Introduction
Roadmap for action

D-SIB designation
Additional capital
Bail-in regime
More disclosure
Closer supervision
Resolution and recovery plans
Comment


Introduction

In November 2010 the Financial Stability Board (FSB) recommended that all FSB jurisdictions put in place a policy framework to reduce the risks and externalities associated with global and domestic systemically important financial institutions in their jurisdictions. The FSB recommended five components for the framework:

  • a higher loss absorbency capacity to reflect the greater risks that these institutions pose to the global or domestic financial system;
  • more intensive supervisory oversight;
  • a robust core financial market infrastructure to reduce contagion risk from failure;
  • a resolution framework and other measures to ensure that all financial institutions can be resolved safely, quickly and without destabilising the financial system or exposing taxpayers to the risk of loss; and
  • supplementary prudential and other requirements.

It appears that Canada has since made good progress in implementing these recommendations. Of course, as is typical with respect to financial services regulation, not all of the measures are transparent. Some of the key accomplishments thus far are summarised below.

Roadmap for action

The Federal Budget for 2013 announced that steps would be taken to "implement a comprehensive risk management framework" for domestic systemically important banks (D-SIBs). These steps were to include the introduction of a higher capital requirement, the implementation of a bail-in regime in the event that a D-SIB depletes its capital, enhanced supervision and a requirement for recovery and resolution plans.

D-SIB designation

Roughly coincident with the release of the Budget, the Office of the Superintendent of Financial Institutions (OSFI) announced that the six largest Canadian banks had been designated as D-SIBs. A description of the designation criteria that OSFI used to make the designations can be found as an appendix to Chapter 1 of the OSFI Capital Adequacy Requirements Guideline. Based on the methodology described in the appendix, OSFI has designated the five largest banks "without further distinction between them". According to OSFI, the National Bank of Canada was also designated because of its importance relative to other less prominent banks and in the interest of prudence, given the inherent challenges in identifying ahead of time which banks are likely to be systemic in times of stress.

Additional capital

At the time that the D-SIBs were designated, OSFI also announced that an additional capital requirement would be imposed on D-SIBs beginning on January 1 2016. The additional capital requirement or 'higher loss absorbency target' was implemented in the form of a common equity surcharge of 1% of risk weighted assets. Accordingly, D-SIBs will be required to meet an all-in Pillar 1 target common equity Tier 1 ratio of 8% of risk weighted assets as of January 1 2016.

Bail-in regime

In August 2014 the federal minister of finance launched a consultation on a possible bail-in structure for D-SIBs. Under the proposal, certain types of debt would be converted to equity if a D-SIB depleted its capital. The comment period for the consultation closed last September. There has been no indication of the timing for the release of the final details of this bail-in regime.

More disclosure

The appendix to the CAR Guideline states that D-SIBs are expected to adopt the recommendations of the FSB's Enhanced Disclosure Taskforce and any future disclosure recommendations that are endorsed by international standard setters and the FSB, as well as evolving domestic and international bank risk disclosure best practices. The FSB recommendations were developed for large international banks rather than specifically for D-SIBs.

Additionally, OSFI Advisory – Public Capital Disclosure Requirements related to Basel III Pillar 3 prescribes a set of capital-related disclosure requirements that are unique to D-SIBs.

Further, OSFI Advisory – Public Disclosure Requirements for Domestic Systemically Important Banks on Liquidity Coverage Ratio implements the liquidity coverage ratio disclosure standards developed by the Basel Committee on Banking Supervision that apply to internationally active banks. These standards now apply to D-SIBs.

Closer supervision

The appendix to the CAR Guideline also discusses the additional supervisory measures that have been implemented in respect of D-SIBs. Although OSFI notes that it has always applied a risk-based approach to determining the intensity of its supervision, it also notes that it has implemented the following additional measures:

  • greater frequency and intensity of on and off-site monitoring of activities, including more granular forms of risk management reporting to OSFI, and more structured interactions with boards and senior management;
  • more extensive use of specialist expertise relating to credit risk, market risk, operational risk, corporate governance and anti-money laundering and compliance;
  • stronger control expectations for important businesses, including the use of advanced approaches for Pillar 1 reporting of credit, market and operational risks;
  • greater use of cross-institution reviews, both domestically and internationally, in order to confirm the use of good risk management, corporate governance and disclosure practices;
  • selective use of external reviews to benchmark leading risk control practices, especially for instances where best practices may reside outside Canada; and
  • regular use of stress tests to inform capital and liquidity assessments.

Of course, most of these measures are not transparent outside of the D-SIBs.

Resolution and recovery plans

The CAR Guideline notes that OSFI is leading on recovery planning and the Canada Deposit Insurance Corporation (CDIC) is leading on resolution planning. Indeed, the CDIC Deposit Insurance Policy Bylaw was recently amended to permit the CDIC to request information from a CDIC member for the purpose of designing and maintaining a resolution plan. According to OSFI, CDIC has committed significant new resources to the resolution planning process.

Comment

It appears that significant steps have been taken to implement the FSB recommendations. While OSFI has historically devoted more attention to the large banks than smaller ones (even before the financial crisis), developing a framework for a distinct portion of the financial services industry marks a departure from the traditional approach to bank regulation in Canada. It will be interesting to see how this approach will be carried forward in the future.

For further information on this topic please contact John Jason at Norton Rose Fulbright by telephone (+1 416 216 4000), fax (+1 416 216 3930) or email (john.jason@nortonrosefulbright.com). The Norton Rose Fulbright Canada website can be accessed at www.nortonrosefulbright.com/ca.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.