2014 was a year replete with new legislative and regulatory initiatives impacting federally regulated financial institutions. The key initiatives introduced or implemented in 2014 are outlined in our annual year in review.
PRUDENTIAL REGULATION: GUIDANCE FROM OSFI
Proposed New Bail-in Regime for Large Banks
On August 1, 2014, the Government of Canada introduced a consultation paper recommending a statutory conversion of long-term senior unsecured bank liabilities into bank common shares in the event of a non-viability of a bank. If implemented, this new "bail-in" regime will apply only to Canada's six largest banks (which are designated as domestic systemically important banks or D-SIBs) and will supplement the existing non-viability contingency capital requirement in respect of noncore bank capital instruments, such as preferred shares and subordinated debt. The consultation paper also proposes "a higher loss-absorbency requirement" for D-SIBs—a new capital measure to be met through the sum of regulatory capital and bail-in eligible senior debt. The consultation paper also contemplates revisions to the Canada Deposit Insurance Corporation Act provisions governing resolution and recovery of banks in Canada. These proposals emanate from recommendations recently published by the Financial Stability Board (FSB), including the updated Key Attributes of Effective Resolution Regimes for Financial Institutionsand the consultation on Adequacy of Loss-Absorbing Capacity of Global Systemically Important Banks in Resolution. The proposals in the government's consultation paper, which have been the subject of considerable industry consultation, are expected to develop into legislation in 2015.
New Liquidity Requirements
On May 30, 2014, the Office of the Superintendent of Financial Institutions (OSFI), Canada's principal banking regulator, issued the final version of its Liquidity Adequacy Requirements guideline for banks, trust and loan companies and retail associations. Under the new guideline, the liquidity coverage ratio (LCR) standard, which is aimed at ensuring that an institution has an adequate stock of unencumbered high-quality liquid assets to meet its liquidity needs for a 30-day liquidity stress scenario, comes into force in January 2015. The implementation of intraday liquidity monitoring tools and the net stable funding ratio standard will follow the implementation timelines to be set by the Bank for International Settlements' Basel Committee on Banking Supervision (Basel Committee).
On July 16, 2014, OSFI issued a new Guideline D-11 on LCR public disclosure requirements for D-SIBs. OSFI also released reporting requirements and instructions related to the LCR standard, the LCR by significant currency monitoring tool, and the net cumulative cash flow monitoring tool. Completed returns associated with these metrics must be filed with OSFI on a monthly basis beginning January 31, 2015.
New Leverage Ratio Requirement
On October 30, 2014, OSFI issued the final version of a new Leverage Requirements (LR) guideline for banks, trust and loan companies and retail associations. OSFI's LR guideline is based on Basel III Leverage Ratio Framework and Disclosure Requirements issued by the Basel Committee. The new three per cent leverage ratio requirement becomes effective in 2015 and replaces the existing assets-to-capital multiple measure. OSFI will also communicate authorized leverage ratio requirements to individual institutions. These institution-specific leverage ratios are treated as "supervisory information" and therefore are not permitted to be disclosed. The capital measure used for calculating the leverage ratio comprises both common equity tier 1 and additional tier 1 capital but excludes tier 2 capital instruments, such as subordinated debt.
On November 24, 2014, OSFI also issued a new Guideline D-12 on Public Disclosure Requirements Related to Basel III Leverage Ratio. The return template for the Leverage Requirements Return, which is required by the LR Guideline, is now posted on the OSFI website.
On December 19, 2014, OSFI published a letter to deposit-taking institutions issuing covered bonds to explain the revisions to the calculation of the covered bond limit resulting from the adoption of the leverage ratio requirement in 2015.
Revisions to Capital Framework for Life and P&C Insurers
On September 24, 2014, OSFI issued the final version of its revised Minimum Capital Test Guideline (MCT Guideline) for property and casualty (P&C) insurers, following extensive analysis and consultations with the industry. The revised MCT Guideline introduces new and updated risk factors and margins, which are intended to provide for a more refined risk-based capital framework for P&C insurers. The new MCT Guideline came into force in January 2015 with a three-year phase-in period. It is expected to result in a 2.8 percentage point decline in the capital ratio on average across the P&C industry, with some institutions being impacted more significantly than others.
On November 11, 2014, OSFI requested life insurers to participate in a sixth Quantitative Impact Study (QIS 6) to gather information on the potential impact of the major components of a future new life insurance regulatory capital framework. OSFI's commonly asked questions on QIS 6 can be found here. OSFI also introduced certain revisions to its Minimum Continuing Capital and Surplus Requirements (MCCSR) guideline for life insurers, which come into effect in January 2015. A policy paper describing the principles and concepts supporting the development of certain key components of the new capital framework (standard approach) for life insurers was released on January 5, 2015.
New Guidance for Mortgage Insurers
On June 26, 2014, OSFI issued a letter informing mortgage insurance companies that they will be required to use a modified version of the 2015 MCT, until a capital guideline dedicated to mortgage insurance companies has been implemented. On September 24, 2014, together with the publication of the new MCT Guideline, OSFI issued an advisory on Interim Capital Requirements for Mortgage Insurance Companies.
On November 6, 2014, OSFI issued the final version of a new Guideline B-21 on Residential Mortgage Insurance Underwriting Practices and Procedures. Guideline B-21 sets out OSFI's expectations with respect to prudent residential mortgage insurance underwriting and related activities and is consistent with the approach that OSFI took with its Guideline B-20 on Residential Mortgage Underwriting Practices and Procedures.
Supervision of CDOR Submission Process
On January 13, 2014, OSFI announced that it will supervise the effectiveness of governance and risk controls surrounding banks' submission processes regarding the Canadian Dealer Offered Rate (CDOR). On September 12, 2014, OSFI published the final version of its new Guideline E-20 on CDOR Benchmark-Setting Submissions. The Guideline E-20 outlines OSFI's expectations for the governance and internal controls regarding the rate submission processes within Canadian banks that are involved in setting the CDOR benchmark rate.
Corporate Governance and Compliance Management
On May 9, 2014, OSFI issued a letter to deposit-taking institutions and insurance companies regarding recent international and domestic initiatives aimed at strengthening external audit quality, such as:
- The guidance issued on March 31, 2014 by the Basel Committee on External Audits of Banks
- The guidance resources issued in January 2014 by the Chartered Professional Accountants of Canada (Oversight of the External Auditor; Annual Assessment of the External Auditor and Periodic Comprehensive Review of the External Auditor)
- The protocol issued by the Canadian Public Accountability Board.
On May 14, 2014, OSFI issued the final version of its advisory on Changes to the Membership of the Board or Senior Management, which came into effect immediately. The advisory outlines the process for informing OSFI of potential changes to the membership of the board and senior management of federally regulated financial institutions.
On November 30, 2014, OSFI published the final version of its revised Guideline E-13 (renamed Regulatory Compliance Management). The new guideline replaces the 2003 Guideline E-13 on Legislative Compliance Management to better align it with recently updated OSFI guidelines and to complement OSFI's Supervisory Framework and Assessment Criteria.
Early Adoption of IFRS 9
Following consultations in 2014 in respect of the early adoption of IFRS 9 in Canada, OSFI issued a new advisory on Early Adoption of IFRS 9 Financial Instruments for Domestic Systemically Important Banks. The advisory outlines OSFI's expectation that D-SIBs will adopt IFRS 9 for their annual period beginning on November 1, 2017. All other federally regulated financial institutions using an October 31 year-end are permitted (but not required) to adopt IFRS 9 on November 1, 2017.
Derivatives Sound Practices
On June 19, 2014, the Economic Action Plan 2014 Act, No. 1introduced amendments to the Bank Act to add regulation-making powers respecting bank activities in relation to derivatives and benchmarks. No regulations have yet been introduced under this new authority.
On October 1, 2014, OSFI issued a draft revised guideline on Derivatives Sound Practices setting out its expectations for federally regulated financial institutions (including Canadian branch operations of foreign banks and insurers) with respect to derivatives activities. The revisions reflect over-the-counter (OTC) derivatives market reforms initiated by G-20, OSFI's expectations for central clearing of standardized OTC derivatives and for reporting derivatives data to a trade repository. A final version of the revised guideline is expected in 2015.
On June 9, 2014, OSFI released the final version of its Longevity Insurance and Longevity Swaps policy advisory (Policy) and an accompanying letter (Letter). As provided in the Letter, the final version of the Policy replaces the earlier draft version issued for comment in August 2013, which was discussed in our September 2013 Blakes Bulletin: Longevity Risk Transfer – Canadian Opportunities.
Supreme Court's Marcotte Decision
The major development in 2014 potentially impacting the market conduct regulation of banks in Canada was the decision by the Supreme Court of Canada in Marcotteand companion cases, released on September 19, 2014. The court held that provincial credit card foreign exchange fee disclosure requirements apply to credit cards issued by banks. The decision may reshape the way banks and other federally regulated financial institutions view the application of provincial consumer protection legislation to their businesses. In 2015, institution-specific and industry-wide initiatives will be key to developing a consistent and workable framework for identifying and complying with provincial laws that may constitutionally extend to banks. The Government of Canada will also need to assess the impact of the court's decision on its initiative to develop a comprehensive financial consumer code for banks, the consultations for which were completed in 2014.
FCAC Decisions and Industry Commitments
The Financial Consumer Agency of Canada issued two decisions in 2014 (decisions #121 and 122) and published observations, findings and best practices on clear language. In addition, a number of industry public commitments were announced in 2014.
For instance, on May 27, 2014, the Department of Finance announced that voluntary commitments have been secured from Canada's eight largest banks to enhance low-cost bank accounts and offer no-cost accounts with the same features as low-cost accounts to a wider range of eligible consumers. No-cost accounts will be available to youth, students, seniors qualifying for the Guaranteed Income Supplement and Registered Disability Savings Plan beneficiaries. Participating banks are expected to implement the commitment by January 15, 2015.
Also, on September 3, 2014, the Department of Finance announced two additional voluntary commitments by Canadian banks. The new Commitment to Provide Information on Mortgage Security sets out the nature of information about mortgage security that banks will provide to consumers. Participating banks have committed to make general information available on their websites reflecting this new commitment by September 1, 2014, general information available in branches/points of service and on request by November 30, 2014, and specific information at or before entering into the mortgage loan agreement by January 31, 2015. The new Commitment on Powers of Attorney and Joint Deposit Accounts sets out the information about powers of attorney and joint deposit accounts that banks will make available to customers. Participating banks have committed to implement the disclosure provisions of this commitment on their websites by September 1, 2014 and in the branches by December 31, 2014, and to implement the staff training provisions by March 31, 2015.
Then on November 4, 2014, the Minister of Finance announced that two payment card networks submitted separate and individual voluntary proposals to reduce their credit card fees to an average effective rate of 1.50 per cent for the next five years.
In addition, on May 1, 2014, the Prepaid Payment Products Regulations governing prepaid payment products issued by federally regulated financial institutions came into force. See our December 2013 Blakes Bulletin: Year-End Blizzard for Financial Institutions for more information.
A number of legislative and regulatory initiatives impacting Canada's anti-money laundering legislation were introduced in 2014. In particular, on June 19, 2014, the Economic Action Plan 2014 Act, No. 1introduced important amendments to Canada's anti-money laundering legislation Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PC Act). Among other measures, the new amendments:
- Extend the application of the PC Act to persons dealing in virtual currencies
- Extend the application of the PC Act to money services businesses and persons trading in virtual currencies that do not have a place of business in Canada but provide services to residents of Canada
- Introduce new enhanced due diligence requirements for providing services to individuals that occupy certain prominent public functions in Canada or in international organizations
- Introduce group-wide information sharing requirements between regulated financial institutions and their affiliates in Canada and in other jurisdictions that are also regulated financial institutions
- Require reporting entities to report to the Canada Revenue Agency (CRA) international electronic funds transfers of C$10,000 or more.
These measures are discussed in greater detail in our April 2014 Blakes Bulletin: Important Changes to Canada's AML Laws: Here We Go Again. The regulations necessary for implementing many of these amendments are expected in 2015. OSFI is also expected to issue a revamped version of its Guideline B-8 on Deterring and Detecting Money Laundering and Terrorist Financing, incorporating a number of recent amendments to the legislation.
Earlier in January 2014, the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) revised its Guideline 4: Implementation of a Compliance Regime and Guideline 6: Record Keeping and Client Identification to reflect the 2013 amendments to the PC Act regulations, which came into force on February 1, 2014. The 2013 amendments are considered in our February 2013 Blakes Bulletin: New Regulations Amending Canadian Anti-Money Laundering Legislation.
FINTRAC also published on its website a number of policy interpretations that were previously issued to individual reporting entities in response to inquiries relating to the PC Act and regulations.
NEW SANCTIONS IN RESPECT OF RUSSIA AND UKRAINE
On March 5, 2014, in response to the developments relating to the Crimea region, the Government of Canada announced targeted economic sanctions against the representatives of the former government of Ukraine. These measures were implemented by way of regulations under the Freezing Assets of Corrupt Foreign Officials Act. Both OSFI and FINTRAC issued notices related to the regulations.
On March 17, 2014, the Government of Canada introduced two additional regulations under the authority of the Special Economic Measures Act imposing economic sanctions against senior government officials and other individuals in Russia and Crimea. These regulations were subsequently expanded through numerous amendments, most recently on December 19, 2014, and set out significant restrictions on dealing with designated entities and individuals and on providing new debt or equity financing to designated major Russian banks and energy companies. The regulations also impose screening and reporting obligations on financial institutions.
FEDERAL CREDIT UNIONS AND COOPERATIVES
On January 24, 2014, the Minister of Finance announced the federal government's intention to provide temporary transitional support to provincial credit unions that wish to move to the new federal credit union framework. The transitional supports will include offering extended deposit insurance and a short-term funding facility, as well as an extended transition period to comply with federal insurance networking rules.
On December 16, 2014, the Economic Action Plan 2014 Act, No. 2 introduced amendments to the federal credit union provisions of the Bank Act to streamline the process for amalgamating two or more provincial credit unions into one federal credit union. As of the end of 2014, no federal credit unions have yet been established under the Bank Act.
The Economic Action Plan 2014 Act, No. 2 will also repeal Part XVI of the Cooperative Credit Associations Act (CCAA), thereby removing federal supervision over provincial credit union centrals that voluntarily subjected themselves to OSFI oversight under the CCAA. In addition, amendments are made to the membership criteria for non-retail cooperative credit associations formed under the CCAA. These amendments will come into force on a date to be fixed by the federal government in consultations with the credit union system. The Economic Action Plan 2014 Act, No. 2 also introduces amendments to the Canada Deposit Insurance Corporation Act, the Bank of Canada Act and the CCAA to restrict CDIC short-term loans to provincial deposit insurance or guaranty agencies and to clarify that emergency lending assistance from the Bank of Canada may be provided only with a province's indemnity to the Bank of Canada.
The Economic Action Plan 2014 Act, No. 2 also amends Canada's Payment Clearing and Settlement Act (PCSA). That Act permits the Bank of Canada to designate and oversee the operations of clearing and settlement systems that pose a systemic risk. There are currently five clearing and settlement systems designated by the Bank of Canada, including the Canadian Payments Association's (CPA) Large Value Transfer System. The amendments will now authorize the Bank of Canada to designate systems for payment clearing and settlement that pose a "payments system risk." This could include CPA's retail payments system, the Automated Clearing Settlement System (ACSS), which is currently not designated under the PCSA. The amendments follow the remarks by Lawrence Schembri, deputy governor of the Bank of Canada, in June 2014 that "CPA's ACSS exhibits characteristics of a prominent payment system and therefore could be subject to Bank of Canada oversight." The deputy governor also noted that the "vision for the other national retail payment systems is that they, too, would be subject to oversight that is proportional to risks. While newer retail systems are not systemically important or prominent, end-user protection is of particular importance."
On February 5, 2014, the Minister of Finance announced an intergovernmental agreement (Intergovernmental Agreement) with the United States concerning the U.S.-enacted Foreign Account Tax Compliance Act (FATCA). In the absence of the Intergovernmental Agreement, under FATCA Canadian financial institutions would have to report information on U.S. residents or citizens directly to the U.S. Internal Revenue Service (IRS). Pursuant to the Intergovernmental Agreement, financial institutions in Canada will not report any information directly to the IRS. Rather, relevant information on accounts held by U.S. residents and U.S. citizens (including U.S. citizens who are residents or citizens of Canada) will be reported to the CRA. The CRA will then exchange the information with the IRS through the existing provisions and safeguards of the Canada-United States Tax Convention Act.
INTERNATIONAL ORGANIZATIONS COMMENT ON CANADA'S FINANCIAL SYSTEM
A number of international organizations published documents discussing the state of Canada's financial system.
On June 13, 2014, the Basel Committee released a Regulatory Consistency Assessment Programme report assessing Canada's implementation of the Basel capital framework. The Basel Committee found 13 of 14 components assessed to be "compliant" with the standards prescribed under the Basel framework, while one component—the definition of capital—was found to be "largely compliant" with the Basel standards. The report also notes that some aspects of Canada's capital rules are more rigorous than the requirements under the Basel framework.
International Monetary Fund
On February 3, 2014, the International Monetary Fund (IMF) issued its Financial Sector Stability Assessment of Canada (Assessment). The Assessment states that Canada's financial system successfully navigated the global financial crisis and that major financial institutions would likely continue to be resilient to risks arising from a severe stress scenario. The Assessment identified elevated housing prices and high household debt as an area of concern. On March 7, 2014, the IMF also issued the following detailed assessments in respect of Canada:
- Basel Core Principles for Effective Banking Supervision
- Intensity and Effectiveness of Federal Bank Supervision in Canada
- Crisis Management and Bank Resolution Framework
- Insurance Core Principles
- The Impact on the Insurance Sector of a Low Interest Rate Environment
- IOSCO Objectives and Principles of Securities Regulation
- Stress Testing
On February 17, 2014, the Financial Action Task Force (FATF), the intergovernmental body on anti-money-laundering initiatives, released its Mutual Evaluation of Canada. The report, among other things, found that:
- Canada adheres to all major FATF recommendations, including those relating to customer due diligence requirements for financial institutions and other reporting entities
- Canada has sound supervision by FINTRAC and OSFI, as well as the effective and thorough analysis of financial intelligence by FINTRAC in line with international standards
- Canada has taken steps in recent years to bolster its efforts to combat money laundering and terrorist financing, including establishing a registration regime for money service businesses, expanding the scope of the regime to include additional businesses and professions.
We expect that the current elevated pace of regulatory initiatives impacting financial institutions in Canada will continue in 2015.
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