2017 marked another year of prodigious development of legislation and regulatory guidance impacting federal financial institutions in Canada. The new wave of initiatives in 2017 included the second stage of the consultation process to renew the federal financial sector legislation, proposed modernization of Canada’s payments systems, regulatory studies on the regulation of fintechs, new bail-in legislation, changes to the Basel III capital framework, a review of corporate governance principles, a new supervision framework for the federal consumer financial services sector, cannabis legislation and a new economic sanctions regime under Canada’s Sergei Magnitsky Law. The key initiatives introduced or implemented in 2017 are outlined in our annual regulatory overview.
REVIEW OF FEDERAL FINANCIAL-SECTOR LEGISLATION
On August 11, 2017, Canada’s Department of Finance launched the second stage of its consultation process to review the legislative and regulatory framework of the federal financial sector, by releasing its second consultation paper, Potential Policy Measures to Support a Strong and Growing Economy: Positioning Canada’s Financial Sector for the Future (Consultation Paper). The Department of Finance is consulting on policy measures that could be addressed in the 2019 update to the federal financial institution statutes or inform longer-term initiatives. The Consultation Paper seeks stakeholders’ views on a broad array of policy measures organized into the following four themes:
- Supporting a competitive and innovative sector
- Improving the protection of bank consumers
- Modernizing the framework
- Safeguarding a stable and resilient financial sector
For more information on the Consultation Paper, please refer to our August 2017 Blakes Bulletin: Back to the Future: Finance Canada Releases Second Consultation on Financial Sector Legislation.
BANKS AND FINTECHS
The August 11, 2017, Consultation Paper also focused on the relations between banks and fintechs in considering changes to Canada’s financial-sector legislation. In this respect, the takeaway is that, although it is a priority to remove barriers to collaboration and foster competition and innovation, it is also a priority of the Department of Finance to maintain the long-standing prohibition on financial institutions engaging in commercial activities. The Department of Finance seeks to strike a balance between modernizing the type of technology activities that financial institutions are permitted to undertake and maintaining the separation of core financial services from other commercial activities. However, in our view, the provision of financial services can no longer be separated from the provision of technology services. A framework that maintains a separation between the two may be expected to fall short of meeting the needs of financial institutions and fintechs alike. In addition, it may be impractical to require banks to offer their services through apps that are restricted to pure financial services functionality only.
Also notable is that the Department of Finance intends to examine the merits of open banking as a forward-looking initiative. This would include consideration of how other jurisdictions are implementing open banking and the potential benefits and risks for Canadians. Finance Canada is not specifically asking for comments on open banking but is seeking views on other adjustments to the current framework that would support competition and innovation. It remains to be seen if a Canadian form of open banking will emerge in the coming year.
Following the Department of Finance’s consultation process, the Competition Bureau released the final report from its market study on Technology-led innovation and emerging services in the Canadian financial services sector in December 2017. The report analyzes the regulatory and non-regulatory issues faced by the fintech industry in Canada and makes 11 recommendations for addressing these issues. Many of the recommendations proposed by the Competition Bureau are a departure from the current paradigm informing the regulation of financial services. For a discussion on the Competition Bureau’s recommendations, please see our December 2017 Blakes Bulletin: Competition Bureau Releases Final Fintech Market Study.
PROPOSED CHANGES TO CANADA’S PAYMENT SYSTEMS
On December 21, 2017, Payments Canada issued a consultation document titled Modernization Target State (Target State), providing more details on Payment Canada’s proposed payment modernization project launched in 2016. The proposed Target State contemplates the following changes to Canada’s core payments clearing and settlement systems:
- Payments Canada proposes to replace the current Large Value Transfer System, Canada’s high-value payment system that facilitates real-time payments with transaction finality, with a new system (Lynx). Lynx will be structured to be better aligned with the Bank of Canada’s risk-management standards for systemically important payment systems.
- A new system will replace the existing Automated Clearing Settlement System, Canada’s core retail payment system. The new system will clear retail batch payments and will be structured to be better aligned with the Bank of Canada’s risk management standards for prominent payment systems. Payments Canada notes that the new system will also enable faster and more convenient automated funds transfers (a payment type typically used for payroll and bill payments).
- Payments Canada proposes to introduce a new “always-on” payments infrastructure that will support immediate payments and could provide non-regulated entities with direct access to payments clearing and settlement systems. This real-time infrastructure is expected to also facilitate the development of overlay services.
The proposed Target State is open for public consultation until February 23, 2018.
Earlier in November 2017, the Bank of Canada released a staff white paper assessing the merits of creating a central-bank digital currency (CBDC), given the trend away from cash. Referencing the continuing trend toward using electronic forms of payment in lieu of physical currency, the white paper explores the possible economic benefits of CDBC and whether such benefits would justify the move. Although none of the proposed benefits are a panacea, the white paper takes the position that a CBDC would not disrupt the financial system in a negative way. Rather, if implemented carefully, it may promote cost savings, efficiency and greater stability. For more information on the white paper, please see our December 2017 Blakes Bulletin: Bank of Canada Gets More Serious About Issuing a Digital Currency.
PRUDENTIAL REGULATION AND GUIDANCE
Revised Corporate Governance Guideline
On November 7, 2017, the Office of the Superintendent of Financial Institutions (OSFI) released for public comment a revised draft of its Corporate Governance Guideline (CG Guideline). The proposed revisions follow Superintendent Jeremy Rudin’s announcement in June 2016 that OSFI intended to streamline and simplify the governance guidance for federally regulated financial institutions. In the draft CG Guideline, OSFI provides a clearer delineation of board and senior management responsibilities, removes some of the more prescriptive elements of the existing CG Guideline and consolidates expectations relating to board responsibilities that are currently set out in OSFI’s capital and risk-management guidelines into the CG Guideline. OSFI expects to issue the final version of the revised CG Guideline in spring 2018. For more information, please see our December 2017 Blakes Bulletin: A Look Inside OSFI’s Draft New Corporate Governance Guideline.
Residential Mortgage Underwriting Practices and Procedures
On October 17, 2017, OSFI published the final revised version of its Guideline B-20 on Residential Mortgage Underwriting Practices and Procedures. The changes to Guideline B-20 address OSFI’s concerns regarding Canada’s residential mortgage market: possible housing bubbles in Vancouver and Toronto, rising interest rates and their potential negative effects on households with high residential mortgage debt, and governance controls.
Among other new measures, the revised Guideline B-20 now requires the minimum qualifying rate for uninsured mortgages to be the greater of the five-year benchmark rate published by the Bank of Canada or the contractual mortgage rate plus two per cent. The revised Guideline B-20 also contemplates more rigorous standards for determining the loan-to-value (LTV) ratio for residential mortgage loans. For more information about the changes to Guideline B-20, please see our July 2017 Blakes Bulletin: OSFI Looks to Further Tighten Mortgage Underwriting Standards, Issues Revised Guideline B-20 for Comment.
The revised Guideline B-20 took effect on January 1, 2018. Federal financial institutions that engage in residential mortgage lending or the acquisition of residential mortgage loans will need to consider changes to their governance and underwriting processes and what operational changes will need to be implemented. OSFI noted that its lead supervisors will be in touch with financial institutions to discuss their respective implementation plans.
The Department of Finance’s consultation on lender risk sharing for government-backed insured mortgages ended on February 28, 2017. The consultation sought comments on whether mortgage lenders should be required to retain and manage a portion of loan losses on insured mortgages that default (currently, mortgage insurance covers 100 per cent of eligible lender claims for insured mortgages that default). No further proposals were released in 2017 following this consultation.
Bank Capital and Liquidity Requirements
On March 6, 2017, OSFI issued a letter notifying deposit-taking institutions that it will delay the Canadian implementation of the Net Stable Funding Ratio (NSFR) to January 2019, given the uncertainty of its implementation in key foreign markets in 2018. The NSFR is a key liquidity measure that is intended to minimize excessive reliance by banks on unstable short-term funding to finance long-term loans. OSFI also stressed that it remains committed to implementing the NSFR measure in Canada in due course.
On July 20, 2017, OSFI issued a letter advising that it will extend the timeline for the Canadian implementation of the minimum capital requirements for market risk rule (also known as Fundamental Review of the Trading Book, or FRTB) to no earlier than the first quarter of 2021. OSFI noted that it remains committed to implementing the FRTB standards and that it expects institutions currently subject to market risk capital rules to begin developing internal strategic plans for implementing the FRTB.
On November 29, 2017, OSFI introduced certain revisions to the Capital Adequacy Requirements Guideline, which took effect for 2018. The revisions, among other things, address the treatment of allowances in anticipation of the 2018 adoption of International Financial Reporting Standard (IFRS) 9 by Canadian deposit-taking institutions.
On December 7, 2017, the oversight body for the Basel Committee on Banking Supervision endorsed the final chapter of Basel III reforms (which, given its significance and expected impact, many observers are referring to as “Basel IV” standards). The reforms endorsed by the Basel Committee introduce, among other things, a new revised standardized approach for credit risk, input floors for the parameters used for calculating credit risk under the advanced internal models and an aggregate output floor requiring that risk-weighted assets generated by internal models are no lower than 72.5 per cent of risk-weighted assets calculated by the revised standardized approach. A short description of the proposed reforms is set out in this summary document.
OSFI released a statement in December 2017 welcoming the development and noting that it will launch a public consultation focused on the domestic implementation of the Basel III reforms in spring 2018. (For OSFI’s observations on the new Basel reforms, see also Assistant Superintendent Carolyn Rogers’ remarks from January 9, 2018). Later in January 2018, OSFI released a letter announcing that it will update the existing capital floor for Canadian banks using advanced approaches for credit risk as a transitional measure before the new output floor proposed by the Basel Committee is implemented (beginning in 2022). OSFI’s current capital floor is based on the Basel I capital accord and will now be replaced by a more risk-sensitive capital floor based on the Basel II framework. Specifically, banks using advanced approaches for credit risk will be required to ensure that the risk-weighted assets generated by internal models are no lower than 75 per cent of the risk-weighted assets calculated under the Basel II standardized approach. This new transitional capital floor will be implemented effective Q2 2018. The floor factor will be set at 70 per cent in Q2 2018, increasing to 72.5 per cent in Q3 2018 and 75 per cent in Q4 2018. OSFI notes that the capital floor will be further updated over time as changes are made to OSFI’s capital framework.
Bail-In and Resolution Planning
On June 16, 2017, the Department of Finance and OSFI published for comment a package of draft regulations and guidelines that set out the final details of Canada’s bail-in framework and related total loss absorbing capacity (TLAC) capital standard for Canada’s six domestic systemically important banks (D-SIBs). The Canadian bail-in framework was first introduced in June 2016 through amendments to the Canada Deposit Insurance Corporation Act (CDIC Act). Under these amendments, the Canada Deposit Insurance Corporation (CDIC) was granted the power to convert a distressed Canadian D-SIB’s specified liabilities and shares into common shares (Bail-In Conversion) in order to recapitalize the D-SIB. The draft regulations specify the type of liabilities and shares that would be subject to a Bail-in Conversion. In conjunction with the release of the proposed bail-in regulations, OSFI also published a draft guideline on the new TLAC capital standard, which D-SIBs will need to satisfy by combination of regulatory capital and bail-in debt. In this respect, OSFI also made certain corresponding draft changes to its Capital Adequacy Requirements Guideline. If the draft bail-in regulations are adopted as proposed, they will take effect 180 days after adoption. D-SIBs will also have until November 2021 to meet the TLAC requirement, if OSFI’s draft TLAC guideline is adopted as proposed.
In addition to the draft bail-in regulations, the Department of Finance also released proposed new Compensation Regulations, which set out a framework for implementing the “no creditor worse off” principle in the context of CDIC resolution actions. Under the proposed framework, CDIC’s deposit insurance fund will pay compensation to a bank’s eligible creditors and shareholders where they are made worse off as a result of the resolution actions by CDIC than they would have been if the bank was liquidated. For more information, on the proposed bail-in framework and the Compensation Regulations, please see our Blakes Bulletin: Canadian Bail-In Regulations: What You Need to Know.
Certain amendments were also made to the CDIC Act. Specifically, the Budget Implementation Act, 2017, No. 1, which received Royal Assent on June 22, 2017, amended the CDIC Act to expressly designate CDIC as the resolution authority for its member deposit-taking institutions and enshrine in the legislation CDIC’s current practice of requiring D-SIBs to develop and maintain resolution plans. The Budget Implementation Act, 2017, No. 2, which received Royal Assent on December 14, 2017, amended the CDIC Act provisions relating to resolution stays for eligible financial contracts to better align those provisions with the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions.
In 2017, CDIC entered into information-sharing arrangements on bank failures with U.S. and European regulatory authorities. Specifically, on March 17, 2017, CDIC announced that it entered into an information-sharing arrangement with the U.S. Office of the Comptroller of the Currency to formalize cross-border cooperation in the event of the failure of a large, complex financial institution with operations in both countries. CDIC already has a similar memorandum of understanding with the U.S. Federal Deposit Insurance Corporation. On December 22, 2017, CDIC also announced the signing of an agreement with the European Single Resolution Board on the exchange of information to facilitate the resolution of financial firms with international operations. CDIC has a similar arrangement in place with the U.K.’s Prudential Regulation Authority.
In the deposit-insurance context, CDIC made certain amendments to the Canada Deposit Insurance Corporation Differential Premiums By-law (registered on March 8, 2017) and the Canada Deposit Insurance Corporation Deposit Insurance Information By-law (registered on September 29, 2017), together with a related information bulletin (released on October 18, 2017).
Insurance Capital Requirements
On March 20, 2017, OSFI issued the final version of its advisory on Deferral of IFRS 9 Application for Federally Regulated Life Insurers. OSFI’s advisory is in response to the amendment to IFRS 4 Insurance Contracts, approved by the International Accounting Standards Board in September 2016, allowing insurance companies to defer the application of IFRS 9 Financial Instruments until January 1, 2021. The advisory notes that OSFI expects life insurers whose activities are predominantly connected with insurance to apply the temporary exemption from IFRS 9 in annual periods beginning before January 1, 2021.
On October 19, 2017, OSFI released updates to the Minimum Capital Test Guideline for Federally Regulated Property and Casualty Insurance Companies. The annual updates for 2017 included removing transition requirements that are no longer applicable and providing certain regulatory capital treatment clarifications. The revised guideline became effective January 1, 2018.
On January 1, 2018, OSFI’s new Life Insurance Capital Adequacy Test (LICAT) Guideline, adopted in 2016, took effect, replacing the Minimum Continuing Capital and Surplus Requirements (MCCSR) capital measure. Earlier in November 2017, OSFI issued certain modest updates to the LICAT Guideline and issued several new guidance materials in connection with the implementation of the new LICAT framework. Specifically, on July 21, 2017, OSFI issued for comment a draft guideline on LICAT Public Disclosure Requirements, which sets out OSFI’s expectations regarding public disclosures relating to regulatory capital for federally regulated life insurance companies. OSFI also issued updated versions of the following guidance documents on December 14, 2017, to reflect the introduction of the new LICAT guideline:
OSFI has released a number of technical videos on each chapter of the LICAT Guideline, which are available on OSFI’s YouTube channel.
Operational Risk Management
On April 12, 2017, OSFI issued a self-assessment template for financial institutions to assess their practices against the principles outlined in OSFI’s Guideline E-21 on Operational Risk Management, which was issued in June 2016 with an implementation date of June 2017. OSFI noted that it may request financial institutions to complete the self-assessment template during future supervisory assessments.
Model Risk Management
On September 13, 2017, OSFI issued the final version of Guideline E-23 on Enterprise-Wide Model Risk Management for Deposit-Taking Institutions. Guideline E-23 establishes OSFI’s expectations for institutions in managing and controlling the use of models, whether for regulatory capital determination, internal risk management, valuation/pricing, business decision-making or stress-testing purposes. The final Guideline E-23 incorporates several revisions based on comments received from stakeholders during the public consultation period that began in December 2016. For institutions that have received OSFI approval to use an internal model for regulatory-capital purposes, Guideline E-23 took effect in November 2017. Other institutions will have until January 1, 2019, to become compliant with Guideline E-23. For more information, please see our January 2017 Blakes Bulletin: OSFI Releases Draft Guidance on Model Risk Management.
OSFI Ruling on Acting Jointly or in Concert
On October 4, 2017, OSFI published a ruling considering the issue of whether two shareholders who are party to a shareholders’ agreement are acting jointly or in concert within the meaning of the Bank Act and other federal financial institution statutes. The agreement provided that the shareholders would act together to cause the company to use all commercially reasonable efforts to conduct its business in a way as to achieve certain tax efficiencies. OSFI concluded that the mere fact the shareholders have entered into a shareholders’ agreement is not conclusive, rather, the focus of the analysis should be on the materiality of the limitations that the shareholder agreement imposes on the shareholders’ decisional independence in respect of their shares.
Updated OSFI Advisories and Transaction Instructions
In 2017, OSFI updated a significant number of its transaction instructions in 2017. The updated transaction instructions are listed below:
- Acquisition of control of, or a substantial investment in, a non-financial services entity (other than a limited commercial entity)
FCAC Business Practices Review
On March 15, 2017, the Financial Consumer Agency of Canada (FCAC) announced that it was launching a review of business practices in the federally regulated financial sector. The review focused on allegations reported in the media that some financial institutions sell products and services to consumers without properly obtaining their prior express consent. In connection with this review, the FCAC also published a new bulletin B-5: Consent for New Products or Services setting out the FCAC’s expectations regarding express consent. Although the FCAC Commissioner indicated that an interim report on the review would be issued by the end of 2017 and a full report in 2018, the FCAC later announced that only a single comprehensive report will be issued, which is anticipated in the first quarter of 2018.
New FCAC Supervision Framework
In April 2017, the FCAC published its new Supervision Framework, which reflects the feedback the FCAC received from its stakeholder consultations in 2016. The Supervision Framework will replace the FCAC’s current Compliance Framework. It outlines the principles and processes that the FCAC will use to supervise federal financial institutions, external complaints bodies and payment card network operators (PCNOs). When announcing the Supervision Framework, the FCAC highlighted that internal processes and functions will be redesigned and phased in over time to support the core components of the new framework. The Supervision Framework will come into effect sometime in 2018, according to the FCAC. For more information, please see our May 2017 Blakes Bulletin: Financial Consumer Agency of Canada Publishes New Supervision Framework.
New FCAC Decisions and Bulletin
The FCAC issued three decisions in 2017:
- Decision #126 (May 15, 2017): Released in respect of a PCNO that incorrectly disclosed certain transactions in the monthly statements issued to merchants, contrary to Element 1 of the Code of Conduct for the Credit and Debit Card Industry in Canada (the Code). This decision marks the first case dealing with a PCNO’s obligation to ensure compliance with the Code by its participants. For more information, please see our May 2017 Blakes Bulletin: FCAC Publishes First Decision Regarding Non-Compliance with Code of Conduct.
- Decision #127 (June 29, 2017): Released in relation to non-compliance by a bank with the requirement that the cost of borrowing be expressed as an amount in dollars and cents, as set out in the Cost of Borrowing (Banks) Regulations.
- Decision #128 (June 29, 2017): Released in respect of a bank that failed to disclose certain cost of borrowing information for its mortgages and obtain consent under the Electronic Documents Regulations in respect of its credit cards.
On August 31, 2017, the FCAC released for comment a proposed bulletin on indirect auto loans. The proposed bulletin sets out the FCAC’s expectation for banks and bank affiliates engaged in selling, or furthering the sale of, indirect auto loans to review their agreements with auto dealers to ensure compliance with consumer provisions under the Bank Act and applicable regulations.
On April 13, 2017, the federal government introduced Bill C-45, better known as the Cannabis Act, the legislation to legalize and regulate the use of cannabis for recreational purposes. Bill C-45 completed the House of Commons committee process on October 3, 2017, and is anticipated to take effect on July 2018. The introduction of this law will impact many types of businesses, including those in the financial services sector. For more details on the impact on the financial services sector, please see our Cannabis in Canada website. For more information on how the anti-money laundering regime may be impacted by the legalization of recreational cannabis, please see our May 2017 Blakes Bulletin: Banking Cannabis Clients Under Canada’s Anti-Money Laundering Regime.
ANTI-MONEY LAUNDERING (AML) AND SANCTIONS
Amendments to AML Legislation Now in Effect
In 2017, the amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Regulations that were introduced in June 2016 took effect. Specifically, on June 17, 2017, the new requirements in respect of politically exposed domestic persons and heads of international organizations came into force. Later in June, the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) released an updated version of its guidance on Methods to identify individuals and confirm the existence of entities and extended the transition period for reliance on identification methods in place before the June 2016 amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Regulations (PC Regulations) until January 23, 2018. These older identification methods have now been fully phased out, and financial institutions must ensure that customer identification is conducted in compliance with the photo-identification method, the three-year Canadian credit bureau method or the dual-process method that are currently provided for in the PC Regulations. FINTRAC also updated and reformatted most of its guidelines, which are now available here.
In 2017, the federal government introduced a number of significant changes to Canada’s economic sanctions framework.
On April 13, 2017, the federal government repealed the United Nations Côte d’Ivoire Regulations and the United Nations Liberia Regulations, following the repeal by the United Nations Security Council of the sanctions measures that were in place against Côte d’Ivoire and Liberia.
On June 20, 2017, the federal government removed Belarus from Canada’s Area Control List (ACL). The ACL, established under the Export and Import Permits Act, is a list of countries against which Canada has instituted a complete export prohibition. The export of any goods or technology to a country listed in the ACL is prohibited unless prior authorization has been obtained under the Export and Import Permits Act. North Korea is currently the only country listed in the ACL.
On September 22, 2017, the federal government adopted the Special Economic Measures (Venezuela) Regulations to impose an asset freeze on 40 Venezuelans identified as key figures in the government of President Nicolas Maduro. For more information about the Venezuela sanctions, please see our October 2017 Blakes Bulletin: Canadian Economic Sanctions Update: New Sanctions Against Venezuela and Other Developments.
On October 18, 2017, the Parliament of Canada adopted the Justice for Victims of Corrupt Foreign Officials Act (Sergei Magnitsky Law) imposing an asset freeze on a number of foreign nationals identified by the federal government to be responsible for, or complicit in, significant corruption or gross violations of human rights. The operating regulations under this legislation were released later in November 2017. For more information about Canada’s Sergei Magnitsky Law, please see our November 2017 Blakes Bulletin: New Canadian Sanctions Legislation in Effect: Sergei Magnitsky Law.
For further information on the Canadian sanctions regime, please refer to our November 2017 Blakes Bulletin: A Primer on Canadian Sanctions Legislation.
New Directive on North Korea
On November 29, 2017, Canada’s Minister of Finance issued a directive under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PC Act) requiring that financial institutions “treat all transactions originating from, or destined to, North Korea (Democratic People’s Republic of Korea) as high risk.” This is the first ministerial directive issued under Part 1.1 of the PC Act.
On December 9, 2017, FINTRAC issued guidance in respect of the directive noting that financial institutions must implement specific measures to mitigate the risk posed by transactions relating to North Korea and document the measures taken. FINTRAC’s guidance provides examples of risk-mitigation measures relating to such transactions. Additional information relating to the directive is available in FINTRAC’s December 12, 2017, operational alert and on the website of the Department of Finance.
Financial institutions should ensure that their AML policies are updated to reflect the requirements of the new directive.
To access our recent annual reviews of legislation and guidance for federal financial institutions, please visit: