Review of the Federal Financial Sector Framework - Department of Finance Canada Second Consultation Paper including Focus on Fintech, Open Banking
On August 11, 2017, the Department of Finance Canada (Finance Canada) released its second consultation paper respecting the review of the federal financial sector framework, Potential Policy Measures to Support a Strong and Growing Economy: Positioning Canada’s Financial Sector for the Future. This is the second stage in a two-stage consultation process on the federal financial sector legislative and regulatory framework being performed in application of the “sunset clause” included in the federal financial institutions statutes (the Bank Act, the Trust and Loan Companies Act, the Insurance Companies Act and the Cooperative Credit Associations Act) which requires the federal government to review these statutes before March 29, 2019. Finance Canada published its first consultation paper in August 2016, in which it set out the landscape of Canada’s financial sector, identified certain trends in the sector and sought input on these trends, focusing on stability, efficiency and utility. Please refer to our commentary on the first consultation paper for further information.
With a second consultation closing on September 29, 2017, Finance Canada now seeks further input on more detailed policy measures and potential directions, including specific potential updates to the federal financial institutions statutes. The issues identified by Finance Canada are separated into four themes:
- supporting a competitive and innovative sector,
- improving the protection of bank consumers,
- modernizing the framework, and
- safeguarding a stable and resilient sector.
- Supporting a competitive and innovative sector
Finance Canada wishes to focus on growth and recognizes the financial sector’s fundamental role in this respect, notably its role in maximizing wealth utilization. As a result, in order to foster growth, Finance Canada aims to support a competitive and innovative financial sector through different measures: clarifying the Fintech business powers of financial institutions, facilitating Fintech collaboration, improving regulatory transparency and coordination, positioning a competitive and innovative sector to support long-term economic growth, streamlining the bank entry and exit framework, and examining the merits of open banking.
Clarifying the Fintech Business Powers of Financial Institutions
Financial institutions are restricted from engaging in commercial, information and technology activities without obtaining the Minister’s consent. These restrictions have evolved over the years to adapt to the changing landscape in which financial institutions evolve, including the rise of technology-driven solutions. Notwithstanding, Finance Canada concludes from the results of the first consultation that some of the relevant language in federal financial institutions statutes is outdated, and, as a result, may impede innovation, notably innovation through the use of financial technology. As a result, Finance Canada may consider updating more statutory language and it is seeking views on whether to clarify and modernize the type of information and technology activities that federally regulated financial institutions are permitted to undertake in-house, while maintaining the long-standing prohibition on commercial activities.
Facilitating Fintech Collaboration
Collaboration between new entrants in the market and incumbent financial institutions allows the combination of the scale and customer relationships of incumbents with the flexibility of Fintechs. However, current legislative language restricts such collaboration. Finance Canada is seeking input on whether to facilitate collaboration by providing additional flexibility to make non-controlling investments in Fintechs and the corresponding authority to make referrals. Regarding arrangements where Fintechs provide outsourcing services to financial institutions, Finance Canada instructs interested parties to direct their comments to the Office of the Superintendent of Financial Institutions (OSFI).
Improving Regulatory Transparency and Coordination
Complicated interaction with federal, provincial and territorial authorities and difficulty in navigating the federal financial institutions regulatory framework were cited as roadblocks for some Fintechs. To remedy this, Finance Canada notes the need for better coordination and information sharing with provincial and territorial regulatory authorities and to provide more detailed information on the framework, such as better regulatory contact information.
Streamlining the Bank Entry and Exit Framework
Finance Canada wishes to see more financial sector entrepreneurs (including Fintechs) enter the market for financial services in order to bolster competition. As a result, it is willing to accommodate their needs to a certain extent and it is open to undertaking a series of targeted refinements to streamline and promote a smooth bank entry and exit process, for example:
- increasing the number of officers a newly incorporated federally regulated financial institution may remunerate to better meet OSFI's prudential expectations around designated officers; and
- providing OSFI with the authority to extend the period to issue an Order to Commence and Carry on Business in exceptional circumstances.
Positioning a Competitive and Innovative Sector to Support Long-Term Economic Growth
Competition in the financial sector can make for more affordable and more innovative financial services for customers. However, the advantages of competition need to be balanced with the importance of managing risk in the financial sector, notably through oversight and regulation. As a result, the Government already applies proportionality in the development of policy and regulation; however, small and mid-sized banks may still face challenges due to proportionately higher regulatory burden and capital expectations relative to their larger counterparts, which requirements may not be reflective of the overall stability risk posed by them. In this context, Finance Canada is seeking views on how best to ensure that the financial sector supports long-term economic growth, while balancing the need for a well-functioning and stable sector and, in particular, recognizes the role that small and mid-sized banks can play in enhancing the innovative and competitive potential of the Canadian economy.
Examining the Merits of Open Banking
“Open Banking” refers to an emerging financial services business model that focuses on the portability and open availability of customer data, including transactional information. In the European Union and United Kingdom, open banking is required by law (under the Second Payment Services Directive (PSD2) and by order of the Competition and Markets Authority, respectively). In both cases, one of the stated goals of the regulatory reform was to drive innovation by requiring financial institutions to give customers the option to share information about their banking activities with third parties that could then deliver an enhanced banking experience (for example by offering comparison and switching services to help customers identify the best financial products for them). Open banking is characterized by:
1) the use of open source Application Programming Interface (APIs) that enable third party developers to build applications and services around the financial institution;
2) greater financial transparency options for account holders, ranging from fully open data to private data; and
3) the use of open source technology to achieve the above.
The UK’s Open Banking Project and similar efforts under PSD2 have taken several years and are just becoming fully operational in those jurisdictions, but are being watched closely by all stakeholders in the financial services sector.
In this consultation paper, Finance Canada announced its intent to examine the merits of open banking, including consideration of how other jurisdictions are implementing open banking and the potential benefits and risks for Canadians. Issues that are key elsewhere (and would likely be key in Canada) are considerations around privacy and data protection, data ownership, cybersecurity issues raised by an open or partially-open environment (including consideration of uniform technical standards), and liability allocation.
- Improving the protection of bank consumers
In 2016, Finance Canada proposed measures to strengthen the protection of bank consumers covering five areas: access to basic banking services, business practices, information disclosure, complaints handling and governance and public accountability. Currently, the Financial Consumer Agency of Canada (FCAC) as well as OSFI have initiated their own assessment of the current regime:
- the Minister of Finance has asked the Commissioner of the FCAC to examine best practices in financial consumer protection across Canada;
- the FCAC is reviewing bank sales practices to assess whether sales targets and incentives are contributing to poor outcomes for consumers, investigating any non-compliance and it will take enforcement action where necessary; and
- OSFI is reviewing domestic retail sales practices at domestic systemically important banks (Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and The Toronto-Dominion Bank), and is focusing on risk culture, the governance of sales practices, and how banks manage the potential reputational risk inherent in sales activities.
- Modernizing the framework
Specialized Infrastructure Investment Powers
In order to keep pace with new developments and best practices, and adapt to a changing macroeconomic environment and a more uncertain international business climate, Finance Canada sets out potential policy measures to better allow federally regulated life and health insurers to match assets to their liabilities.
Finance Canada is seeking views on whether to provide federally regulated life and health insurers with additional investment powers in infrastructure and on the conditions that should be applied to additional infrastructure investment powers of life and health insurers so as to protect policyholders and maintain the long-standing limitation on commercial investments.
While recognizing that federally regulated financial institutions are recognized leaders in establishing and applying strong corporate governance frameworks, Finance Canada stresses the importance for financial institutions to take into account Bill C-25, which proposes a number of changes to the Canada Business Corporations Act (on which the corporate governance requirements in the federal financial institutions statutes are based). As a result, it proposes (a) to promote diversity on boards and seeks views on whether to implement a "comply or explain" model to promote the participation of women on boards of directors and in senior management of federally regulated financial institutions; (b) to strengthen shareholder democracy in the election of directors by establishing annual elections, mandating individual director elections, or establishing majority voting for directors of the board in uncontested elections; (c) to permit electronic distribution of meeting materials by permitting the use of the "notice and access" approach for all federally regulated financial institutions; and (d) to strengthen corporate transparency by prohibiting bearer shares and bearer share warrants under the federal financial institutions statutes. Please refer to our commentary for further information.
Federal Credit Unions and the Cooperative Credit Associations Act
Considering that there are currently no active institutions subject to the Cooperative Credit Associations Act, Finance Canada proposes to repeal this Act.
Limitations on Using the Terms "Bank," "Banker" and "Banking"
Section 983 of the Bank Act provides that, subject to very limited exceptions, a non-bank entity that acquires, adopts or retains a name that includes the word “bank”, “banker” or “banking”, either alone or in combination with other words, to indicate or describe a business in Canada or any part of a business in Canada, without being authorized to do so under the Bank Act or any other Act of Parliament, is guilty of an offence under the Bank Act. On June 30, 2017, the OSFI Advisory 2017-01 provided additional guidance on OSFI’s interpretation of the limitations in the Bank Act on the uses of the words “bank”, “banker” and “banking” and related exceptions. Please refer to our commentary for further information.
In this context, Finance Canada notes that credit unions, which are not banks, use the verb "bank" and the term "banking" to describe their activities and the services they provide, such as by having online "banking" websites or using the marketing phrase "come do your banking with us," rather than using alternative common terms such as "online transaction accounts" or "providing personal financial services." As a result, it is seeking views on whether prudentially regulated non-bank deposit-taking institutions should be given flexibility to use the terms "bank" or "banking" to describe their activities and services in appropriate circumstances, on how to refine the limitations on the use of these terms and on how to avoid marketplace confusion and ensure appropriate protection of consumers.
- Safeguarding a stable and resilient sector
After the global financial crisis, the Government’s efforts to safeguard the stability and resiliency of Canada's financial sector have widely focused on banks. However, Finance Canada is considering policy measures regarding the ability of Canada's property and casualty insurance sector to cope with a low-probability, high-impact earthquake. Finance Canada is considering how to limit the system-wide risks an extreme earthquake could pose to federal property and casualty insurers and notes that the FCAC intends to improve consumer education products related to catastrophic risk and insurance. It is also seeking views on possible enhancements to the life insurance resolution framework.
Finally, Finance Canada sets out for comment potential policy measures of a more targeted nature to the federal financial sector framework.
For more information about our firm’s Fintech expertise, please see our Fintech group‘s page.