Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Financial Services, April 2010
As part of the federal budget for 2010 (the Budget), the Canadian government announced that it would strengthen the Canadian financial sector. With the introduction of Bill C-9, the Jobs and Economic Growth Act (the Bill) on March 29, 2010, the Canadian government introduced measures in furtherance of this goal. The Bill introduces new legislation relating to the regulation of financial services and amends other currently existing financial services legislation. Highlights of the Bill include:
- the enactment of the Payment Card Networks Act, designed to regulate national payment card networks and their commercial practices
- amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the PC Act) to confer on the Minister of Finance the power to issue directives in respect of certain financial transactions and to implement new reporting requirements
- amendments to the Financial Consumer Agency of Canada Act (the FCAC Act) to:
(i) expand the mandate of the Financial Consumer Agency of Canada (the Agency) to supervise payment network operators
(ii) provide the Agency with a broader oversight role to cover certain ministerial undertakings and directions
- the establishment of a new framework that will enable credit unions to incorporate or continue existing operations federally
- other general amendments to financial institutions legislation
Each of these areas of the Bill and others are discussed in greater detail below.
THE PAYMENT CARD NETWORKS ACT
The Bill enacts the Payment Card Networks Act (the PCN Act), which is designed to regulate payment card networks. A payment card network is defined in the PCN Act as an electronic payment system (other than a prescribed payment system) used to accept, transmit or process transactions made by payment card for money, goods or services and to transfer information and funds among issuers, acquirers, merchants and payment card users. This definition would extend to all major payment card networks operating in Canada (including Visa and MasterCard). It is worth noting that the definition of a "payment card" in the PCN Act excludes credit cards issued for use "only with the merchants identified on the card." As such, retailers and single merchant credit card operators are intended to be exempt from the scope of this legislation.
While the majority of the regulatory requirements to be imposed upon payment card operators will be provided in the regulations, the PCN Act does provide some insight into what the regulations governing the payment card industry may look like.
As a starting point, the PCN Act will be regulated by the Agency, the federal consumer regulator. As such, the mandate of the Agency under the FCAC Act is being expanded to provide the Agency with the authority to, among other things, supervise payment card network operators and monitor the implementation of voluntary codes of conduct. This new authority will give the Agency the power to monitor compliance with the Code of Conduct for the Canadian Credit and Debit Card Industry introduced by the Canadian government in December 2009 (the Debit Code). The Debit Code imposes compliance obligations on network operators, financial institutions and merchant acquirers. Criticism levied in respect of the Debit Code when it was released focused on the fact that, because it was a voluntary code, it did not have the power to effect change in the behaviour of the those involved in the payment card industry. By providing the Agency with the power to monitor compliance with voluntary codes in respect of payment card operators, the Canadian government has gone part way to addressing this criticism. If the FCAC finds that there is not an acceptable level of compliance with voluntary codes, additional legislation is likely to follow.
Highlights of the PCN Act:
- The PCN Act is stated to apply to payment card network operators, which are defined as those that operate or manage payment card networks. The PCN Act also defines the terms "acquirers" and "issuers." Unlike the Debit Code, it does not apply directly to issuers or acquirers. Accordingly, the Agency will not have the authority to regulate compliance by the acquirers with the provisions of the Debit Code.
- While the PCN Act is drafted to apply to payment card networks or systems, there is an exemption from its application for "prescribed payment systems." This envisions that certain payment systems can be exempted from the provisions of the PCN Act.
- As previously noted, the obligations imposed on payment card network operators under the PCN Act will be addressed in the regulations. In this respect, the PCN Act provides that the regulations may deal with the following matters:
- The types of rates that a payment card network operator must disclose and the manner in which disclosure must be made. This provision addresses only the disclosure of rates as opposed to the regulation of the rates themselves.
- The time and manner in which notice of new rates or rate or fee schedule changes must be given and to whom such notices must be given. This provision will likely mirror the provisions of the Debit Code where minimum notice periods are provided for in respect of rate changes.
- Conditions that payment card network operators must include in their arrangements with both issuers and acquirers. Presumably this is intended to provide for the regulation of the payment card network rules, policies and procedures. In furtherance of this provision, the PCN Act requires payment card network operators to take "reasonable measures" to ensure that any amendments to payment card network rules that are required by the PCN Act and that impose obligations on issuers or acquirers be enforced by the payment card network operators themselves. Accordingly, while the PCN Act does not directly regulate issuers or acquirers, it will likely require certain provisions that affect issuers and acquirers to be included in the network rules, and payment card network operators will be required to enforce such provisions as against the issuers and acquirers.
- There is also a broad power given to make regulations "respecting payment card networks." Given the wording of this provision, the Minister would appear to have extensive power to regulate almost any aspect of payment card networks.
This legislation reflects a dramatic change for payment card network operators in Canada who, unlike in other jurisdictions, have been operating essentially free of regulatory oversight. In that respect, the Commissioner of the Agency has broad powers in its newly expanded mandate, including the right to access the records of payment card network operators and the right to require the directors and officers of payment card network operators to provide information and explanations to the Agency to the extent they are reasonably able to do so. Payment card network operators must also provide the Agency with any information that they may require to carry out their supervisory function.
Where there has been violation of the PCN Act, the Agency may enter into compliance agreements with the network operators. Such compliance agreements will implement measures to ensure compliance with the PCN Act and its regulations. In addition, amendments to the FCAC Act allow the Agency to impose penalties on payment card operators for non-compliance with the PCN Act, similar to the penalties that it currently can impose on financial institutions under the FCAC Act.
It is clear with the introduction of the PCN Act that the Canadian government is following through on its commitment made to merchants when it introduced the Debit Code in November 2009 by, in effect, regulating adoption of the Debit Code by payment card network operators.
PROPOSED AMENDMENTS TO THE PROCEEDS OF CRIME (MONEY LAUNDERING) AND TERRORIST FINANCING ACT
The amendments made to the PC Act in the Bill expand the objectives of the PC Act to include enhancing Canada's capacity to take targeted measures to protect its financial system and mitigate risks that the Canadian financial system be used as a vehicle for money laundering or terrorist financing.
In keeping with this goal, the Bill amends the PC Act to provide for new reporting requirements to the Financial Transactions and Reports Analysis Centre of Canada (FinTrac) for financial transactions that occur (or are attempted) in the course of a regulated entity's activities that fall within a class of financial transactions specified under any directive issued under the new Part 1.1 of the PC Act.
Under Part 1.1 of the PC Act (entitled "Protection of Canada's Financial System"), the Minister of Finance has the authority to issue a directive (Directive) requiring any entity regulated under the PC Act to take "prescribed measures" in respect of transactions originating from or bound for any foreign state.
Measures that may be specified in a Directive may include:
- the requirement to verify the identity of any person or entity
- the requirement to exercise customer due diligence, including ascertaining the source of funds, the purpose of the transaction or the beneficial ownership or control of any entity
- the monitoring of any financial transaction or account
- keeping and retaining specified records
- reporting on specified transactions to FinTrac
The Minister is to take into account circumstances that it considers relevant in determining whether to issue a Directive, but in any event, a Directive under Part 1.1 of the PC Act may only be issued if:
- an international organization (such as the Financial Action Task Force (FATF)) has called on its members to take measures against a particular foreign state or entity, or
- the anti-money laundering or anti-terrorist financing measures that the foreign state or entity has implemented are ineffective or insufficient and the Minister believes this could have an adverse effect on the Canadian financial system or cause a reputational risk to the system
Directives can also be issued requiring regulated entities under the PC Act to take additional measures when dealing with a person or entity subject to any Directive.
Part 1.1 of the PC Act is likely enacted in response to recent guidance issued by FATF (and recently restated by the Office of the Superintendent of Financial Institutions), which identifies certain jurisdictions that have strategic deficiencies in their anti-money laundering regimes. As a result, Directives can be passed that will require transactions to or from those jurisdictions to be examined with greater scrutiny and that will impose additional reporting, identification, due diligence and other compliance measures on regulated entities in respect of transactions with such jurisdictions. These jurisdictions include Iran, Pakistan, Korea, Ethiopia, Ecuador, Greece, Indonesia, Kenya, Nepal, Syria, Thailand, Turkey, Ukraine and others.
The addition of Part 1.1 of the PC Act will require regulated entities to revise their anti-money laundering policies, procedures (and possibly their systems) to ensure compliance with any Directives issued under Part 1.1. In addition, regulated entities should update their risk-rating matrixes to reflect the increased risk of dealing with the jurisdictions of concern. In fact, one of the amendments to the PC Act made in the Bill expressly requires that regulated entities ensure that their compliance programs address the requirements of the new Part 1.1.
Where a Directive is in fact issued under the PC Act, regulated entities are required to comply with it in the time and manner specified. In addition, all regulated financial entities (other than authorized foreign banks) and securities dealers are required to ensure that any of their foreign subsidiaries or foreign branches also comply with any Directives issued under Part 1.1 (except for reporting requirements) provided they are permitted by law to do so.
There is another amendment made in the Bill that affects regulated entities under the PC Act. Under the Bill, certain regulations under the Criminal Code have been amended, the result of which is that income tax evasion in Canada will now give rise to a money-laundering offence under the PC Act. Accordingly, in terms of suspicious transaction monitoring and reporting, regulated entities under the PC Act will now be required to consider any activities that may be related to income tax evasion respecting their clients to the extent they are not already doing so. This will require regulated entities to update their anti-money laundering policies and procedures for suspicious transactions and monitor and report any transactions related to potential income tax evasion by their clients.
PROPOSED BANK ACT AMENDMENTS TO CREATE FEDERAL CREDIT UNIONS
In order to promote the continued growth and competiveness of the credit union industry, the Bill introduces a new legislative framework to enable credit unions to incorporate or continue existing operations federally. This is intended to promote financial stability, improve financial services across provincial borders, provide consumers with a broader range of financial service options, and attract a range of new members to credit unions that pursue this option.
While many credit unions remain dedicated to serving a specific community and will not find this of interest, others may see this as a platform that will allow them to serve members who move from province to province and to diversify their risk by building their business in various regions across the country. Ultimately, it may give provincial regulators of credit unions an opportunity to move some of the regulatory burden associated with the regulation of provincial credit unions to the Office of the Superintendent of Financial Institutions (OSFI), as many have done with respect to trust and loan companies.
As part of the Bill, the Canadian government has introduced legislation that would amend the Bank Act to create federal credit unions (FCUs), which would be constituted as a new form of federal deposit-taking financial institution. As a federal deposit-taking institution under the Bank Act, FCUs would be designated in the legislation as a new form of bank. Under the proposed legislation, FCUs can be created (i) by incorporation or (ii) by continuing a provincial credit union under the Bank Act where its provincial governing legislation so allows.
Federal Credit Unions as "Banks"
As the Supreme Court of Canada has made clear on several occasions, the designation "bank" does not have a functional component. That is, there is no particular set of attributes that would cause an entity to be considered to be a bank for Canadian legal purposes instead of some other type of deposit-taking institution, except that Parliament has designated the institution to be a bank. Accordingly, in considering the implications of an FCU being designated as a new form of bank, one must keep firmly in mind the fact that the designation "bank" does not necessarily imply anything about its material attributes, which will be determined by the new legislation. However, because the authority to incorporate banks and regulate the business of banking is exclusively federal under the constitution, the fact that FCUs are being designated as a new form of bank should mean that they will be immune from provincial regulation of their core business functions. In addition, they will be subject to the federal laws applicable to core business functions, such as federal employment and pension legislation, instead of the corresponding provincial laws.
Credit Union Name
An FCU will be permitted to use the expression "credit union" or certain similar expressions in its corporate name, so long as an FCU that does so also includes either "bank" or "federal" in its legal name. In addition, although an FCU is permitted to carry on business under a trade name that is different from its actual legal name, OSFI has the power to prohibit the use of a trade name that includes "credit union" or certain similar expressions unless the trade name also includes "bank" or "federal." It remains to be seen how OSFI intends to use this discretionary power.
Credit Union Attributes
Under the proposed legislation, FCUs are required to be organized and carry on business "on a co-operative basis." The concept "on a co-operative basis" is defined as follows:
(a) a majority of the FCU's members are natural persons
(b) it provides financial services primarily to its members
(c) membership in the FCU is wholly or primarily open, in a non-discriminatory manner, to persons who can use the services of the FCU and who are willing and able to accept the responsibilities of membership
(d) each member has only one vote
(e) a delegate, which is defined as a natural person who is appointed or elected to represent a member of an FCU at a meeting of members, has only one vote even if the delegate may be a member or may represent more than one member
(f) any dividends on membership shares are limited to the maximum percentage stated in the FCU's letters patent or by-laws
(g) surplus funds arising from the FCU's operations are used:
(i) to provide for the financial stability of the FCU
(ii) to develop its business
(iii) to provide or improve common services to members
(iv) to provide for reserves or dividends on membership shares and shares
(v) for community welfare or the propagation of co-operative enterprises
(vi) as a distribution to its members as a patronage allocation
In addition, the proposed legislation provides for the following attributes for FCUs:
- in general, membership shares are non-transferrable
- members do not have personal liability for the FCU's obligations
- within broad parameters, membership attributes, rights and obligations are to be determined by the FCU's by-laws
- although FCUs may have shares (other than membership shares), those shares may not be permitted to receive the remaining property of the credit union upon dissolution and may only have highly restricted voting rights (e.g., an FCU's by-laws may permit shareholders to elect up to 20% of the board of directors and, as is typically the case with preferred shares, may provide for voting rights for shares where there has been an event of default)
- the governance associated with meetings of the FCU's members is unique but is based on the rules applicable for meetings of a federal mutual insurance company
- FCUs are granted the same business powers as are available to Canadian banks
- where a provincial credit union continues as an FCU and, at the date of continuance, carries on business activities that are not permissible for an FCU, those activities may be grandfathered for any period of time established by the Minister of Finance
The proposed legislation does not set out the capital regime that would apply to FCUs, which is left to be dealt with by way of regulation and OSFI guidelines. Accordingly, the federal legislation does not speak to the interaction between FCUs and centrals.
OTHER CHANGES TO FINANCIAL INSTITUTION LEGISLATION
The FCAC Act
In addition to the amendments related to the PCN Act, the Bill amends the FCAC Act to expand the objects of the Agency to:
- extend its supervision of financial institutions to cover certain ministerial undertakings and directions
- include promotion of the adoption by financial institutions of policies and procedures designed to implement such undertakings and directions and voluntary codes of conduct and public commitments
- extend its promotion of consumer awareness to cover "all matters connected with the protection of consumers of financial products and services"
- add the monitoring and evaluation of trends and emerging issues that may have an impact on consumers of financial products and services
These last two changes go well beyond issues arising from the "consumer provisions" in the federal financial institutions legislation and, as drafted, could even extend beyond financial products and services offered by federally regulated financial institutions.
The Bill also broadens the powers of the Commissioner and allows the Minister to give a written direction to the Commissioner in certain circumstances.
Finally, failure to comply with ministerial undertakings and directions that fall under the supervisory powers of the Agency has been added to the list of items that may be designated as violations by regulations.
The Budget states that these new responsibilities will leverage the existing role and market-place proximity of the Agency. The intention is that the Agency will increase its field testing and stakeholder engagement to provide information that will ensure regulatory initiatives of the government are more responsive to the needs of financial consumers.
As a result of these proposed changes to the FCAC Act, the Bill includes consequential changes to the Bank Act, the Cooperative Credit Associations Act, the Insurance Companies Act and the Trust and Loan Companies Act, providing the Commissioner with the ability to take the same measures to ensure compliance with ministerial undertakings and directions as the Commissioner could take in respect of consumer provisions.
Regulation by undertaking or direction provides the Minister with the flexibility to address issues arising at specific institutions but raises the risk of some institutions being subject to limitations or requirements that do not apply to their competitors.
CANADA DEPOSIT INSURANCE CORPORATIONS ACT (THE CDIC ACT)
The Bill proposes some changes to the CDIC Act that are intended to ease the take-over of a deposit-taking institution by the CDIC or a bridge institution.
BANK ACT, COOPERATIVE CREDIT ASSOCIATIONS ACT, INSURANCE COMPANIES ACT, AND TRUST AND LOAN COMPANIES ACT
The legislation following from the 2009 Budget made some changes to the federal financial institution legislation that come into force July 1, 2010, together with new Mortgage Insurance Business Regulations and Mortgage Insurance Disclosure Regulations.
These changes and the associated regulations set out how institutions are to calculate the actual cost of residential mortgage insurance and also establish permitted and prohibited activities in respect of mortgage insurance transactions, all with the goal of enhancing the transparency of mortgage insurance transactions.
OSFI has released an Implementation Bulletin on Mortgage Insurance related to the new Mortgage Insurance Business Regulations.
OFFICE OF THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS ACT (THE OSFI ACT)
Senator Ringuette's Senate Bill S-201, "An Act to amend the Office of the Superintendent of Financial Institutions Act (credit and debit cards)" received second reading in the Senate on March 30, 2010, and was referred to the Senate Standing Committee on Banking, Trade and Commerce. This Bill would extend the purpose of the OSFI Act and the duties of the Superintendent to provide for OSFI to monitor and make recommendations relating to the use of credit and debit cards in Canada, in consultation with the FCAC and provincial regulatory authorities.
BUDGET INITIATIVES STILL TO COME
The Budget includes a number of proposals that will affect consumer financial products that are not covered by the Bill. These proposals will be implemented by regulations or other means that do not require amendments to the financial institution legislation. The proposals include the following:
- a prohibition on negative option billing in the financial sector
- standardizing the calculation and disclosure of mortgage pre-payment penalties
- reducing the maximum cheque-hold period to four days from the current seven days and providing consumers access to the first C$100 within 24 hours
- strengthening the dispute resolution framework for consumer complaints; presumably in this regard, the government will designate the Ombudsman for Banking Services and Investments pursuant to section 455.1 of the Bank Act and the similar provisions of the other financial institution legislation
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