The Bank Act and a number of other federal statutes relating to financial institutions must, by law, be reviewed every five years. As a result, the Bank Act review process must be completed by April 20, 2012 (the current statutory sunset date). As part of this five-year review process, the Canadian federal government launched its five-year review of legislation governing federally regulated financial institutions on September 20, 2010. This review process has culminated in Bill S-5 (the Bill) which is entitled the Financial System Review Act (the FSRA).The Bill had first reading in the Senate on November 23, 2011, and requires second and third readings in the Senate, first through third readings in the House of Commons and then Royal Assent before the FSRA can come into effect.
The Bill will amend legislation relating to the regulations of financial institutions, including amendments to the Bank Act, the Cooperative Credit Associations Act, the Insurance Companies Act and the Trust and Loan Companies Act, with the stated aim of reinforcing stability and fine-tuning the consumer-protection framework. The Bill will also make technical amendments to a number of statutes including the Bank Act, the Cooperative Credit Associations Act, the Insurance Companies Act, the Trust and Loan Companies Act, the Bank of Canada Act, the Canada Deposit Insurance Corporation Act, the Canadian Payments Act, the Winding-up and Restructuring Act, the Office of the Superintendent of Financial Institutions Act, the Payment Clearing and Settlement Act and the Financial Consumer Agency of Canada Act. The full text of the Bill can be accessed at http://www.parl.gc.ca.
The summary below only addresses amendments proposed to the Bank Act (the Act). The Act applies to domestic Canadian banks, bank holding companies, foreign banks and authorized foreign banks which carry on business in Canada. In most cases, the Act provisions that apply to domestic Canadian banks have similar or identical counterpart provisions that apply to foreign banks, authorized foreign banks and bank holding companies. Unless otherwise noted, the amendments discussed below will apply to all such bank entities.
Five Year Review Process
The government has preserved the provisions in the Act which require the Act to be reviewed every five years. This is accomplished by having a five-year statutory sunset date. The government's decision to preserve the five-year review process will likely be well received by market participants because it forces the government to review and update the Act on a regular basis.
Bank Act Security
Last year the Supreme Court of Canada (SCC) issued two decisions in which it determined that an unperfected Personal Property Security Act (PPSA) security interest had priority over a subsequent but perfected the Act security interest. The result of these SCC decisions undermined the utility of the Act security and has resulted in its non-use by Canadian banks. The proposed amendments to the Act security regime address the priority of the Act security in light of these SCC decisions. In summary, the Act, when amended, will include a statement that security properly taken under the Act has priority over a PPSA security interest (or any other security interest) that was unperfected at the time the Act security was taken except if the relevant bank, when it acquires the Act security, has knowledge of such unperfected security interest. It remains to be seen whether Canadian banks are satisfied with the legal effect of such proposed amendments such that Act security will once again be used.
Ministerial Approval Required for Significant Foreign Acquisitions
The Act currently requires the approval of the Superintendent of Financial Institutions (the Superintendent) before a bank can acquire control of a foreign regulated entity such as banks, cooperative credit societies, insurance companies, fiduciaries or securities dealers. The proposed amendments to the Act will augment the current requirements by requiring the Minister of Finance's approval in respect of transactions of a certain size. In particular, the Minister's approval will be required for any acquisition of control of a foreign regulated entity if (i) the acquiring bank has an equity of $2 billion or more (this would include all Canadian banks with public shareholders) and (ii) the value of the consolidated assets of such foreign regulated entity, combined with the aggregated consolidated assets of all other foreign regulated entities acquired by the bank in the last 12 months, exceeds 10% of the value of the acquiring bank's consolidated assets. In considering whether to grant approval for acquisitions of such foreign entities, the Act will permit the Minister to take into account all matters considered relevant in the circumstances including the stability and best interests of the Canadian financial system.
Foreign Bank Subsidiaries
Part XII of the Act applies to foreign banks. Under the current provisions of the Act, entities which would otherwise be considered foreign banks are excluded from the definition of "foreign banks" if such entities are subsidiaries of Schedule I banks (i.e., domestic Canadian banks). This exclusion had the potential of creating a regulatory gap if a foreign bank subsidiary of a Schedule I bank were to carry on business in Canada. The proposed amendments to the Act will close this gap by providing that this exclusion does not apply to the application of Part XII of the Act in relation to such foreign banks.
Inspection of Banks
The Act gives the Superintendent broad powers, including the power to examine the business and affairs of banks and, in connection with this power, the right of access to any records, cash, assets and security "held by a bank". The Bill proposes amendments to the Act to clarify that the Superintendent also will have the right of access to any records, cash, assets and security held "on behalf of a bank". This is an important clarification in the context of the growing trend in the outsourcing of certain operations and functions by banks (including storage and processing of information and records).
Exceptions to GAAP
Beginning November 1, 2011, the large Canadian banks with public shareholders will be switching to International Financial Reporting Standards (IFRS) for purposes of preparing their financial statements (some of the smaller Canadian banks may already have switched to IFRS). IFRS will be considered "Canadian GAAP" for such purposes. The Act and the regulations require banks to make certain calculations and valuations. The use of IFRS could result in such calculations and valuations yielding results that may not be considered appropriate by the Superintendent in view of prudential considerations. Recognizing this concern, the Bill proposes amendments to the Act that will give the Superintendent the power to make exceptions to the use of Canadian GAAP. Under this power, the Superintendent could specify the amounts, calculations or valuations to be used for any relevant purpose instead of what is prescribed by Canadian GAAP.
Widely-Held Ownership Threshold
The Bill proposes to increase the widely held ownership threshold for large Canadian domestic banks from $8 billion to $12 billion (the threshold was previous increased from $5 billion to $8 billion as part of the 2007 five-year annual review process). Corresponding changes have been proposed to the various size-ownership provisions of the Act, including the provisions relating to the number of eligible votes that may be cast at applicable shareholder meetings of such banks. The purpose of the proposed increase is to help banks keep pace with the growing financial sector. First introduced in 2001, the size-ownership framework of the Act prohibits a person from owning more than 20 percent of the voting shares, and 30 percent of the non-voting shares, of any large Canadian domestic bank.
Enhanced Consumer Protection
One of the primary objectives of the Bill is to fine-tune the consumer protection framework under the applicable federal financial institution and payment systems statutes. This theme prevails throughout the Bill, including the proposed amendments to the Act. Changes have been proposed to the cost of borrowing, tied-selling and other related consumer disclosure and notice provisions of the Act that permit the Governor in Council to make regulations in respect of the "place" and the "form" at and in which such disclosure and notice are to be provided, signalling that more prescribed federal government regulation in this area is likely to come.
The Bill also proposes to expand the scope of entities that are subject to the consumer provisions of the Financial Consumer Agency of Canada Act to include the agents and intermediaries of banks and their affiliates who offer bank products and services. In line with this change, the Bill also proposes to broaden the Governor in Council's current powers to regulate dealings between banks and their customers or the public to capture dealings between customers or the public and the agents and intermediaries of such banks, again signalling a potential increased consumer protection regulatory presence.
Mutual Fund Trustees
The Bill confirms the current market practice that Canadian domestic banks and authorized foreign banks can have an asset manager who also acts as a trustee of a mutual fund trust.
Stephen D.A. Clark practice focuses on financial institutions and corporate finance. Kashif Zaman is a partner in the firm's Financial Institutions Group. Victoria Graham practice focuses on corporate and regulatory issues relating to financial institutions and public and private corporations, including mergers and acquisitions, reorganizations, restructurings and corporate finance.
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