On March 27, 2018, the federal government introduced Bill C-74, Budget Implementation Act, 2018, No. 1 (Bill), which includes proposed legislative changes that will be of interest to Canada’s financial sector.
The Bill provides the government’s response to consultations undertaken in 2016 (see our August 2016 Blakes Bulletin: Canada’s Financial Sector: Legislation for the Future) and 2017 (see our August 2017 Blakes Bulletin: Back to the Future: Finance Canada Releases Second Consultation on Financial Sector Legislation) (2017 Consultation). It also proposes changes to the Canada Deposit Insurance Corporation Act (CDIC Act) and Payment Clearing and Settlement Act (PCS Act).
In addition to the legislative changes proposed by the Bill, on March 26, 2018 the federal government released the final version of the bail-in regulations under the CDIC Act and Bank Act.
FINANCIAL SECTOR LEGISLATIVE RENEWAL
Significant but limited changes to the legislation governing federally regulated financial institutions (FRFIs) are proposed in the Bill in satisfaction of the obligation to review such legislation prior to the March 29, 2019 sunset date, which the Bill will extend another five years. Notably, the Bill does not include the long-anticipated consumer code and related paramountcy provisions, which seem to have floundered following their introduction in 2016 in Bill C-29 and subsequent withdrawal due to the strong opposition from certain senators and some provinces. Nor does the Bill address the specific targeted refinements intended to streamline the bank entry and exit process and the governance changes that would have better aligned the FRFIs’ statutes with the Canada Business Corporations Act, as suggested by some of the issues raised for consideration in the 2017 Consultation.
Broadened Scope of Permitted Activities
Among the more significant proposed changes to the Bank Act, Trust and Loan Companies Act and the Insurance Companies Act (collectively the Federal Financial Institutions Legislation), the Bill proposes to broaden the scope of activities in which FRFIs may engage. Note that each of the expanded and new powers is subject to restrictions that may be imposed by regulations that are not yet available. FRFIs will need to monitor any developments in this area closely to see the extent to which the fairly broad expansion of their powers, discussed below, will be curbed when the draft regulations are released for comment.
Expanded Existing Additional Powers
Each of the Bank Act, the Trust and Loan Companies Act and the Insurance Companies Act permit the applicable FRFIs to carry on certain activities beyond the core activities of banking, financial services or insurance, as the case may be. The existing additional powers include engaging in information transmission and management, as well as certain technology activities, but subject to byzantine restrictions, requirements and approvals. These provisions were last updated in 2001 and FRFIs have struggled to interpret the outdated provisions in a manner that reflects the transformation in technology that has taken place in the last 17 years. Further, these provisions have been interpreted restrictively by the Office of the Superintendent of Financial Institutions (OSFI) and, to engage in these activities, FRFIs are often required to obtain ministerial approval. The cost, time and uncertainty associated with seeking ministerial approval has left many FRFIs unable to compete or collaborate with fintechs that are not similarly encumbered and can more quickly enter into transactions.
The Bill proposes to broaden the scope of the existing additional powers so that FRFIs may:
- Collect, manipulate and transmit information generally, without the current limits on the type of information that can be collected, manipulated or transmitted
- Develop, design, manufacture, sell and otherwise deal with technology if doing so relates to another permitted activity or the provision of financial services by another entity.
Implementing these changes would help to modernize the Federal Financial Institutions Legislation by making it less prescriptive so that it will not become quickly outdated as technology evolves. In connection with these changes, the Bill also proposes removing the ministerial approval requirement, which will allow FRFIs more freedom and flexibility when engaging with technology. Together with the expanded scope of activities, these changes would help to facilitate the commercialization of technology by FRFIs.
New Additional Powers
The Bill proposes to add two new permissible activities for FRFIs. The most significant of these is the proposal to allow FRFIs to engage in “any activity that relates to the provision of financial services” by the FRFI or any of its affiliates. Such an open grant of power is a major departure from the more prescriptive, and restrictive, approach followed in the existing Federal Financial Institutions Legislation. Among other things, the new power could potentially allow FRFIs to market the technology and processes they have developed to non-financial entities, opening up new sources of revenue for the FRFIs and allowing them to compete more effectively with fintechs. However, the term “financial services” is not defined and the question of what is required in order for an activity to be “related to the provision of financial services” may lead to differences of opinion on the extent of this new power.
The Bill also proposes to permit FRFIs to engage in identification, authentication or verification services. Many FRFIs are likely already providing these services and we consider them to appertain to the business of banking or the business of providing financial services, as the case may be. This proposed amendment would simply provide greater certainty.
Expanded Networking Power
The existing networking provisions in the Federal Financial Institutions Legislation provide that FRFIs may act as an agent for, or provide referrals to, other FRFIs and permitted entities. What is considered a permitted entity is defined in the Federal Financial Institutions Legislation, but has historically been interpreted restrictively, with the result that OSFI considers that FRFIs may only network with FRFIs and the types of entities that they would be able to obtain approval to acquire. These limits on networking have become a point of frustration for FRFIs, fintechs and others that wish to work with FRFIs.
The Bill proposes to permit FRFIs to enter into arrangements with “any person” in respect of carrying on certain activities or providing certain services. It would also allow FRFIs to refer people to “another person” without limitation. These changes will allow FRFIs and fintechs (and others) to work together and mutually refer customers, which may help foster greater collaboration in the financial technology space, resulting in greater innovation.
Broadened Investment Powers
Under the existing legislation, FRFIs are permitted to make a substantial investment in other financial institutions or entities whose business is limited to certain listed activities or combinations of listed activities. If the entity in which a FRFI wishes to invest carries on any other activities, the investment may be prohibited or restricted by the specialized financing or temporary investment rules. In the past this has restricted the ability of FRFIs to invest in fintechs and other entities outside of the financial services industry.
The Bill proposes to allow FRFIs to invest in an entity if a majority of the entity’s business consists of financial services activities of the type that the investor FRFI may engage in (not including the additional powers discussed above). What is considered a “majority” will be prescribed by regulation, implying that the analysis will be more complex than an estimation of 50 per cent of the target entity’s activities and may require ongoing monitoring.
Although perhaps not as open as some FRFIs may have wished, the proposed amendments would greatly expand the investment options of FRFIs, particularly in the financial technology space where many entities develop technology that is of potential value to FRFIs — as well as technology that is unrelated to financial services — which previously disqualified such entities from investment by FRFIs. The potential targets of investment by FRFIs would also likely welcome the proposed changes, which would broaden the pool of potential investors.
Insurance Company Investments in Infrastructure Entities
In addition to the expanded investment powers discussed above, the Bill introduces infrastructure entities as a permitted investment for federally regulated life insurers, subject to various conditions that are to be prescribed by regulation. A “permitted infrastructure entity” is an entity that only makes investments in “infrastructure assets”, which are physical assets, including long-lived physical assets that support the delivery of public services. It will be interesting to see the scope of conditions that are ultimately proposed on infrastructure investments and whether the powers will provide sufficient flexibility to be beneficial to life insurers.
Sunset Clause Extended
The Federal Financial Institutions Legislation includes sunset clauses that provide that the applicable statute, and any charters issued under it, will expire every five years unless a review takes place. The last review of the Federal Financial Institutions Legislation was completed in 2012, and accordingly the current review was originally scheduled for 2017. In the 2016-2017 budget document, the government extended the interval between reviews by an additional two years until March 29, 2019.
The Bill proposes to extend the period during which FRFIs may carry on business under Federal Financial Institutions Legislation by five years after the day on which the Bill receives royal assent. Assuming the Bill receives royal assent before this session of Parliament rises in June 2018, the next mandatory review will be scheduled to take place by 2023.
Use of Bank Words
On June 30, 2017, OSFI issued Advisory 2017-01 (Advisory), which set out how OSFI interpreted and administered the Bank Act restrictions on the use of the words “bank”, “banker” and “banking” (Bank Words). The Advisory stated that OSFI would no longer accept the use of the Bank Words by non-bank financial service providers to indicate or describe their business (See our July 2017 Blakes Bulletin: OSFI Cracks Down on the Use of the Words “Bank”, “Banker” and “Banking”). The Advisory provoked a strong response, in particular from provincial credit unions that routinely use such words in a generic manner throughout their materials. Consequently, the 2017 Consultation included a section seeking comments on whether prudentially regulated non-bank deposit-taking institutions should be allowed flexibility to use the Bank Words to describe their activities and services in appropriate circumstances. Also on August 11, 2017, OSFI suspended the Advisory compliance expectations set out in its June 30, 2017 cover note to the Advisory.
The Bill incorporates feedback received during the consultation process. If passed, the Bill would permit corporations to which the federal Trust and Loan Companies Act applies, trust or loan corporations incorporated or formed by (or under) a provincial act, provincial credit unions, caisses populaires, centrals and federations, ATB Financial, and prescribed entities to use the Bank Words under certain circumstances to indicate or describe their business, including any of their products or services or the means by which any of those products or services may be obtained. A permitted entity may also cause or authorize a second person to use the Bank Words in this manner in respect of the permitted entity’s business. The circumstances are:
- Subject to the regulations, the permitted entity must disclose:
- The type of entity that it is (for example, that it is a local cooperative credit society)
- Its primary jurisdiction of regulation (for example, Ontario)
- Whether it participates in a deposit insurance system in Canada and if yes, the name of that system (for example, the Deposit Insurance Corporation of Ontario).
- The permitted entity must disclose any other prescribed information and comply with any other prescribed requirements or conditions.
As regulations have not been published yet, we do not know whether any additional entities will be prescribed for this purpose or if the permitted entities will need to meet any additional requirements or conditions, including any additional disclosure requirements. It is also unclear whether the rules will consider the practicalities of disclosure in various media, such as in-branch signage, large billboard advertisements or television, internet, mobile or radio advertisements.
The Bill makes other changes to section 983 of the Bank Act, which prohibits the use of the Bank Words, except as permitted. These changes, which are not extensive, reflect that banks are increasingly offering products and services online and entering into arrangements with fintechs to offer their products and services.
The prohibition against using the Bank Words in the name of a non-bank remains unchanged.
When OSFI suspended its compliance expectations set out in the Advisory, it stated that once the Department of Finance announced the outcome of its consultation on section 983, OSFI would communicate its revised expectations for compliance with the Advisory. We will be watching for these revisions to the Advisory.
Finally, the Bill makes a related change to the Office of the Financial Institutions Act. If passed, the Superintendent will be required to publicize any section 983 violation, the name of the person who committed the violation and the amount of the penalty that was imposed. This requirement to name and shame should prompt non-bank financial services providers to re-evaluate their risk assessment regarding section 983 violations.
In 2016, the Department of Finance published a detailed consultation paper seeking views on possible improvements to the deposit insurance framework in Canada. The consultation paper identified three broad areas that merited consideration: streamlining deposit categories, updating the scope of eligible deposits, and addressing the complexity of trusts. For more detail on the specific proposals included at the consultation phase, please see our September 2016 Blakes Bulletin: Deposit Insurance Review: Improving the Current Framework. The legislative amendments that are now proposed address some of the concepts considered in that consultation paper.
Some of the most significant amendments to the CDIC Act proposed in the Bill deal with deposits made in trust. Currently, trusts are a deposit insurance category that allows each beneficiary to receive separate coverage of up to C$100,000, subject to the trustee providing and annually updating specified information about the trust for inclusion on the CDIC member institution’s records. Trustees are not required to report this information to CDIC. In addition, certain professional trusts are currently exempted from disclosing beneficiary information. The proposed changes would provide for accounts to be designated as professional trustee accounts if the depositor makes an attestation that they are a professional trustee and provides specified contact information. The proposed amendments set out a definition of professional trustee that includes: a public trustee of a province; a federal, provincial or municipal government (or a department or agency of such a government); a lawyer or notary; and individuals who act as trustees in the normal course of their business and are subject to regulation by statute or a regulatory body. The deposits of each beneficiary under a professional trustee account would receive separate coverage of up to C$100,000 as long as the professional trustee maintains its own up-to-date records setting out the current name and address of each beneficiary of a deposit in the account and the amount or percentage interest of each beneficiary. These records do not have to be disclosed to the CDIC member institution, but the professional trustee must provide information contained in them to CDIC on request.
The proposed amendments would also provide for nominee brokers to make deposits on behalf of another person while protecting that person’s confidentiality. Under the current framework, certain depositors, such as lawyers, regulated individuals who act as trustees in the normal course of their business, or public trustees of a province, may replace the name and address of beneficiaries with alphanumeric identifiers. The proposed amendments define a nominee broker as a person who is a party to an agreement or arrangement with a CDIC member institution in order to make deposits as a nominee on behalf of another person. The proposed amendments would require that whenever a nominee broker makes a deposit or change to a deposit, they must disclose to the member institution the fact that the deposit is made by a nominee broker, the unique alphanumeric code for each beneficiary, the amount or percentage of the interest or right of the beneficiary, and any other information specified in the CDIC Act bylaws. The nominee broker would also be required to provide the name and address of the beneficiary associated with an alphanumeric code to CDIC within three days of a request from CDIC. These amendments will ensure nominee broker deposits receive separate CDIC coverage similar to trustee deposits.
Additionally, the proposed amendments would add two new eligible deposit categories for Registered Education Savings Plans (RESPs) and Registered Disability Savings Plans (RDSPs) to ensure that each registered product is covered up to the C$100,000 limit. Currently, only Registered Retirement Savings Plans, Registered Retirement Income Funds and Tax-Free Savings Accounts are treated as separate categories of eligible deposits, while other registered products such as RESPs and RDSPs are included in the more general trust or individual coverage categories.
Under the current framework only deposits held in Canadian currency are considered eligible deposits. The proposed amendments remove this restriction and provide a formula for calculating the amount of deposits payable in a foreign currency. Finally, the proposed amendments clarify the rules with respect to the C$100,000 cap for co-owned deposits.
BAIL-IN REGULATIONS UNDER THE BANK ACT AND CDIC ACT
On March 26, 2018, the Government of Canada released the final version of the bail-in regulations under the CDIC Act and Bank Act (Bail-in Regulations). A draft version of the Bail-in Regulations was published for consultation in June 2017. The Bail-in Regulations specify the type of instruments issued by Canada’s six domestic systemically important banks (DSIBs) that may be converted into common shares in the event of a resolution of a DSIB. The final Bail-in Regulations do not materially deviate from their draft version published in 2017 and are discussed in detail in our June 2017 Blakes Bulletin: Canadian Bail-In Regulations: What You Need to Know. One key new requirement added to the Bail-in Regulations is that DSIBs are prohibited from advertising or otherwise promoting a bail-in eligible security as a deposit to a purchaser in Canada.
The Bail-in Regulations take effect on September 22, 2018 (the 180th day after the date of the registration of the regulations, which is March 26, 2018). As such, securities issued by a DSIB on (or after) such date, that satisfy the eligibility requirements set out in the Bail-in Regulations will be subject to CDIC’s power to convert them into the DSIB’s common shares in the event of the DSIB’s resolution.
OSFI has not yet released the final version of its related Total Loss Absorbing Capacity (TLAC) Guideline, which was published in draft form in June 2017. The draft TLAC Guidelines are discussed in detail in our June 2017 Blakes Bulletin: Canadian Bail-In Regulations: What You Need to Know. A draft version of OSFI’s TLAC Disclosure Requirements Guideline was released for consultation on March 21, 2018, with comments due by April 17, 2018.
PCS ACT: RESOLUTION FRAMEWORK FOR CLEARING AND SETTLEMENT SYSTEMS
The Bill introduces a resolution framework for systemically important or prominent clearing and settlement systems that are designated by the Bank of Canada under the PCS Act. The resolution framework will apply only to those designated systems whose clearing house is located in Canada (Canadian Designated Systems). Currently, the only Canadian Designated Systems are CDSX, the Canadian Derivatives Clearing Service, and the large-value and retail payments systems operated by Payments Canada (PC). Under the proposed amendments, the Bank of Canada will act as the resolution authority for all Canadian Designated Systems and must develop and maintain a resolution plan for each such system. The Bank of Canada may declare a Canadian Designated System non-viable if it concludes that the Canadian Designated System has ceased, or is about to cease to be viable, and the Canadian Designated System cannot restore its viability on its own initiative. A declaration of non-viability imposes a stay in respect of all contracts with the Canadian Designated System’s clearing house or central counterparty, subject to certain exceptions for eligible financial contracts. Upon declaration of non-viability, the Bank of Canada may be appointed as receiver of the Canadian Designated System or the shares of such system’s clearing house (other than PC) may be vested in the Bank of Canada. The Bank of Canada will have broad powers in respect of a non-viable Canadian Designated System and may transfer its assets to, and arrange for the assumption of its liabilities by, a bridge clearing house designated by the Bank of Canada or other third parties. During the resolution process, the Bank of Canada must develop an exit plan to restore a Canadian Designated System’s viability. The exit plan must be approved by the federal Minister of Finance. If the resolution measures are in respect of a payments system operated by PC, certain provisions of the Canadian Payments Act are suspended during the resolution process.
The Bill also proposes making oversight information in respect of designated clearing and settlement systems confidential, similar to the confidentiality requirements for supervisory information relating to FRFIs. The scope of the oversight information that would be subject to this non-disclosure requirement will be set out in regulations, which have not been published yet.
For further information, please contact any member of our Financial Services Regulatory group.
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