Madam Speaker, I too am pleased to have the opportunity to join in the debate on Bill S-40, an act to amend the Payment Clearing and Settlement Act.
I will start by saying there is not much in the world I know less about than the clearing of derivatives, et cetera. However I undertook to learn a bit about it so I could convey my party's opinion and the recommendations of our critic. I found it quite fascinating. It is an area of study I have never expressed an interest in or spent a lot of time on but I found it gripping.
I can tell from some of the speeches given today that some people view this as a rather dry issue. I do not. Even as a layperson in the financial market sector I sense there is a crisis of confidence in the financial community on Bay Street, on Wall Street and among major institutional investors. Bill S-40 is one step that may re-instill at least some semblance of confidence because it deals with making sure investments enjoy a greater degree of security.
The bill seeks to amend the Payment Clearing and Settlement Act to permit securities and derivatives clearing houses to realize the collateral of members, for example deposits for commodities, securities, or currency contracts in the event of bankruptcy or insolvency. This would give a measure of added confidence to the sector.
Bill S-40 had its genesis in extensive consultations with officials from clearing houses and from the stock exchange in Montreal. The finance critics of all opposition parties had broad consultation and were allowed input at the early stages. This may explain why we are seeing a great deal of co-operation in putting the bill through.
Bill S-40 is a technical bill with only one clause. It is short and to the point. It was expedited through the Senate in only two weeks. The committee stage lasted only an hour. Clearly there was broad consensus that it was a necessary and desirable thing to implement.
Canadian securities and derivatives clearing houses enable consumers and businesses to buy and sell securities and derivatives in a timely manner and at a reasonable cost. They do this by providing clearing and settlement services and acting as a central counter party to securities and derivatives trades. This is what our research revealed.
Although the NDP generally and I personally do not have a lot of use for unfettered speculation and are no great friends of derivatives, in researching the issue we have come to learn that there are good and bad derivatives. Our criticism of the speculative derivative market is therefore only valid in a certain sense.
There are good and bad derivatives. Good derivatives help hedge corporate treasuries against risk such as price changes and currency fluctuation risks. There is a role for such derivatives in helping corporations hedge risk with their investments.
Bad derivatives, the ones we are critical of, are about gambling. They are about rolling the dice with people's money. They are about casino capitalism. Speculative derivatives allow corporate or individual gamblers to make bets on the future price of underlying assets by betting a fraction of the cost of an asset. The leverage comes about because the derivative instrument replicates the borrowing or lending of the underlying asset.
This is what I have found although I had to read it a couple of times to get the gist of it. The opportunity for leverage comes about because the derivative instrument involved replicates the borrowing or lending of the underlying asset without ever having to physically own it.
This is an abstract concept a lot of lay people and ordinary Canadians would not necessarily know. However they had better get to know it because it is an unbelievably exploding market. A lot of people's pension dollars may be invested without their knowledge. Money managers who handle employee benefit plans and investments are surely dealing with some of these issues. We should know about it.
I will give members an illustration of the explosion of the derivatives market. Some $64 trillion was traded in derivatives in 1995. In 1997 the figure was $360 trillion. Today more than $1,000 trillion is invested in the derivatives market. Surely we need to take great interest if that is the direction in which the investment marketplace is going.
We view this as a negative. We do not believe such massive investment marketplace can be regulated in an adequate way. As members might expect, the scope and magnitude of the investment marketplace causes major regulatory problems. It is a moving target. Anything growing and expanding at that rate is difficult to nail down. The bigger the corporation the less transparency and accountability. That is what has led to the crisis of confidence in the investment marketplace. It is because of the massive losses of companies like Enron. We have all heard of Merrill Lynch. Merrill Lynch is being charged by the New York state attorney general for biased research. It is causing a crisis of confidence in the whole financial sector.
As we are dealing with this or trying to get our minds around what $1,000 trillion worth of activity and derivatives speculation looks like we must also try to get our minds around how to safeguard those involved in the massive free for all gambling in the derivatives speculation marketplace.
There are major regulatory problems. The Enron fiasco is only the tip of the iceberg. It was partly due to the fact that derivatives transactions were booked between private parties rather than a public, transparent and fully regulated clearing house system. The failure of auditors and their lack of independence was a contributing factor but the real root of the problem can be traced to the fact that derivatives transactions were booked through private parties rather than a public, transparent and fully regulated clearing system. Anything we can do to alleviate the problem would surely would give comfort to those involved in the financial sector.
A massively leveraged hedge fund was held by Long Term Capital Management fund or LTCM. I am sure most people are familiar with it. It showed up in the news. LTCM had a substantial amount of the world's economy hedged on the future narrowing of interest spreads by the U.S. treasury. It rolled the dice based on the future of narrowing of interest spreads in the U.S.
By mid-1998 LTCM had about $4 billion in equity capital and borrowed funds of about $120 billion, a hefty leverage of about 30 times. Red lights should be going off all over the place when a company is leveraged at 30 times, with $4 billion in equity capital and $120 billion borrowed on something as speculative as the spread between real interest rates. It is a recipe for disaster. Amazingly, the leverage was compounded tenfold by LTCM's off balance sheet derivatives exposures which amounted to another trillion dollars.
These are the stakes the big guys play with. With $4 billion in equity capital LTCM borrowed funds of about $120 billion for a leverage of 30 times. It compounded that tenfold with off balance sheet derivatives exposures that amounted to more than $1 trillion. It is like Rumplestiltskin spinning straw into gold when a company takes $4 billion and spins it into a trillion dollars. It is incomprehensible to little people like us.
A consortium of private banks led by the federal reserve in New York had to bail out LTCM. Fortunately no public sector money was involved, but it goes down in history as one of the biggest runaway freight train catastrophes in financial sector history. The truth of the matter is that we really do not know the long term consequences of what I call derivatives wizardry. We do not know what the real implications are for the real economy. What does it mean to real people? These guys are playing for big stakes in casino style capitalism. They are rolling the dice in this derivatives market and I think they are putting us all at risk.
Frankly, the real losers at Enron were not even the investors and the shareholders but the ordinary Americans who, with confidence, had their pension funds invested in that company on their behalf by money managers. They believed the auditors' accounts. They had no reason not to believe them. They trusted this institution of American capitalism. They thought that a company that big was beyond corruption. People think surely to God a company that big is regulated carefully and analyzed by the government and surely to God somebody is in our corner in that marketplace. It turns out that was not true. Tragically there were snakes at the top who were doing terrible things to thousands and thousands of Americans, because a lot of them have personally directed pension funds, like the Alliance has always advocated. The Alliance wants pension plans to be private, individual accounts that are invested on people's behalf. In this case, people's privately invested accounts disappeared and they lost their retirement security.
The step we are taking today in Bill S-40 is a step in the right direction to help alleviate some of those concerns and some of those fears. Our critic, the member for Regina--Qu'Appelle, who actually knows something about this kind of thing, recommends that we support Bill S-40. He points out some of the positives of Bill S-40, stating that it:
Enhances the stability of the financial system by enabling a securities and derivatives clearing house to immediately realize assets pledged as collateral in the case of default or bankruptcy.
I note as well that the bill will have primacy over the Bankruptcy and Insolvency Act. In the case of a clearing house being involved, this amendment to the bill will now have primacy over the terms and conditions and the order of disbursement of assets under the Bankruptcy and Insolvency Act.
What is good about this change in Bill S-40 is that it guarantees a swift payment of collateral to those clearing houses and ultimately it protects the stability of the system. That is what we are trying to do: restore people's faith in the integrity of the system. Frankly, that faith is wounded. It is damaged, it really is, and that is not good. We live in a system that relies very much on confidence in the system to promote investment. Bill S-40 achieves this by taking a shortcut to override the other bankruptcy legislation, as I have pointed out. It will have primacy over the Bankruptcy and Insolvency Act.
The mainstream argument in favour of Bill S-40 is that the legislation puts Canada on a level playing field with the U.S. and Europe and increases our financial competitiveness and Canada's ability to attract capital. That point has been made adequately by most who have spoken to the bill.
A main beneficiary of the bill would be the Montreal Stock Exchange, which also clears derivatives transactions for the Winnipeg Commodity Exchange in my riding of Winnipeg Centre. The Montreal Stock Exchange also specializes in futures.
We normally do not support legislation originating from the other place, but because this is a purely technical bill I think maybe it is a good idea to waste the time of the Senate instead of wasting the time of the House of Commons, so we can in fact approve of the bill coming forward through this method.
I will replay some of the key things. I caution members of the House. The truth of the matter is that we really do not know the long term consequences of derivatives wizardry. We are still critical of what we call the bad derivatives, because it is a rolling of the dice. It is gambling with futures and it is gambling with the confidence of the investment community, with the real implications for the real economy. Are we playing sorcerer's apprentice with the system?
Financial deregulation has expanded the investment horizon of private investors but has also created new systemic risks without really improving access to affordable capital and loans, which is one of the critical requirements for a moving economy. The increasing poverty of so-called emerging countries is an obvious case in point. The disciplining effects of markets adjusting to speculative derivative bursts contribute to endemic deflation, which, I would caution again, hurts the weakest and most vulnerable of countries, especially developing third world nations.
What is key in this debate? We believe that in order to restore confidence in the mainstream investment marketplace it is necessary to obtain a regulatory environment that would mandate transparent, standardized and strictly regulated off balance sheet items such as derivatives. We want to see this regulated for our own protection, not so that the heavy-handed estate interferes with the marketplace but for own protection. All derivative products should fall under that same regulation.
I note that when we dig a little deeper into the details around this amendment to the Payment Clearing and Settlement Act, Bill S-40, what it does is provide the Canadian securities and derivatives clearing houses with legal protections similar to those in place in the United States and other G-7 countries in the event that one of their members becomes insolvent or declares bankruptcy. There is a remedy put in place that is above and beyond the courts. It saves the lineup for who will divide up the assets of an insolvent company.
With over 190 member firms, the Canadian securities and derivatives industry is a key and vital player in Canada's financial system. The industry provides a mechanism for raising capital, channeling savings into investments and minimizing and hedging risks through these derivatives contracts. To explain the network throughout Canada, the three clearing houses, the Canadian Derivatives Clearing Corporation, the Canadian Depository for Securities and the WCE Clearing Corporation, clear and settle trades on four different exchanges, these being the Toronto Stock Exchange, the Bourse de Montreal, the Canadian Venture Exchange in Calgary and the Winnipeg Commodity Exchange.
As a central counter party, they assume settlement risks, that is, the risk that a member may default before a transaction is settled, which would result in a financial loss to both the clearing house and its members. Because of this, securities and derivatives clearing houses have risk reducing measures that require members to post collateral and net their obligations with the clearing house.
The Canadian securities and derivatives industry is in need of a competitive legal regime that lowers settlement risks for the clearing houses, and we support that point of view, and therefore lowers trading costs. We support that as well. This will make these clearing houses more efficient and competitive with the United States and other G-7 countries.
We are satisfied that the amendments in Bill S-40 accomplish this by expanding the scope of the Payment Clearing and Settlement Act to include legal protection for these securities and derivatives clearing houses of their netting agreements and collateral posted by their members. I would note that the protections being sought are above and beyond the current bankruptcy and insolvency laws.
Before closing I should mention that the changes in the bill are in line with recommendations made by the Bank for International Settlements, which is an international forum that fosters co-operation among central banks and other agencies in the pursuit of monetary and financial stability. The BIS supports a well founded legal basis for securities settlements so that rules and procedures can be enforced with a high degree of certainty. In particular, the BIS favours the enforceability of netting arrangements and the ability to realize assets pledged as collateral.
We believe that the amendments to Bill S-40 will help to ensure that Canada's financial sector remains efficient and competitive.
