to retain deposits and attract new ones. That's the whole purpose of trying to keep a systemic institution serving its customers and the Canadian economy. That's what is at root attracting this level of oversight and this power. It's because the institution is so important to keep its deposits and its customers going that we have this tool.

To answer the latter part of your question, concerning the process and safeguards, in this instance we're entrusting that the process would work in the future. If there were a bank that potentially got into trouble, it would obviously be made known to the Superintendent of Financial Institutions and all the agencies that are involved. If we got to a point that there was deemed to potentially be non-viability of that institution—which means that there's a very significant, remote, circumstance in which their level of regulatory capital or losses would be such that the bank would technically be insolvent—the superintendent would go to the CDIC and basically indicate that there's a scenario of non-viability.

They would consult on what the appropriate remedy would be. As you can see in the act, there are various options in the tool kit for taking control of an institution: temporarily or over time, assets and liabilities, bail-in. It depends on the circumstance.

The superintendent would in turn go back to the Minister of Finance, who would have to come to the government authority to seek permission and authority to use one of those tools. The safeguard is built in that the Minister of Finance has a role and that the Governor in Council has a role. The Governor in Council would then approve which of the tools in the tool kit could be exercised for that bank under that scenario. That would be communicated to the CDIC, and then they would have the authority to move forward on one of those options around taking control and, depending on the scenario, executing bail-in.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

I will quickly summarize what you just said. It's not as simple as the cabinet, or the Governor in Council, deciding to change the definition and amend the regulations, which would then be published in the Canada Gazette and applied. The executive could not proceed in this fashion. Is that what you are saying?

[Glenn Campbell]

Yes, that's what I'm saying.

Also, to clarify concerning what is included in the regulations, before we promulgate regulations, we need to consult with all of the industry. If a future government or Governor in Council wanted to change those regulations, the same rules would apply. They would have to go back and negotiate with all of the industry that have issued this debt and these securities and with all the investors.

To change the nature of what constitutes a long-term debt or what constitutes an asset available for bail-in is quite a complicated ordeal. The premise here is to give the industry certainty and to give foresight into how long it would come into play. It does not apply to legacy assets; it only applies to new instruments. The Canadian regime would be fully transparent. It would really be set in the framework and legislation and clarified in regulations.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Mr. Chair, I have other questions, but I can let my colleagues ask some before I come back to mine.

[The Chair, Liberal, Wayne Easter]

Okay. Mr. Albas, then Mr. MacKinnon, and then Mr. Bittle.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

Thank you, Mr. Chair.

Thank you, witnesses, for being here today and for the work you do for Canadians.

I would like to discuss some of the unintended consequences of a new policy. Obviously, the terms “risk” and “reward” come up quite often when we talk about financial institutions and whatnot. With this new framework it sounds to me that putting more certainty in these kinds of scenarios is a good thing. Elected officials making decisions by the seat of their pants is not something most people want to see. I think people want to see what kind of plans we could do ahead of time.

Will the market respond by offering new ways to use this system to trade in different options on whether or not someone or a bank will be viable? Will any of that come because of this legislation?

[Glenn Campbell]

That's a good question. Thank you for it.

In simple terms, a bank will issue different varieties of short-term and long-term debt securities to fund itself in the ordinary course where those creditors are funding the bank for a return over time and there are different types of instruments. Those instruments are issued and they're also traded on the secondary market, much like on the other side of the balance sheet you have shareholder equity where you'll have common shares that are issued and held by individuals, but are also traded in the secondary market.

On any given day, shares or debt securities are constantly being traded, based on the market scenario and their understanding of the profitability of an institution.

I can't speculate on whether new instruments will be created, but I can say on any given day in the normal course or in stress times the market on both sides does work as it should, and it offers pricing scenarios on both of those instruments. I would see that as a normal functioning of the marketplace.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

Secondary markets are usually not as transparent as a primary market. You spoke earlier that the aim is to be fully transparent. I'm going to leave that thought, and I'll come back to it in a second.

We've made it very clear that depositors are not included in this regime, which I think is an important message to send to Canadians, so they understand what the model is trying to do.

Hard-working Canadians have put a lot of investments into pension funds. Obviously, you have the Ontario teachers and their very large pension funds, but individual investors have also put money into banks and whatnot.

Many Canadians invest in banks and often they may or may not have put in the time and energy to investigate a bank, where it's at and its viability. In this unprecedented remote scenario, If a bank were in a conversion process, would that put their investment at a disadvantage?

[Glenn Campbell]

Again, that's a very clear question. In ordinary course and in stressful times the value of a bank's market capitalization, which is the value of its shares, will fluctuate. In ordinary and in stressful times where there is profitability, headwinds that are fully transparent on a listed exchange, then the value of those shareholdings will fluctuate whether Canadians own them directly or indirectly. That's just a common share, which is not being touched here.

A debt security will have a value on its own for a period of time that will be repaid and will not necessarily fluctuate. There will be some impacts on the secondary markets if the bail-in is converted, in the sense that the value of the common share will obviously decline to some degree. To the extent to which any asset or any fund has exposure to any of the debt securities they will also decline. In that case you're converting a debt to a potential common share, which may have future value.

It would be very rare for average Canadians to have direct exposure to big bank debt securities. Generally large asset managers and pension funds own them on a very diversified funding basis, and even funds, mutual funds and others that Canadians may be exposed to that have the debt security side rather than the equity side are likely highly diversified if not to the whole banking sector, let alone an individual bank.

Of course, if the bank were to get into trouble, whether or not we have a bail-in regime, the value of those instruments in the capital market will adjust appropriately.

As last comments, one, we would hope that any Canadian would get the advice they need to prudently manage their exposure to any financial instruments, and two, trading in the secondary market for debt securities is quite transparent to all the large players in the market.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

I have a very brief comment, because I want to tie the two of them together. You're absolutely right. If an investor participates and is a shareholder, there is inherent risk with that, so it's incumbent upon them to get the information.

The one thing I would simply ask is whether the current legislation requires the Office of the Superintendent of Financial Institutions to publicize the stress tests that are done to make sure that these banks are within a comfortable zone.

[Glenn Campbell]

No, this legislation does not do that. The issue of a stress test is at the discretion of the Office of the Superintendent of Financial Institutions. During different parts of an economic cycle they may do stress tests, but the decision about whether to publicize them in any jurisdiction is always one that trades off various balances. It's really a decision for the superintendent, but there's nothing in the bill here that pertains to stress testing.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

As a parliamentarian, I would just say that's a concern, because again the whole idea of the legislation, as you've said a number of times, is to create a fully transparent model and to make certainty. If there is going to be secondary market trading of instruments that are not available today, your ability to trade is only as good as the information you have.

That is a very sophisticated market. I'm not as concerned with that, but when you go back to it, many Canadians hold their wealth in banks through shares or through mutual funds. I do believe that we need to be fully transparent.

I would ask government members to maybe consider, as part of a future budget implementation act, requiring that stress tests be made freely available, so that both the public and the professionals who deal in these secondary markets can actually make up their own minds.

Thank you.

[The Chair, Liberal, Wayne Easter]

Thank you, Mr. Albas.

Mr. MacKinnon, the floor is yours.

[Steven MacKinnon, Liberal, Gatineau, QC]

Thank you.

Thank you for the work you are doing to facilitate the long-term work before us.

We all know that Canada has a very strong financial system that is the envy of the whole world. It is thanks to people like yourself, and to other institutions not represented here today, that we have this kind of a system.

I have a few questions. If there is a lesson we have learned from the financial crisis, it's that the notion of systemic risk goes beyond the banking sector, correct?

[Glenn Campbell]

Generally speaking, that is true, in the sense that this legislation clearly pertains to the banking sector, but clearly, it has a feedback mechanism into the whole economy.

[Steven MacKinnon, Liberal, Gatineau, QC]

I would like to follow up on the questions of my colleague opposite.

We know that pension fund managers, including the Caisse de dépôt et placement du Québec, hold securities in our financial institutions—either shares or debt securities—which represent a considerable amount of the investments and shares in those institutions.

[Glenn Campbell]

They do. Our Canadian asset manager class, which includes pension funds and other asset managers, does hold an extensive exposure to the Canadian banking and financial sector. A lot of global asset managers also have exposure to the Canadian banking sector.

If I understand the premise of your question, whether you're an asset manager or anyone else who is a shareholder in a bank, there is a responsibility to be an owner and to actually influence the outcome of that institution.

Likewise, if you're a creditor and a significant creditor of a bank, this legislation basically means that even as a creditor, you're also responsible and your incentive should be aligned to ensure that the institution in which you're investing is following prudent, responsible practices. It's actually the incentive of those asset managers' pension funds to ensure that they know what they're investing in and that they have an influence through their shareholdings on the common side, but also an influence given that big debt purchasers of the bank also have a role in the solvency of that institution.

[Steven MacKinnon, Liberal, Gatineau, QC]

The risk or the risk premium has to be calculated and assessed properly by those security holders.

[Glenn Campbell]

Correct. This is all about aligning the risk to the appropriate return and ensuring that incentives are aligned for prudent management.

[Steven MacKinnon, Liberal, Gatineau, QC]

I know that we are discussing remote possibilities. I hope they are not even remote, but minute.

It is explained here that there is a process regarding provisions on redress available to holders of securities or debt in a bank. Who is in charge of that process?

[Glenn Campbell]

Under the legislation that exists now, CDIC is in charge, or a steward, if you will, of an institution while under control, as we transition to the private hands.

If a bail-in were to have been triggered, there is a redress mechanism for compensation built into the regime on due process, to basically allow any affected party from the bail-in to ensure that they would have a claim on the CDIC if it turns out in some way that they would have been better off in a bankruptcy insolvency situation. This is a very high standard, but it is built in as a redress mechanism for those. So those who do invest in bank securities, they are aware under that very remote, highly unlikely scenario that there is a redress mechanism built in so that if they can make a claim that they would have been better off under insolvency, they could seek redress from the Canada Deposit Insurance Corporation.

[Steven MacKinnon, Liberal, Gatineau, QC]

So the request....