PACC Committee Report

The Standing Committee on Public Accounts has considered Chapter 30 of the December 1997 Report of the Auditor General of Canada (Office of the Superintendent of Financial Institutions: Insurance and Pensions) and the Committee has agreed to the following report:

The financial industry is rapidly changing. The accelerated pace at which financial institutions are consolidating, technological advances and the ongoing development of interconnections between capital markets are resulting in a restructuring of the financial sector.

The Office of the Superintendent of Financial Institutions (OSFI) is a federal organization responsible for monitoring deposit-taking institutions, insurance companies and pension plans. On the whole, OSFI enjoys an excellent reputation among financial institutions and other regulatory agencies.

Since OSFI's inception in 1987, numerous changes have occurred in the financial industry and been made to the statutory provisions that govern it. OSFI has taken significant steps to adjust to those changes, in particular by placing greater emphasis on issues pertaining to solvency and good corporate governance to guarantee prudent management by the entities subject to OFSI supervision rather than to rely on compliance with statutes and regulations.

OSFI and other stakeholders, together with the financial industry, have developed sound codes of administrative and financial practice and guides to intervention for each of the sectors it regulates. OSFI continues to improve its regulatory framework by developing performance measures and new approaches to audit compliance with statutory and regulatory requirements.

An essential component of OSFI's success is its ability to adapt quickly to change. To meet these new challenges, OSFI must develop and maintain a strategic vision enabling it to revise its management strategy and framework to meet changing regulatory requirements over the long term. Although OSFI has managed to respond to the financial environment's present needs, it must nevertheless correct certain significant deficiencies in order to meet the needs of the future.

In view of the importance the federal government attaches to having efficient regulatory agencies, the Committee decided to consider Chapter 30 of the December 1997 Report of the Auditor General. On March 31, 1998, it met Mr. Denis Desautels (Auditor General of Canada), Mr. Ron Thompson (Assistant Auditor General) and Ms. Crystal Pace (Director, Audit Operations) from the Office of the Auditor General. The following individuals represented the Office of the Superintendent of Financial Institutions: Mr. John Palmer (Superintendent of Financial Institutions), Mr. John Thompson (Deputy Superintendent, Policy Sector) and Ms. Edna MacKenzie (Assistant Superintendent, Corporate Services Sector).

The Auditor General noted in his report that OSFI is experiencing certain difficulties in its human resource management and planning: many key positions are vacant, it is difficult to retain most valued staff and there is a high staff turnover rate (30.30). As a result of these problems, OSFI has for the past two years been completely reviewing its human resource management framework in light of the requirements of OSFI's mission and strategic objectives. The result of this process of reflection has enabled OSFI to isolate three major issues that must be resolved: How to recruit and attract staff, how to retain valued staff and staff training and development.

Many Committee members were concerned by the human resource issues, particularly the need to establish a formal human resource management system at OSFI and how to recruit and retain valued staff. As regards to the human resource management system, the Superintendent of Financial Institutions, Mr. John Palmer, indicated that OSFI subscribed to the Auditor General's recommendations on the need to formalize and document OSFI's human resources strategy (1545). At the time of the audit, OSFI was developing a draft strategic planning document which is expected to be completed in late spring 1998. The purpose of the document is to respond to the need perceived by the Auditor General to introduce a formal human resource strategic planning framework to link OSFI's human resource management activities with its vision of future developments in the regulation of the financial industry.

The Committee was informed by Mr. John Palmer that most of the major initiatives were still under way (1550). The most time-consuming initiative is the so-called "universal classification", which consists in integrating 15 separate pay groups and 14 occupational groups. When the exercise is completed, OSFI hopes that the universal classification will give it more flexibility to assign employees to positions that make the best use of their abilities and to eliminate salary differences between various pay levels, which, in OSFI's view, is one cause of staff dissatisfaction.

The Committee also learned that OSFI was having problems retaining valued staff. More than ever, many of its new recruits are leaving OSFI after one or two years in the organization for more highly paid positions in private sector financial institutions. This phenomenon has resulted in a high staff turnover rate and some positions have remained vacant for long periods of time. Committee members questioned the witnesses to determine the causes of this high staff turnover rate. According to the Superintendent of Financial Institutions, Mr. John Palmer, the main cause was that OSFI's pay structure was not comparable with that provided in the private sector and that OSFI did not have all the flexibility it needed to adjust its pay scales in view of the limits imposed by the Public Service Employment Act. OSFI stated however that it was not seeking complete parity with the private sector, but rather to adjust the mid-ranges of its pay structure to become more competitive with the market (1625). Mr. Palmer mentioned that OSFI was developing a proposal for the government to request adjustments to its pay structure.

Committee members nevertheless expressed certain reservations over OSFI's main approach, which is to readjust its pay scales so as to better retain staff. Some suggested that, instead of adjusting the pay structure, it would also be prudent to promote the organization's employee benefits, working conditions, training and development opportunities and job permanence or security. Other members went so far as to suggest inserting non-compete clauses in employment contracts or even adding conflict of interest guidelines to counter private sector raiding of OFSI staff. As a result, the Committee recommends:

The Auditor General observed that OSFI is a recognized leader in the regulation of financial institutions. By introducing its standards for sound business and financial practices and guides to intervention, developed in cooperation with its financial sector partners, OSFI has developed from a regulatory framework based on the compliance of statutes and regulations to a risk assessment and management system (30.7 and 30.8). In his report, the Auditor General observes that the system should be applied more uniformly (30.60). In particular, he describes cases in which OSFI was reluctant to inform a company of a change in its risk rating (30.61 and 30.90) out of fear that public disclosure of the change would undermine the efficiency and effectiveness of its work (30.61).

The Superintendent of Financial Institutions, Mr. John Palmer, wished to inform the Committee that there was no question of OSFI disclosing rating changes to the public, that OSFI was required by law to keep confidential information obtained from financial institutions and that it was impossible for OSFI to publicly disclose its conclusions based on that information. What OSFI fears the most is that financial institutions, which are not legally required to keep their ratings confidential, could disclose them to the public in order to secure an unfair competitive advantage.

The witness for OSFI, Mr. John Palmer, indicated that the ratings disclosure process could be better documented and informed the Committee about recent OSFI initiatives to inform financial institutions of changes to their ratings in a more uniform way.

One of the main initiatives is a thorough reorganization of OSFI to restructure the operations and policy sectors and to review the main mechanisms for monitoring financial institutions and developing regulatory policy (1540). At the same time as the reorganization of its operations sector, OSFI intends to introduce a new form of monitoring and a new risk rating system based on the main risks to which financial institutions are exposed and on the controls they have established to manage those risks. The key components of the new monitoring method will be a standard evaluation of compliance with sound business and financial practices and a coherent implementation of the guides to intervention. This rating system review process is expected to be completed in two years.

The Superintendent of Financial Institutions, Mr. Palmer, then informed the Committee that OSFI currently has set up certain transitional measures for disclosing the results of its examinations of the financial institutions, without giving out overly specific information that the financial institutions could then disclose to the public. OSFI will arrange to be in a position to communicate ratings to financial institutions as soon as the new monitoring method is completed, in two years. In the meantime, OSFI hopes of the passage of appropriate statutory measures compelling the financial institutions to keep their ratings confidential. The Committee acknowledges OSFI's efforts regarding monitoring and disclosure of rates and recommends:

Committee members also raised the question of the lack of actuarial resources and felt there should be better co-ordination between the work of OSFI's examiners, analysts and actuaries. The Superintendent of Financial Institutions, Mr. John Palmer, accepted the Auditor General's observations and recommendations and, in his address to the Committee, outlined the measures OSFI intends to take to correct the situation. The main initiatives amount to a thorough reorganization of OSFI, part of which will focus on the operations sector and should appreciably improve co-ordination of the work of analysts, examiners and actuaries.

The reorganization is expected to do two things for the actuaries. Some actuaries will be incorporated in monitoring groups and will be responsible for directly overseeing and examining insurance companies. Second, OSFI is currently forming a team of consulting actuaries who will support the control teams, show them how to better understand important actuarial issues and focus on certain projects that OSFI is conducting jointly with the Canadian Institute of Actuaries (CIA) to consolidate its actuarial practice because OSFI relies on the work of the actuary designated by the company to conduct its own actuarial analysis. OSFI intends to finish the reorganization by the end of the next fiscal year and to complete the actuarial component within three years (1620). The slow pace of the consolidation is attributable to the fact that the Canadian Institute of Actuaries is an organization of volunteers and it is very difficult to set a deadline. In view of the above, the Committee recommends:

Lastly, the Committee questioned the witnesses on the financial industry's readiness for the year 2000 problem. The Committee was informed that, in the course of its annual examinations over the past two years, OSFI has been looking at the work done by the financial institutions to prepare their computer systems. OSFI is closely monitoring progress by the financial institutions and reviewing their plans to audit year 2000 readiness. Since OSFI is not an expert in the field, all it can state with any certainty is that the financial institutions and companies appear to be taking the necessary steps to prepare themselves. OSFI recognizes the need to expand and strengthen its knowledge of information technologies and thus intends to set up an expert group consisting of eight advisory groups by the end of the year. With this organization, OSFI hopes to take a closer look at the issue and to identify more clearly potential problems that may arise in preparations for the year 2000.

OSFI reported on its own year 2000 preparations. It has introduced a conversion program to replace all its computer hardware, approximately 400 microcomputers, with new bug-free equipment. This conversion should be complete by the end of 1998 . In view of the above, the Committee therefore recommends:

The Committee wishes to mention that the Office of the Superintendent of Financial Institutions has made significant progress in recent years to become a leader in the regulation of financial institutions and congratulates it on the initiatives it has taken to respond to the recent recommendations by the Auditor General of Canada.

The Committee has every hope that adoption of these recommendations and those of the Auditor General will help the Office of the Superintendent of Financial Institutions to continue its efforts to regulate the financial industry in the interest of the depositors, insurance policy-holders and pension plan members.

Pursuant to Standing Order 109, the Committee requests the Government table a comprehensive response to this Report.

A copy of the relevant Minutes of Proceedings (Meetings Nos. 25 and 40) is tabled.

Respectfully submitted,

JOHN WILLIAMS