OSFI has published Remarks by Superintendent Julie Dickson to the 58th Annual Canadian Reinsurance Conference, Toronto, Ontario, April 2, 2014:
We were recently subject to an IMF financial sector assessment (i.e. FSAP). The FSAP process determines a country’s compliance with international standards and provides an overview of the economic health of a country as well as regulatory effectiveness. The assessors were asked to look for any signs of complacency at OSFI. I am happy to say that they did not find any. They have concluded that we continue to be effective with a high level of compliance with international standards. [Footnoted link]
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OSFI tends to strongly support global standards and practices, versus entering into endless debates about whether we need them.
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I was very happy to see the December 2013 report of the U.S. Department of Treasury, on modernizing insurance regulation. It did not mince words in advocating group capital adequacy and consolidated supervision in the U.S., something that has been debated for a long, long time. [Footnoted link]
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The IAIS [International Association of Insurance Supervisors ] is developing backstop capital requirements, as well as higher loss absorbency requirements for designated Global Systemically Important Insurers (G-SIIs), as well as global Insurance Capital Standards for all internationally active insurance groups (or IAIGs).Harmonization of insurance capital requirements globally is an important development. It is premature to determine the impact these will have on Canadian capital requirements. Therefore, as expected, OSFI intends to continue development of our internal set of rules, given the international global standard might initially act as only a minimum requirement until sufficient time has been allowed to develop and test a robust enough capital test.
The first footnoted link is to the IMF’s Canada page, which is headed by a link to CANADA – FINANCIAL SECTOR ASSESSMENT PROGRAM – CRISIS MANAGEMENT AND BANK RESOLUTION – FRAMEWORK—TECHNICAL NOTE:
The ex-ante funding of CDIC should continue to be bolstered. To achieve the targeted 100 basis points coverage of the insured deposits (from the current 39 basis points), an increase of the premiums paid by financial institutions will be necessary. Enhanced data collection on depositors would ensure that the coverage limit and the target ex-ante financing strike the right balance between depositor protection, financial stability, and market discipline. The proposed simplification of the rules for eligibility for deposit insurance of complex deposit products is welcome.
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The Canadian financial system is large, relatively complex, and concentrated. The financial system accounts for almost 500 percent of the GDP and is composed of a large spectrum of federally and provincially regulated institutions. The six domestic systemically important banks (D-SIBs) and one large provincially incorporated credit cooperative network hold almost half of the financial sector assets. The financial system was exceptionally resilient during the global financial crisis and no financial institution had to be closed or rescued.
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A number of legal provisions create room for “constructive tensions” between the
OSFI and CDIC, at which point their actions should be closely coordinated. For example, CDIC can terminate deposit insurance, even if the institution is still solvent (Section 30 of the CDIC Act). In the past, the CDIC has terminated deposit insurance as an enforcement action against two solvent members. Such powers were used by the CDIC when it was responsible for the administration of the Standards of Sound Financial and Business Practices. The CDIC has to be concerned about minimizing the exposure of the insurance fund to loss from failing institutions. This could create an incentive to resolve an institution sooner rather than later—for instance, to lean against perceived regulatory forbearance—but may conflict with supervisory interests. Such risks call for close bilateral coordination between the OSFI and CDIC, as well as though the FISC cooperation.
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The authorities should consider introducing some form of depositor preference. Depositor preference not only mitigates the risk of depositor runs, it can also improve recoveries for depositors, the deposit insurance agencies, and the government in the case of a bank’s failure. In the context of the proposal to introduce bail-in powers, the introduction of depositor preference is all the more important as unsecured creditors will need to be written-down or have their debts converted into equity. If depositors are ranked equally with unsecured creditors, a bail-in cannot be effected without discriminating within the class of creditors. Depositor preference could be tailored to take different forms (although national depositor preference should be avoided as it could hamper cross-border resolution), based on a rigorous analysis of the desired impact and interaction with other features of the existing bank operating and resolution framework (Appendix II).
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The CDIC is ex-ante funded and reviews its target funding level regularly.CDIC currently has funding of Can$2.6 billion representing an estimated 39 basis points of insured deposits. The existing resources are sufficient to repay insured deposits in all small banks individually, or concurrently in a number of small banks, but would not be sufficient to cover insured deposits in a medium-sized institution. The relatively low level of ex-ante coverage reflects a long period of time in which the corporation had to recover from substantial losses incurred in the mid eighties and early nineties. The CDIC plans to achieve a minimum target ex ante funding of 100 basis points of insured deposits (currently equivalent to Can$6.5 billion), over the coming ten years.
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In addition, CDIC can terminate deposit insurance (as per Section 30 Report). The basis for termination can be evidence of unsound standards of prudent business financial practices (e.g. unsound capital management). The issuance of a Section 30 report is typically preceded by the conduct of a special examination, following which the institution has to rectify the situation. A copy of the Section 30 report shall be provided to the MOF (or provincial Minister if provincial member) and indicates that a failure to remedy the situation could lead to the termination of the deposit insurance policy. The MOF has the power to override such decision based on public interest grounds.76. The termination of deposit insurance triggers the taking control of the supervised institution by OSFI. The existing eligible deposits would continue to be insured for two years from the termination date (or for term deposits with a longer term, until the maturity date of the term deposit). Alternatively, CDIC has the discretionary authority to make an immediate deposit insurance payment for all eligible deposits. In its history, CDIC has terminated the deposit insurance policy of three member institutions through the Section 30 process and has immediately reimbursed deposits in all the three cases.
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The NVCC is a gone-concern contingent instrument. The NVCC aims to ensure that investors in non-common Tier 1 and Tier 2 regulatory capital instruments bear losses before taxpayers where the government determines it is in the public interest to rescue a non-viable bank, based on clearly specified trigger events. The NVCC triggers are very late and very remote and the Canadian authorities confirm that they would only elect to trigger the NVCC where there is a high level of confidence that the conversion accompanied by additional measures (i.e. liquidity assistance provided by BOC, liquidity assistance provided by CDIC, change in management, change in business plan, public or private capital injection) would restore the viability of the failed financial institution. The NVCC instruments are not contingent convertible instruments (Co-Cos), the key distinction being the timing and nature of the NVCC triggers, which can be exercised only at the discretion of the authorities at the point of non-viability.
…The NVCC is just an option in the resolution toolkit. The decision to maintain an institution as a going concern where it would otherwise become non-viable will be informed by OSFI’s interaction with the FISC and on the CDIC Board of Directors. However, the Canadian authorities will retain full discretion to choose not to trigger NVCC notwithstanding a determination by the Superintendent that an institution ceased, or is about to cease, to be viable. Therefore, other resolution options, including the creation of a bridge bank, could be used to resolve a failing institution either as an alternative to NVCC or in conjunction with or following an NVCC conversion, and could also subject capital providers to loss.
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To the date when the FSAP was conducted, none of the major banks had issued a de novo NVCC instrument, although the first issuance was expected soon. CIBC did, however, amend via a deed poll the terms of three series of its preferred shares to make them NVCCcompliant. A number of smaller, closely-held banks have issued NVCC or modified instruments to make them NVCC-compliant. For these banks, OSFI has permitted alternatives to the market-based conversion required under the CAR Guideline to accommodate the unlisted nature of their common shares or intercompany issuances where all of the capital has been issued to the parent or affiliates. Under the CAR Guideline, each instrument must have a formula governing the conversion mechanism that references the market value of equity when OSFI determines the institution is no longer available. OSFI expects good demand from institutional fixed income and other investors for NVCC.
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Furthermore, the bail-in regime needs to be consistent with other financial stability objectives. Several long-term aspects will need to be carefully taken into consideration when introducing the new regime. The introduction of bail-in could increase the funding costs for unsecured debt and which may, in turn, trigger shifts in banks’ liability structure towards other forms of funding (i.e. secured) which are outside the scope of the bail-in regime. Such arbitrage incentives would be countered, however, by other regulatory measures including the Basel III Net Stable Funding Ratio which will incentivize banks to hold higher levels of stable, long-term funding; and asset encumbrance limits that restrain banks’ reliance on secured debt funding. It would be also useful to consider requiring the D-SIBs to hold a minimum amount of capital instruments and senior, unsecured debt in conjunction with the bail-in regime to ensure a minimum amount of gone-concern loss-absorption capacity. Last, when deploying bail-in, authorities should be mindful of cross-sector contagion in crisis times, as for example insurance companies are major investors in banks’ debt instruments.
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The second footnote of Dickson’s speech references the Reports & Notices page of the US Treasury; the first link there is to How to Modernize and Improve the System of Insurance Regulation in the United States:
By drawing attention to the supervision of diversified complex financial institutions such as American International Group, Inc. (AIG), the financial crisis added another dimension to the debate on regulating the insurance industry. The crisis demonstrated that insurers, many of which are large, complex, and global in reach, are integrated into the broader U.S. financial system and that insurers operating within a group may engage in practices that can cause or transmit severe distress to and through the financial system. AIG’s near-collapse revealed that, despite having several functional regulators, a single regulator did not exercise the responsibility for understanding and supervising the enterprise as a whole. The damage to the broader economy and to the financial system caused by the financial crisis underscored the need to supervise firms on a consolidated basis, to improve safety and soundness standards so as to make firms less susceptible to financial shocks, and to better understand and regulate interconnections between financial companies.
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If an insurer is to receive credit against a capital or reserve requirement because of risk transferred to an insurance captive, the rules governing the quality and quantum of assets offered in support of the captive should be uniform across states and sufficiently robust and transparent in order to prevent arbitrage by insurers. The matter is one that must be assessed within the rubric of the capital adequacy of an insurance group as a whole. Under the current state-based capital adequacy regime, group capital assessments rely on CRA ratings or on a firm-produced ORSA to evaluate a group’s capital position and the strength of intra-group guarantees. Neither of these measures of group capital adequacy, however, is a substitute for group capital standards that are established and supervised by regulators.