PACC Committee Meeting

STANDING COMMITTEE ON PUBLIC ACCOUNTS

COMITÉ PERMANENT DES COMPTES PUBLICS

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, March 31, 1998

• 1530

[English]

The Vice-Chairman (Mr. Andrew Telegdi (Kitchener—Waterloo, Lib.)): I call the meeting to order.

Starting off we will have Mr. Desautels, followed by Mr. Palmer.

Mr. Desautels, please make your opening statement.

Mr. L. Denis Desautels (Auditor General of Canada): Thank you, Mr. Chairman. We appreciate this opportunity to discuss with the committee the results of our audit of the Office of the Superintendent of Financial Institutions' insurance and pension operations. Joining me at the table today are Mr. Ron Thompson and Mrs. Crystal Pace, who are responsible for carrying out this work.

OSFI plays a key role in the rapidly changing financial industry. As the Bank for International Settlements said in its latest quarterly report:

A number of underlying trends continued to assume growing importance. Prime among these was the accelerating pace of consolidation in the financial industry.... Advances in technology are forcing a reshaping of the industry's structure. At the same time, the Asian crisis has served as a painful reminder that the interconnections between markets are becoming increasingly complex. Adjusting to such a rapidly evolving but uncertain environment will be a challenging task for market participants and regulators.

OSFI has been active on a number of committees in the international policy development area, and in September 1997 Mr. John Thompson was elected chair of the executive committee of the International Association of Insurance Supervisors.

In 1995 we reported our findings on OSFI's deposit-taking institutions' operations. With this audit of insurance and pensions, we've completed our review of OSFI. Once the government has had time to respond to the report of the Task Force on the Future of the Canadian Financial Services Sector, expected in September 1998, we will conduct a follow-up of both our 1995 and our 1997 audits.

Since 1987, when OSFI was established, there have been many changes in the financial industry and in the legislation that regulates it. We believe OSFI has made significant progress in responding to these changes.

[Translation]

Most important, OSFI and other players have developed, in consultation with the industry, standards for sound business and financial practices and guides to intervention for each of the sectors it regulates. OSFI continues to enhance its regulatory framework by developing performance measures and new approaches to examining compliance with regulatory and legislative requirements.

A key to success for OSFI, particularly in the challenging and changing years ahead, is having the right people with the right competencies and using them effectively. OSFI has made progress in developing a human resource framework that includes stated values and a learning guide. It recognizes the need to further improve its human resource management and has undertaken a number of important initiatives in this area.

Given the rapidly evolving financial industry, we believe that OSFI needs to take a more strategic view of how its human resource strategies and management framework will meet changing regulatory requirements in the longer term. In our view, it would be helpful if, in developing these strategies, OSFI were able to demonstrate more clearly and completely its analyses of issues related to recruitment, retention and learning. This would help ensure that decisions are timely, that activities are carried out in the right sequence and that proposed changes are necessary and appropriate.

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Overall, we found that OSFI is highly regarded by senior managers in the financial industry and by other regulators. While OSFI meets the needs of today's environment, it nevertheless needs to address some important gaps in order to meet the needs of tomorrow.

OSFI's ability to meet its objectives in the future would be improved if its risk assessment and risk management systems were enhanced. For example, while OSFI has developed the standards and guides that I mentioned earlier, their implementation is uneven. Standards for Property & Casualty Companies (P&C) and for Pension Plans are under development.

[English]

A rigorous risk-rating system is important to ensure consistency and transparency in the application of the guides to intervention. OSFI needs to develop more rigorous criteria for its rating systems—in particular, criteria for more qualitative elements such as the rating of management. In some cases, we found the work of analysts, examiners and actuaries could be better coordinated. To improve risk-rating systems, the views of all OSFI staff need to be taken into account when a company is rated.

Given the constraints on OSFI's resources, it's important for it to focus examination on key risks such as future business viability. Discussions with senior management of regulated firms and more specific rationale for relying on internal and external auditors could help OSFI examiners identify areas on which to concentrate.

As the financial industry becomes more global and more integrated, the importance of communicating and coordinating with other regulators grows. Exhibits 30.4 and 30.5 of our chapter show that sometimes the Canadian operations are only a small part of the overall business of a company. While OSFI has been active at the policy level, we believe it could and should strengthen its relations with other regulators in dealing with individual companies.

In addition, improved communication with the regulated entities would help OSFI do a better job and add value to the process.

To summarize, Mr. Chairman, OSFI has made significant progress since its inception 11 years ago. Nevertheless, it needs to address the important gaps I have described to you today, in order to meet its objectives in the future.

That concludes my opening statement, and I would be pleased to answer your committee's questions.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you.

Mr. Palmer.

Mr. John Palmer (Superintendent, Office of the Superintendent of Financial Institutions): Thank you, Mr. Chairman, and honourable members of the committee, for this invitation to appear before you today to discuss matters related to the OAG's report with respect to OSFI's insurance and pension sectors.

With me today are Mrs. Edna MacKenzie, assistant superintendent of corporate services, and John Thompson, deputy superintendent of policy.

At the time of the OAG's audit, Mr. Thompson was in direct charge of the insurance and pension sectors, which were the subject of the audit. Mrs. MacKenzie's responsibilities include staffing, training and development.

[Translation]

Mr. Desautels has described for you the results of the OAG's audit of the insurance and pension sectors. He has also described some of the initiatives which OSFI has implemented and has identified areas within OSFI where further work is required. I would like to follow up on some of the OAG's remarks, and provide the Committee with additional details of the work under way at OSFI which may address some of the outstanding issues identified by the OAG.

[English]

First, I would like to congratulate the OAG on a comprehensive and useful report. We agree with and support most of the recommendations made. Not surprisingly, we welcomed references in the OAG's report to areas in which we seem to be proceeding in the right direction.

OSFI is moving forward with a number of strategies to enhance its ability to carry out its mandate. Since receiving the OAG's report, we have rechallenged those strategies to be sure they are consistent with the OAG's recommendations, and we believe they are.

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One of our current major initiatives is a significant reorganization of OSFI staff. When complete, this reorganization will include both the operations sector and the policy sector and will address the major processes we use to supervise institutions and develop regulatory policy. An overriding objective of the reorganization is to improve the matching of our limited resources with the most important areas of risk.

In the first phase of this reorganization, dealing with the operations sector, we hope to achieve significantly improved coordination of analysts, examiners and actuaries. It's also expected to facilitate greater consistency in our processes in respect of the various types of institutions we supervise.

Concurrent with the reorganization of the operations sector, we will be introducing a new supervisory methodology and a new rating system. This will focus on major risks within financial institutions and the controls they have established over those risks.

Consistent assessments of compliance with standards of sound business and financial practices and consistent implementation of our guides to intervention will be important elements of the new supervisory methodology.

In addition to the changes brought about through reorganization and redeployment of staff and skills, we're taking some important steps on the human resources front. One of the most important of these is an increased emphasis on training, including increased financial resources, together with a more structured approach for ensuring that the training provided matches the specific skills required. We're also working to improve our systems to ensure that human resource data is captured and maintained in an up-to-date manner. This will enable us to better analyse and manage changes in our staffing experience and help to ensure that our staffing and hiring practices are appropriate to meet our goals.

[Translation]

We think that we are proceeding in the right direction, and are pleased also that, in most respects, the OAG seems to agree with our approach and initiatives. However, as the OAG suggested, we are chasing a moving target, and have some distance to travel before I can assure you that we are able to successfully discharge our mandate in the future. The financial services world continues to change at an accelerating rate, driven by the forces of technology and increasing internationalization. What is appropriate today will almost certainly be inadequate tomorrow.

[English]

Thank you very much for your attention. We would be pleased to answer your questions.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you.

Mr. Mayfield.

Mr. Philip Mayfield (Cariboo—Chilcotin, Ref.): Thank you very much, Mr. Chairman. You look good at the head of the table today.

I was pleased to listen to the Auditor General present his report, and also the superintendent, Mr. Palmer. I thank you very much for being with us here today.

As I was looking through the back of this chapter, at the recommendations, I was interested in the final response. It says, “While there are a few conclusions that, in our view, miss the mark...”. That is a rather general statement and I wonder if you could briefly elaborate on those few conclusions where you feel the Auditor General has missed the mark in his audit and in his report. Could you do that for us, please?

Mr. John Palmer: I'd be happy to do that.

I think it's important to put it in context. The general statement that's important here, Mr. Mayfield, is that we are in broad agreement with the thrust of the Auditor General's recommendations. I think we are largely ad idem with the Auditor General in his findings.

• 1545

If there was an area of disagreement—and I don't want to overemphasize this—it was in the degree of weight the Auditor General gave to the need to, perhaps, formalize and document our human resources strategy. We're doing a lot on the human resources front because, in our view, the key to carrying out our mandate is to have the right people in the right places with the right kind of training. So we're doing a lot of this.

The Auditor General is right; we have not put together a document that says here is our human resources strategy and here is the way all of these initiatives fit together. But we think it's pretty easy to explain why we're doing each of the initiatives we're doing and we don't think it takes a rocket scientist to understand how they all fit together. But in broad terms, he is right.

In the best of all possible worlds we would have a document describing all of this, and we will. When the Auditor General was in, we were working on a draft strategic planning document. We plan to complete that in the late spring and that document will address the issue he raised.

I wouldn't give that particular point great emphasis, Mr. Mayfield. We're not a large distance apart from the Auditor General on that issue.

Mr. Philip Mayfield: I can certainly see with the changing circumstances of the financial institutions of the country that your hands are full. As it mentions in the report, you're chasing a moving target in this regard.

At this point, I would like to ask the Auditor General if he would concur with Mr. Palmer's response. Do you feel there has been a meeting of minds on this, Mr. Desautels?

Mr. Denis Desautels: That's hard to say. I think the main issue on which we did disagree at the time was on the human resources issue. The point that was most important to us was not so much documenting the situation for the sake of documentation but more for the sake of demonstrating, as we say in paragraph 30.34, what needs to be done in the human resources area to accomplish what I think OSFI has to accomplish in that area in the next few months and years.

I believe that whole discussion is more behind us now. Since we've carried out that report, I feel the work OSFI seems to have done in that area indicates that they didn't disagree that much with us at the time.

Mr. Philip Mayfield: I gathered that from your report. As we talk about human resources, though, there were some targets set up.

I wonder—I'm asking Mr. Palmer and his staff—if you feel these initiatives are complete. If not, when do you think the analysis will be in final form? What conclusion have you drawn from these analyses? I guess the real question is, what actions do you intend to take?

Mr. John Palmer: Mr. Mayfield, I think there are probably different levels of analysis. We have, if you like, the overall explanation of our human resource strategy, which Mr. Desautels and his staff are quite correct in saying did not exist at the time they were with us. We talked to them and we explained to them verbally why we were pursuing each of the initiatives we were pursuing. So outstanding item one is that overall rationale.

A lower-level analysis, I guess, is what's happening on each of those initiatives, how much progress we are making, whether we are there yet and what results have been achieved. That's an issue we could certainly speak to in more detail in a written response to this committee, if you wish.

Most of the big initiatives are still under way. One of the most time-consuming initiatives was the task of taking 15 separate pay groups and 14 separate occupational groups in a little shop of 400 people and merging them into one single staff group. This is what we call our “universal classification” program. We've been working on that for about two years. It's a large undertaking in the public sector and we hope to complete that...would I be right in saying this spring, Mrs. MacKenzie?

• 1550

Ms. Edna MacKenzie (Assistant Superintendent, Corporate Services Sector, Office of the Superintendent of Financial Institutions): Yes.

Mr. John Palmer: We'll then have to monitor that to see it's producing the results we intended, which include greater flexibility in terms of moving people around the office to areas where their skills are best suited and also eliminating some of the pay disparities between the various pay groups that were creating a certain amount of unhappiness within the office.

In short, I could take you through each of the major initiatives and tell you where they stand, if that would be helpful, or we could follow up in a written report, if you prefer.

Mr. Philip Mayfield: There are a number of questions I'd like to ask, but I'm told by the chairman I have only one more. In response to your offer to provide a written report to the committee, I would very much appreciate it if you could do that, sir.

The question I wish to ask is not directly related to the issue we're discussing, but I'm concerned about the year 2000 system changeover that the Auditor General also mentions. I'm wondering what you're doing to ensure that the companies you're responsible for are compatible before it's too late, whether you're assisting them to be compatible, and how much effort that has required of you.

Mr. John Palmer: Mr. Mayfield, if I may, I'm going to direct that question to my colleague, John Thompson, who was very much involved in launching our year 2000 initiative with the institutions we supervise. We launched this more than two years ago. He will bring you up to date on that.

Mr. John Thompson (Deputy Superintendent, Policy Sector, Office of the Superintendent of Financial Institutions): I'll be glad to make a few comments in that regard.

Approximately two years ago, perhaps even a little longer, we began an analysis of the issues and concerns, from our point of view, around the year 2000 transition facing the banks and insurance companies that we supervise.

Immediately following that, as part of our annual examination process, we began looking at what the banks and insurance companies were doing in this regard, in terms of identifying the problems they had within their own systems, the amount of resources they were putting on it, their plans that were in place for dealing with it, the processes they had in place for monitoring progress against those plans and the degree to which senior management and the boards of directors were informed of these sorts of issues.

Following that work, we prepared a very brief report back to all of the companies we supervise, basically saying that, not surprisingly, we found no one surprised that this was an issue. There was only one concern that emerged and that was the lack of readiness outside of the institutions themselves. Institutions, primarily, were focusing on their own systems, their own hardware, and they weren't looking very closely at the systems of their key suppliers and their customers, and in the case of banks, other banking institutions and institutions for clearing and settlement, that kind of system.

We brought that to their attention. That would have been two years ago. We carried on with our examination process the year following, monitoring progress, again, against the plans. At the end of that process, in the fall of 1997, we issued a best practices paper, a guideline for institutions to follow in getting ready for the year 2000.

Most institutions, particularly the larger institutions, met the requirements we had set out. But there was basically a process of checks and balances in place and setting target dates to make sure their main systems work was completed by year-end 1998, so they had a year in advance to test systems, to do their last bit of fixing up in less important systems and things like that. In other words, so they would be ready for the year 2000.

Mr. Philip Mayfield: No stragglers?

Mr. John Thompson: We really can't afford any stragglers on this one.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you.

Mr. Laurin.

• 1555

[Translation]

Mr. René Laurin (Joliette, BQ): Mr. Chairman, the Auditor General's report states that one of the problems is the high staff turnover rate at OSFI. An attempt is made to explain it, in particular through arguments about technical points, such as pay structures and so on. In fact, not much study has been given to the real reasons.

I would like to know your feelings on this. You spoke to these people and they no doubt gave you reasons. Can you tell us the main reasons you were given to explain this high turnover rate? Are we talking about young employees or older employees? I would like to have more of an explanation.

Mr. John Palmer: Ms. MacKenzie, can you answer that question?

Ms. Edna MacKenzie: Thank you very much, Mr. Laurin. The first thing we do is interview the people who are leaving, and the first remark we hear always concerns pay, salaries.

[English]

The market we compete with is the financial institutions, a very hot market in Toronto, and they are going primarily for money. We recognize that in some cases we have people who are leaving going from 50% to 100% promotion the next day. We simply can't compete with that. That's the primary reason. Also, the other reasons are that they are a young group, they are very mobile and they want to improve themselves, so they are leaving OSFI.

[Translation]

Mr. John Palmer: I would add that mainly young people are leaving our office. The older people stay.

Mr. René Laurin: Are you a training ground for the financial institutions? Are you preparing employees who are then hired away?

Mr. John Palmer: In a way, yes.

Mr. René Laurin: What is their average length of stay at OSFI? Do you hire new university graduates? How long do they stay with you?

Ms. Edna MacKenzie: Fourteen months.

[English]

Mr. John Palmer: Not even that.

[Translation]

Ms. Edna MacKenzie: About that.

Mr. John Palmer: That may be a bit extreme. Let's say 14 months, two or three years.

Mr. René Laurin: When these people enter OSFI, are they well informed about the pay structure? Do they know what to expect?

Ms. Edna MacKenzie: Yes.

Mr. René Laurin: And that's not enough to keep them?

Ms. Edna MacKenzie: Not at all.

Mr. John Palmer: Not at all.

Mr. René Laurin: Are there more departures at certain periods rather than at others? Do more frequent departures coincide with certain political or economic events?

Mr. John Palmer: Yes. More people are resigning right now than previously because of the economy and as a result of the growth in the financial institutions, which need highly qualified employees. I'm sure that if the economy slows down, it will be easier to keep our employees.

Mr. René Laurin: Is OSFI completely independent in recruiting employees?

Ms. Edna MacKenzie: Not really.

Mr. René Laurin: Are there any order-in-council appointments?

Ms. Edna MacKenzie: Order-in-council appointments? No.

Mr. René Laurin: Are any appointments made by other bodies than OSFI itself? When you say you aren't really independent, what do you mean?

Ms. Edna MacKenzie: We still have to comply with the Public Service Employment Act. Consequently, we first have to consider priorities and determine whether candidates have the appropriate qualifications. If those people aren't suitable, we are authorized to recruit employees on our own.

Mr. René Laurin: Does a general election or a change of government have an impact on staff departures?

Ms. Edna MacKenzie: No, not at all.

Mr. John Palmer: No.

Mr. René Laurin: No more employees left in 1993 and 1997 than in other years?

Ms. Edna MacKenzie: No.

Mr. René Laurin: There's a constant turnover. There is no political impact in this area.

Mr. John Palmer: None.

Mr. René Laurin: Okay. You also mentioned something that has nothing to do with staff, but that still troubles me. You said there were problems with the rating system. You also said that OSFI hesitated to inform a corporation that it was being rated stage 3 out of fear that public disclosure of its deteriorating solvency would result in a crisis of confidence by the investing public in the company in question.

• 1600

That intrigued me and disturbed me because I wonder whether it isn't OSFI's main purpose to inform people when something goes wrong. If you hesitate to say so, how can the public be protected?

Mr. John Palmer: Mr. Laurin, I can tell you that there are other ways to protect the public. It is true that there may be a way of disclosing the status of financial institutions, but there are great dangers involved in informing the public of difficulties at those institutions.

[English]

In my opinion—and I'm not alone in this; this is a view that most supervisors and regulators around the world share—if we were to inform the public about our preoccupations, our concerns, with specific institutions while we are working with them, our ability to help the institution back to health would be seriously jeopardized.

Let me give you one example—

[Translation]

Mr. René Laurin: Excuse me, Mr. Palmer, but I would like to ask you whether you exist for the sake of the financial institutions or to protect the public.

It seems to me you play somewhat the same role as the Auditor General with respect to the general public. I find it very disturbing that the Auditor General is reluctant to criticize a departmental policy for fear of harming the Minister.

If you act in this way, it seems to me you are no longer protecting the public, but rather the financial institution.

Mr. John Palmer: Our objective is definitely to protect the public and, more particularly, depositors and insurance policy holders, but there are various ways to protect the public.

[English]

If we can prevent the failure of a financial institution, then we improve the chances that a depositor or a policyholder will not lose money.

So we do work. We can't guarantee that financial institutions won't fail, but we can help, and we think we have a pretty good track record. Let me give you one example.

When I became superintendent there were quite a number of financial institutions on what we call our “watch list”, institutions that we are worried about. Of those institutions, two-thirds that we considered troubled and were on our watch list in 1994 have now returned to health and are off our watch list. Of the remaining third, some failed and some were amalgamated into other institutions.

I believe that had we published our concerns, had we advised the public that these institutions were on our watch list, very few of them would have survived. There would have been a run on deposits. There would have been a cashing in of policies. Many people who could not withdraw their deposits quickly enough or who could not cash in their policies quickly enough would have lost money.

[Translation]

Mr. René Laurin: I understand your reasoning, Mr. Palmer, since what you say seems justified. However, an institution that knows in advance that it could be rated stage 1 by the Office of the Superintendent of Financial Institutions and that OSFI could tell the public will definitely make sure it never makes it to stage 1 and will constantly take preventive action. An ounce of prevention is worth a pound of cure.

If you do not disclose that a company is rated stage 1 or stage 2, it will be even more difficult to report that it has reached stage 3. At that point, the phenomenon you fear could easily occur.

• 1605

Consequently, I believe that if you used a transparent process, all companies would know that the situation of a company rated stage 1 would be made known to the public, and everyone would react much more quickly. Do you agree?

It seems to me that transparency is more effective than complicity with the companies in question. I don't agree that a company rated stage 1 should be told it will be given a chance and that nothing should be done even when it reaches stage 2, etc. It seems to me that your existence would no longer have any meaning and that you would completely lose the role you were supposed to be playing.

Mr. John Palmer: Mr. Laurin, I agree with you in one sense.

[English]

If the principal reasons that financial institutions got into trouble were simply unwise decisions of management, decisions that they could reverse, then I think I would be more inclined to accept that argument and change our strategies. But in many cases, the reasons that financial institutions get into trouble are not those of management's own making.

In the early 1990s most financial institutions got into trouble because of the unprecedented decline in real estate values, something that very few people anticipated. So the knowledge that we were going to publish their standing on our watch list, their existence on our watch list...I don't think that would have affected the behaviour of managements or financial institutions.

I grant you, or I accept your point, that in some circumstances that knowledge might influence the behaviour of management. I think we have to balance the costs and the benefits. I agree with you that in certain circumstances the knowledge that supervisory ratings would be published might influence management behaviour, but on the other hand, I think it might cause more institutions to fail and more depositors and policyholders to lose money than has been the case historically. We have to balance these.

[Translation]

Mr. René Laurin: Is the decision whether to disclose the financial institution's rating an arbitrary decision by OSFI or are there specific criteria requiring you to disclose or not to disclose information?

Mr. John Palmer: It's an OSFI policy. The act that governs us make us responsible with respect to confidential information that we obtain from the institutions and we cannot publicly disclose the conclusions we draw from that information.

[English]

The Vice-Chairman (Mr. Andrew Telegdi): Mr. Myers.

Mr. Lynn Myers (Waterloo—Wellington, Lib.): I want to go back to the departure of employees, premature or otherwise. I think I heard Mrs. MacKenzie say that you did exit interviews. However, the Auditor General points out in 30.44 that no profile reports are kept on employees. I wondered if you were going to move to correct that and in fact implement that kind of suggestion.

Ms. Edna MacKenzie: Absolutely. We agree with the Auditor General. What has happened is that there is no true human resources information management system that exists within OSFI. There is one that is somewhat cursory and I believe what the Auditor General was saying is that we should have much more detailed analysis for it.

We're a very small organization. In fact, in OSFI, the superintendent himself and I, along with several people within the organization, were conducting the exit interviews, so we had a very good knowledge of that. But we didn't have that in any kind of a centralized system and we are moving towards that. In fact, a part of our priorities this year is to have that implemented. What the trend was telling us, as I indicated earlier, was that primarily they were leaving for salary issues. We wanted to make sure that there weren't things that we could do to retain them. The retention issue is a major initiative for us.

One of the initiatives, if I may so, that we've taken upon ourselves is to start looking at maybe “growing our own”. When you recruit university students you find that they're very bright and very good. They come in to OSFI and they're well trained. They leave within 14 months to two years, perhaps three years. We thought if we were able to bring in very junior university people, provide them with a broad scope of training under what we're calling “an umbrella of university recruitment management”...we're testing that right now, for four years.

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But as we said earlier, there are so many initiatives going on that what we have to do is pull them all together to make sure they're going to meet the needs of the future.

Mr. Lynn Myers: It sounds like a good initiative, but I'm wondering if there is a difference between short-term strategy and long-term strategy in terms of employee retention.

Ms. Edna MacKenzie: I think what we've had to deal with is interesting. Because people were moving, there was no quick fix to get them to stop. We're trying to recruit, but inevitably, with the market the way it was, we were doing some very quick fixes to try to recruit.

We believe that long-term, we have to grow our own. We'll continue to need people forever within OSFI, because what we do have is an incredible training ground. When our examiners go out to the industry and do an extremely good job, they're picked out very quickly. We can't control that. We do want to have the best people onboard, but inevitably they're seen in the markets.

So our short-term plan is to fill the gaps as best we can, and long-term it's part of the initiative of the university recruitment. As well, as Mr. Palmer indicated earlier, we're looking at a learning guide in order to make sure we keep our staff very well up to date, can equip them, can give them the tools and the training, so that we can keep them interested. This is a fascinating industry.

The other thing we have to be looking at is our compensation, because that's also a major issue for OSFI.

Mr. Lynn Myers: I was going to ask about that. In terms of remuneration, do you have latitude or flexibility in that area?

Ms. Edna MacKenzie: At the current time, we're conducting a study. We have conducted a study with Hay consultants—they are primary consultants within the Government of Canada, certainly, as well as the financial institutions—just to find out where we are on the mark of salaries. There is no question that we are below the mark, and we knew that from our initial exit interviews. People were leaving for fairly hefty increases.

We talked earlier about the universal classification. What we are currently doing is assigning different salaries to it, but we do not have total freedom to act. This has to be supported through the Treasury Board ministers, and we are in the process of doing that at this point in time.

Mr. Lynn Myers: Thank you very much.

I wanted to ask Mr. Palmer about paragraph 30.65 of the Auditor General's review. It was noted that in half of the life insurance cases that were reviewed, it was not clear that examination was focused on significant risks. I wonder if you could comment on whether or not you think there is improvement to be made with respect to that area.

Mr. John Palmer: Mr. Myers, the short answer is yes. Frankly, I think part of the problem here is one of documentation. In the life area, we have not documented our methodology, our examination activities, perhaps as fully as we have in other sectors. But broadly speaking, I also think there is more we can do right across the office to become more risk-focused. The new supervisory methodology that I talked about in my opening remarks is one that focuses on and forces an analysis of the key risks in every institution. It then forces an analysis of the risk mitigators, the controls over the risks, and assesses the net risk in the institution. We then allocate our resources according to the net risks that we see right across the institution, business by business, product by product.

So there is substance to the Auditor General's comment. We've been aware of that, and we're working to address it.

Mr. Lynn Myers: Thank you.

I have a final question, if I might, Mr. Chairman, because I wanted to go back to Mr. Thompson.

I was very interested in what you said about the year 2000. As you can appreciate, at this committee and elsewhere, we've been bombarded with those kinds of either real or perceived problems. I got some level of comfort from you in terms of what you were saying, but I wondered if something might still happen where it would be a problem in terms of what you're doing. Is there a weak link in the chain in any way, one that would lead to a level of discomfort?

Mr. John Thompson: I would be foolhardy if I tried to give you a complete assurance that everything is being done so that there is no chance of failure. We are talking about computers that were built by humans. We're talking about computer systems that were written by humans. Anyone who has worked in that field knows that even with all efforts to make sure systems are completely foolproof and do exactly what they're supposed to do, there is a chance the system won't work perfectly when it's finally put into place. This is one of the reasons why we've asked institutions to aim to have their computer system work done a year in advance. That allows them to at least do a year's testing on their own systems.

The financial services business in the world today is highly interlinked with computer systems, clearing and settlement systems, with other financial services providers. They go around the world. So the issue is not simply a Canadian one, and the issue is going to require a great deal of vigilance on the part of everybody to make sure that all of the people who they rely on in the supply chain, so to speak, are doing their best to make sure that they're ready for the year 2000 issue.

• 1615

To this extent, there are initiatives under way to make sure that people around the world in the financial services business are aware of this. Efforts have gone out from the Basle Committee on Banking Supervision, from IOSCO and from the International Association of Insurance Supervisors to make sure that regulators around the world and the institutions they supervise are aware of this issue and doing everything they can to mitigate the losses in this area.

Mr. Lynn Myers: You're confident that the time lines will be met as you've outlined?

Mr. John Thompson: I am confident that at least here in Canada everything is being done that can be done. I think the financial services sector in Canada is in reasonably good shape in this regard.

Mr. Lynn Myers: Thank you very much.

The Vice-Chair (Mr. Andrew Telegdi): Mrs. Wayne.

Mrs. Elsie Wayne (Saint John, PC): Mr. Palmer, the Auditor General states that the work of your actuaries is well done, but that the results of their analysis are not fully exploited by analysts and examiners of yours. In addition, the audit revealed that there are insufficient resources for life insurance actuarial work.

My question is, what do you intend to do to improve the integration of actuarial analysis activities with the work of your group and your analysis and inspectors, and do you intend to increase the number of actuarial staff?

Mr. John Palmer: Thank you for that question.

First of all, the observation is entirely accurate. We have not satisfactorily linked the work of our actuaries with the rest of the supervisory process in respect of insurance companies.

As part of the reorganization that I talked about in my opening remarks, we're going to do two things with the actuaries. Some of the actuaries will actually move into supervisory groups and will become involved in the direct supervision and examination of insurance companies, rather than working in the back room on reports.

The second step is that we are forming a specialist group of actuaries that will work to support the supervisory teams, train the supervisory teams to better understand the key actuarial issues and to focus themselves on doing some of the things that we're currently doing with the Canadian Institute of Actuaries to strengthen actuarial practice, because the essence of our actuarial report is reliance on the work of a company's appointed actuary.

We don't purport to do the actuarial work ourselves to calculate a company's actuarial liability. What we do is review the work of the appointed actuary. We don't have the resources to review it at a particularly detailed level so we're focusing.... We have a number of initiatives under way to improve the work of the appointed actuary in an insurance company and we're working with the Canadian Institute of Actuaries to improve disclosure of actuarial practice.

What are the key actuarial assumptions used by an actuary in forming his conclusions? We're trying to narrow the standards of practice so that actuaries don't have quite as much room to manoeuvre in making their calculations. We're also working with the CIA, the Canadian Institute of Actuaries, to institute a program of peer review so that each actuary knows that another actuary, a peer, is going to be looking over his or her shoulder. So our specialist group is going to be focusing on those initiatives as well as supporting our supervisory groups.

Mrs. Elsie Wayne: These changes are taking place now, are they?

Mr. John Palmer: They are getting under way now, although the work with the CIA has been under way now for two years.

Mr. Mac Harb (Ottawa Centre, Lib.): Could you please use another word?

• 1620

Mrs. Elsie Wayne: When do you think you will complete all of these changes? Have you a timeframe for that?

Mr. John Palmer: The reorganization of our own actuaries will be completed by the end of the next fiscal year. The transition in the nature of our actuarial work will probably take longer than that. It will probably be three years before we're carrying out our full plans within our actuarial group.

The work with the CIA is going slowly because the CIA is an organization composed largely of volunteers—my CIA, not yours, Mr. Harb—and it's difficult to put a timeframe on that work.

Mrs. Elsie Wayne: I have one other question.

It has been observed, in paragraph 30.61, that the analyses do not always contain a clear rationale for changing a company's rating. My question is, what action do you propose to take to correct the situation, and what is your schedule for achieving same?

Mr. John Palmer: What we're doing to add more precision to the changes of ratings is to put in place a self-analysis process, if I can put it that way. We are instituting an internal review process in which we go over internally the work that our people have been doing with institutions on what we call our guide to intervention. The shorthand description of that is our “watch list”. So we're going to be evaluating our own performance.

Did we move quickly enough? Did we act according to the publicly stated criteria that appears in our guides to intervention? That internal review process will be in place by the end of the year. We're developing the criteria for that review now, and we'll be building on that subsequently, but that will be in place at the end of the forthcoming fiscal year.

Mrs. Elsie Wayne: Thank you very much.

Thank you, Mr. Chairman.

The Vice-Chairman (Mr. Andrew Telegdi): Along those lines, Mr. Palmer, there was an incident in Ontario in the 1980s where a trust company—Mr. Rosenberg was involved in it—was active in buying properties and then remortgaging them, fraudulently so, I guess the case was proven to be. If you had any kind of situation like that, you'd report on them right away, I would take it.

Mr. John Palmer: The short answer, Mr. Chairman, has to be, yes, we would. The key to it would be, of course, discovering the problem. We would hope that our examinations would uncover that kind of activity, and when we became aware of it, or to the extent that we became aware of it, that company would certainly go on our watch list. We would then be working out the remedial action that we would be requiring the company to take.

To the extent that activities were unlawful, of course, that moves us into a separate domain. I don't have first-hand knowledge of the situation you're talking about, so I can only speak hypothetically.

The Vice-Chair (Mr. Andrew Telegdi): Thank you.

Mr. Ritz.

Mr. Gerry Ritz (Battlefords—Lloydminster, Ref.): Thank you, Mr. Chairman.

I want to shift gears here a little bit, if I might, Mr. Palmer.

In the Auditor General's report, he talks about you having been quite active in international policy development, risk management and risk strategies, and so on, and he also speaks to the interconnections of markets around the world, as we're seeing happen in the Asian crisis, and so on, and other marketplaces.

When you're verifying investments and so on like that, are there going to be ramifications with the MAI investment package that we're seeing dealt with now? Is that going to double your workload, is it going to make it easier for you, or is there any type of ramification there at all?

Mr. John Palmer: To be truthful, I have no idea.

• 1625

Mr. Gerry Ritz: Okay. You haven't been asked to make presentations or to speak to issues that may—

Mr. John Palmer: All I know about the MAI is what I read in the newspapers and what I receive from Maude Barlow.

Some hon. members: Oh, oh.

Mr. Gerry Ritz: It has to be fact, then.

Mr. John Palmer: John?

Mr. John Thompson: I can't speak to that issue either.

Mr. John Palmer: I think you're suggesting we ought to bone up on that, and we will.

Mr. Gerry Ritz: I'm just thinking about it. When we're talking about investments that are going to be worldwide coming into Canada, how do you safeguard Canadian investors from outside people and so on?

Mr. John Palmer: I think that they're—

Mr. Gerry Ritz: These are the people who are asked to safeguard for the investors out there. I'm just wondering.

Mr. John Palmer: Let's first of all be clear. Our responsibility is not to protect all investors. Our responsibility, quite clearly, in our legislated mandate, is to protect depositors and policyholders in Canadian regulated financial institutions. We only have an obligation to protect depositors and policyholders in foreign institutions if those institutions enter Canada in an appropriate way and fall under our regulatory regime.

So to the extent that a depositor wants to put money in an offshore bank which is not a Canadian regulated institution, we offer no protection to that individual, nor can we. What we are trying to do is to inform consumers of the difference between making a deposit or buying a policy in a Canadian regulated institution and putting his or her savings in a foreign institution.

On our web site, which is receiving a surprising amount of activity—surprising to us—we have a page that explains to consumers what regulation in Canada means, what protection it affords and what the differences are between Canadian regulated institutions and regulation in other jurisdictions, and it suggests to consumers steps that they might take to obtain further information about the institution with which they're planning to do business.

Mr. Gerry Ritz: From what I understand of the MAI, from the limited information I've received as well, that's exactly what it speaks to, those cross-border investments and so on like that.

Mr. John Palmer: Yes.

The Vice-Chairman (Mr. Andrew Telegdi): Mr. Harb.

Mr. Mac Harb: I was very interested in the comments you made concerning the turnover. I know that some of the government departments have made recommendations to the Treasury Board in order to readjust the salaries of some of the professionals in those departments so that they are in line with those in the private sector. Have you given any thought to the notion of recommending to the Treasury Board that for certain categories you should offer the same salary—or within a range—that is offered in the private sector? Has anything like that taken place?

Mr. John Palmer: You have no idea how much I welcome that question, Mr. Harb. Yes, we've given a lot of thought to this issue, and we are bringing forward a proposal for bringing our salaries closer to those in the market. We are not seeking to achieve complete parity with the market, and at this stage we don't think we have to achieve complete parity. We think we have enough advantages in terms of the nature of our work, the fact that we are a training ground to some extent, and the fact that we can offer, I think, particularly attractive conditions to people with young families. We think we can get away without having perfect parity.

We do believe we have to get very close to the market in the mid-ranges. At the upper ranges, we think we can fall a bit short of the market and still retain and attract people. This is to some extent untested, but this is the way we're proceeding at the moment.

We are developing a proposal for the government. We hope that it will be accepted, and we will be then putting it into effect and hoping it works.

We're less ambitious in this respect than the Ontario Securities Commission, for example, which is competing in the same marketplace we are for talent. They've decided to go for full market compensation, and they will be offering considerably higher compensation than we will, so we may find that we have to go further to retain, recruit, and build the talent that we need. But we thought we would take this more measured approach first of all, and we hope it brings us the results that we need.

• 1630

Mr. Mac Harb: If you don't do that, I suppose your whole operation will be compromised in a way because of the high turnover, as the Auditor General has clearly stated.

The second and final question has to do with this business of the year 2000. My understanding is that most financial institutions, or a good number of them, look at this antique system of theirs—the old system that goes with the two digits—and they scrap it altogether. They made a business case for scrapping it altogether and transferring the data from this old, archaic system into a system that is up to date. I would suggest that perhaps your department would be one of the best candidates for an executive decision of that sort.

I wanted to find out if you have really explored the opportunity of just simply junking the old system altogether and taking the information and putting it on a state-of-the-art system whereby the benefit in the long run would be there even though it may look like you are spending a little more money up front than you should be. Has any business case like that been made in order to do that?

Mr. John Palmer: John, do you want to comment on that?

Mr. John Thompson: I'll try to comment on it.

There are a number of computer systems that are used by any financial services provider in this country, some of which are software packages that are purchased by providers, some of which are designed and developed by independent software developers, and some of which are written in-house—those last ones being home-grown computer systems.

A lot of the computer systems that we're talking about were actually home-grown computer systems that were driving the accounting systems and the administration systems that were developed way back in the 1960s and the 1970s. By and large, some of these systems have not been exposed to substantial rewriting in that period because the changes in the business have not been in the fundamental core business. For example, savings accounts have not changed fundamentally in that period. The fixes required in those systems are not huge. They are expensive to carry out, but it would be more expensive to scrap the system and start over again.

Having made that statement, there are exceptions. Some institutions are finding that moving to the off-the-shelf type of software is a good move for them, so you'll find that the solutions that individual institutions take will actually depend on the hardware they're working with, the software they're working with, and the individual packages they're working with. There will be a variety of applications and solutions that they're actually using all at the same time.

Mr. Mac Harb: Thank you.

The Chairman: Mr. Mahoney.

Mr. Steve Mahoney (Mississauga West, Lib.): Mr. Chairman, it seems to me that in reference to the CIA comments that Mr. Harb was making, the young people who are going over to the companies you are regulating are somewhat sleeping with the enemy. If I was running a business that was highly regulated, it would make sense to me to lure away the people who are being trained to regulate me in order that they could tell me what I could do to advance my interests within those regulations. If you simply increase your wages to keep them, I suspect the companies are going to increase the packages they offer to lure them away, so I don't know that this is the solution to your problem.

Is it feasible to look at things like non-competition clauses in contracts for these employees? They're coming in to get training at your agency's expense, and then they're taking it out into the marketplace. I don't mean to be overly restrictive, because I tend to believe in the marketplace system, but it seems to me that just increasing salaries is almost a never-ending problem.

Mr. John Palmer: Yes, you make a good point, and there is an element of sleeping with the enemy, frankly. In that sense, I don't think any of our staff members breach confidences.

• 1635

Indeed, we're very careful to explain to our employees when they come in the door what their obligations are with respect to institution-specific confidentiality, and even the confidentiality of OSFI's own processes and conclusions. I'm not aware that anyone has let us down in that regard, but there is a perception of that.

Another aspect of that, in addition to the point you've raised, Mr. Mahoney, just to add to the concern, is that a number of institutions have been quite concerned when somebody who has developed a deep knowledge of bank X goes to work for bank Y. So they're worried about the leakage of confidential information from institution to institution. Again, I'm not aware that it has ever happened, but there is a concern out there, which can impact on the willingness to share information with us, which is really, in turn, key to our supervisory success.

How can we prevent that? Would requiring people to sign an agreement when they joined us that they could never go and work for a bank do it? I'm no lawyer, but my hunch is that's probably unenforceable. It would be a restraint of trade.

Mr. Steve Mahoney: In my experience, it seems to me that one of the attractive aspects of working for government, or quasi-government, is security, or what some might call tenure or whatever: benefit packages, good working conditions, that type of thing, wages to put yourself in the position that while they have to be reasonably competitive, you can't expect people to work for 30% less, or something along those lines.

I have some concern about the mentality that says they're raiding us, therefore we have to jack up all our salaries to keep our people. There have to be better ways of doing that. Also, in my both private sector and government experience in the past, I've found that while money is important to people, it quite often is not the top motivator in making their decision. It can be quality of life, quality of work, the atmosphere in which they work, the people they work with, time off, or whatever. There are many aspects to employment.

I note that you're down 12 to 20 examiners in the life insurance department in Toronto alone. That sounds like a lot; I don't know if it is. But are you looking at these other aspects as to what you can do to put in place perhaps a better working environment that will encourage these people to make a life out of this career?

Ms. Edna MacKenzie: I'd be happy to talk about that, Mr. Mahoney. We are certainly looking at all aspects. We're not sitting here thinking salary is going to be the only component to retention. We're looking at things like our flexible working arrangements because, clearly, in the public service you have a lot more flexibility.

We are also looking at life and wellness programs. We're looking at extensive learning and development of a learning culture for the office. We believe salary is one component, compounded with all the other things that you've eloquently expressed. We don't think it's just salary, but we do know, currently, if they're leaving for a 30% to 50% increase, we have to do something to try to increase that. But we do recognize there's a whole gamut of other things, and we are moving forward on quite a few of those.

Mr. Steve Mahoney: But I wouldn't like you to completely disregard—

Mr. John Palmer: We don't. If you're a young guy or a young gal with a big mortgage and somebody comes along and offers you $10,000 more a year—and our people were being extensively headhunted, particularly this summer—it's pretty darn tough to say no. That represents a huge percentage of your disposable income, and it represents an awful lot of family comfort.

In many cases, the people who left us were not seeking to leave; they were approached. Somebody simply made them an offer they couldn't refuse. We need to get our salaries a little bit closer so they can resist those offers and they can look at the other benefits of OSFI. But the gaps are too big now for us to have an intelligent conversation with them about the benefits of staying, so we need a package that includes the elements—

Mr. Steve Mahoney: Charge the companies a fee every time they raid, a little commission for your training efforts.

Ms. Edna MacKenzie: I like that.

Mr. John Palmer: They pay our fees, in any case.

Mr. Steve Mahoney: Just jack them up when they steal somebody.

Mr. John Palmer: We'll pass that on to the bankers, Mr. Mahoney.

• 1640

The Vice-Chairman (Mr. Andrew Telegdi): I'm quite sure the point you raised is a very good one. I know with deputy ministers we have a regulation that you can go back doing business with the department you left. I wonder, in some of these areas, if we could not have some kind of regulation saying you cannot go and all of a sudden become a greater attraction than you should be because of the sheer fact that you are the former regulator, who is now switching sides.

I'm not sure, Mr. Desautels, if this is something you have looked at in terms of conflict of interest, having the regulator leave government and work for the other side. Should there be some guidelines?

Mr. Denis Desautels: That's an interesting question, but we have not looked at that aspect yet.

The Vice-Chairman (Mr. Andrew Telegdi): It might be useful, because it might help us in a number of respects, one of them being that there wouldn't be such a financial windfall.

Madam Caplan.

Ms. Elinor Caplan (Thornhill, Lib.): Thank you.

I have two questions. I think it is important to look at the rules for changing sides, changing jerseys, playing on that other team, sleeping with the enemy, or however you want to describe it.

Mr. Steve Mahoney: We're not paranoid.

Ms. Elinor Caplan: However you want to describe it, I think there should be a cooling-off period, especially for people who are privy to sensitive information.

I worry that what the raiders are really attempting to do is headhunt people who do have access to privileged information that will be of benefit. I know that often, as a management technique, people are headhunted from the other company to weaken the management team or actually buy the expertise—not so much because of their competencies but because of access to information they have had. I think a cooling-off period is a very appropriate human resource policy for a regulator.

I just wanted to add my support for looking at those kinds of regulations.

The question I have has to do with the year 2000. I note the auditor says you could be doing more. I'm wondering what you have done as far as surveys, and how prepared you believe the industries are.

I think there's sort of an assumption that the big companies are going to be ready and the problems might be with the little companies. But we know that within those big companies, as you mentioned, there are all kinds of programs and so forth, and I worry we're making an erroneous assumption that those big insurance companies are going to be ready.

Mr. John Palmer: Ms. Caplan, thank you for the question.

Before you came in, I think, Mr. Thompson provided a response to a similar question.

I wonder, Mr. Thompson, if you could provide just a short summary of the answer to that question, because it's certainly an important issue.

Mr. John Thompson: We have, for the past two or three years, been making, as part of our annual examinations, a review of the work going on in each one of the companies we examine. We look at each one of the banks every year, we look at most life insurance companies every year, and we look at the property and casualty companies every second year. This has been a standard part of our examination process for two or three years now, and we have been doing exactly that. Large or small, we have been monitoring their progress and their plans for making sure their systems are ready for the year 2000.

Ms. Elinor Caplan: Are you sure they are ready? Can you tell us they are ready?

Mr. John Thompson: I tried to answer that question a little earlier. I can't swear they will be ready. We're talking about things that are built by and programmed by humans, but we are monitoring the progress being made, and with all the best intentions they should be ready.

Ms. Elinor Caplan: By the way, my apologies for arriving late. The one thing I have found difficult is being in two places at once. I haven't quite mastered that yet.

Mr. John Palmer: I understand.

This question gives me the opportunity to make two points. First of all, we are not technology experts. We have a working knowledge of technology issues, but we're not experts, so we don't have the capacity to drill down and do a detailed audit on year 2000 readiness.

• 1645

What we're relying on, really, are the reports that the institutions themselves have commissioned, in some cases at our initiative. We look at the process they've followed. Do they have experts? Have they brought in outside experts? What do the reports say? Do they seem to be taking this seriously? Is the board dealing with these sorts of issues?

So we're reviewing process, and we're not in a position at the end of the day to say they will be ready. What we can say is that they seem to be doing the right things to get ready.

The second point I'll make is that the Monty report, that assessed readiness across Canada, was highly complimentary of the work that OSFI has been doing in the year 2000 area, including recognizing that we were one of the first organizations in Canada to recognize the seriousness of the problem and to take action.

I would be happy to provide the committee with a copy of that extract of the report, if necessary.

Ms. Elinor Caplan: Thank you.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you.

Mr. Mayfield.

Mr. Philip Mayfield: I want to continue on this subject a little bit. I've been looking at a report called The Treasury Board Secretariat Chief Information Officer Branch Year 2000 Project Office, Government Year 2000 Readiness as of the Fall of 1997, printed in January 1998.

On page 9 is table 3, which is entitled “Readiness of Smaller Departments and Agencies”. Now, it's interesting. There are some agencies, using the seven criteria, that are completely ready. Then there are three or four agencies that, really, have barely started.

I noticed that the Office of the Superintendent of Financial Institutions really has started in all of these phases but is only about 50% complete in one of them. So I'm wondering about your own office and its readiness for the year 2000 and the problems we hear about that can come if we're not ready. How far along is your office in preparing for the year 2000 problem?

Mr. John Palmer: In terms of our conversion, Mr. Mayfield, we are about 50% along.

Our challenge is not as complex as that of the institutions we supervise, so we have put our primary efforts into making sure the institutions were ready and that their customers and suppliers were not going to bring them down.

With respect to our own conversion, the principal challenge is dealing with about 400 microcomputers. We have a program to replace those computers. That conversion process will be complete by the end of the year, and we will be year 2000-compliant.

So we have an orderly process. We're careful about the way we spend money. We spend it in a measured way and we didn't see a need to be 100% compliant at this stage, when we could defer some of the costs into another fiscal year.

Mr. Philip Mayfield: Nobody can complain about prudence. I'm relieved to hear you say that it's a problem that is well in hand and that you will be ready by the end of the year.

I want to go on to another area. You mentioned earlier about changing the status of institutions that were in trouble. Two-thirds of them, I think you said, are out now, but the Auditor General, in paragraph 30.61, points out that the analyses do not always contain a clear rationale for changing a company's status.

I wonder what action you propose or have taken to correct this, and if it's not completed, do you have a schedule you're working on to do this, for rationalizing this?

Mr. John Palmer: First with respect to that recommendation, because Mr. Thompson and I work very closely with the institutions that are on that watch list—for example, we meet with the minister every month to talk about the institutions on the watch list—I have a pretty good sense of why they come on, how they come on, and whether we're timely enough about putting them on.

• 1650

I'm reasonably comfortable with the job we're doing. It is quite true that we don't always document the analysis, the reasons for putting it onto the watch list, as fully as we should. That's a matter of discipline that will be dealt with in two ways.

First, our new supervisory methodology that we're putting in place will deal with that. Second, because of the importance of this issue—and I mentioned this a few minutes ago—we are introducing an internal evaluation process to review the way in which we work with watch list institutions or institutions that should be watch list institutions to provide a bit more focus on this particular issue. We want to be documenting it properly as well as doing it properly in substance.

Mr. Philip Mayfield: How far along are you in this proposal, in accomplishing this?

Mr. John Palmer: The internal evaluation is going into effect in the forthcoming fiscal year. The change in our methodology is a major undertaking. We've developed the new concept underlying the methodology now. We will be moving it into our institutions this year in the examination cycle. It will be rough this year. It will be far from perfect. We will be refining and improving the methodology and documenting it in the following year. It's really a two-year process before we'll be comfortable that the methodology is in place and working.

Mr. Philip Mayfield: This process of rationalizing, you're telling the committee, will be completed in two years. Is that correct, sir?

Mr. John Palmer: Yes, I think that's fair.

Mr. Philip Mayfield: Thank you very much.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you. Mr. Laurin.

[Translation]

Mr. René Laurin: I'd like to come back to the question I asked earlier concerning the disclosure of ratings. The Auditor General noted that any hesitation to disclose changes in ratings could undermine the efficiency of OSFI's early warning system.

In view of the answer you gave me earlier on the subject and of the Auditor General's comment, am I to conclude that you don't agree with the Auditor General's recommendation? You don't appear to be on the same wave length on this point.

I would like to have your comments, and those of the Auditor General as well.

Ms. Edna MacKenzie:

[Editor's Note: Inaudible]... Mr. Laurin?

Mr. René Laurin: Unfortunately, I don't have the same document and I don't have the exact reference. Perhaps the Auditor General can help me. It concerned public disclosure. These are notes I took.

Mr. Denis Desautels: 30.90.

Mr. René Laurin: 30.90, you say?

Mr. Denis Desautels: We're talking about the disclosure of ratings.

Mr. René Laurin: Yes.

Mr. Denis Desautels: It's in paragraph 30.90.

Mr. René Laurin: 30.90.

Mr. John Palmer: I talked about the public disclosure of ratings. Here we are dealing with the disclosure of ratings to institutions. We agree on this recommendation. We don't disclose them for two reasons.

[English]

The first reason is that we have wanted to have more precise criteria for our ratings of institutions before we communicated that information to the institutions. The second reason is that right now there is nothing to prevent the institutions, having received our rating, from telling the public that they are rated in the first category by OSFI. Before we communicate ratings to the institutions, we want to be sure that we have the power to require the institutions to keep that information private. Such legislation exists in the United States, and we think it's essential to maintaining the kind of supervisory process we carry out.

• 1655

The problem we're concerned about is if our ratings are communicated to institutions and there is no requirement that they keep that information to themselves, the institutions that are highly rated will communicate that information to the public and those who are poorly rated will not and they will become recognizable by their failure to communicate.

[Translation]

Mr. René Laurin: But it seems to me that...

[English]

Mr. John Palmer: So we've taken the position that we will not do this until the legislation is in place.

[Translation]

Mr. René Laurin: Governments are also rated on the quality of their solvency and credit, and those ratings are published. Every time a government brings down a budget, we learn starting the next day that the credit ratings have changed: Quebec was rated AA+ or AAA, the Government of Canada AA. We find that healthy and people continue to buy bonds. Perhaps they'll change the government. But no one stops publishing them out of fear the public will stop buying a particular government's bonds if its rating falls. It seems to me that the public safety is based on this and this is fundamentally important.

I find it hard to understand your reluctance, and I would like the Auditor General to give his opinion on this as well. It also seems to me that you are making each other vulnerable. A company could be tempted to offer you I don't know what to prevent the rating from being disclosed, knowing that you alone control the situation and are free to disclose or not to disclose. Are we facing a real danger or am I operating on insufficient information? Am I getting worked up over nothing? I would like the Auditor General to give his opinion on this question as well.

[English]

Mr. Denis Desautels: Mr. Chairman, I'd like to ask Ms. Crystal Pace to respond to Mr. Laurin.

Ms. Crystal Pace (Director, Audit Operations Branch, Office of the Auditor General of Canada): Thank you.

As you've noted, there is a great deal of controversy on this question. Some people believe it is not a problem to disclose ratings. As Mr. Palmer has said, there is a potential moral hazard in the regulator giving his opinion on the rating of a company in that it could cause potentially a run on a company.

The Auditor General in his report has not commented on whether disclosing the rating publicly is a good thing or a bad thing. Our comment in paragraph 30.61 was made in relation to disclosing to a company it's own rating. One of the reasons we heard for not disclosing to a company its rating was that this rating would then become public. What we said in our recommendation was that's a real concern, there are ways of dealing with the issue and we feel it's very important to disclose to a company what it's rating is.

[Translation]

Mr. René Laurin: Thank you.

[English]

Mr. John Palmer: I would add that we are working toward being in a position to disclose our ratings to companies.

I also want to make clear that we have ways now of telling companies what we think about them. We have ways of telling them our concerns, of letting them know where they stand without giving them hard information that they can disclose publicly. So we give each company a management letter identifying our concerns after our examination. We give them almost everything but the number.

We are organizing ourselves to be in a position to give them the number once we have fully developed our new supervisory methodology. So it's about two years off, not this current year but the next year, when we expect to be in a position to do that. We are hoping to have the legislative protection to make that possible.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you, Mr. Laurin. We've exceeded the time quite a bit.

[Translation]

Mr. René Laurin: Thank you for your kindness, Mr. Chairman.

[English]

The Vice-Chairman (Mr. Andrew Telegdi): Mrs. Wayne.

Mrs. Elsie Wayne: We've been discussing everything this afternoon with regard to the life insurance industry. Could you just tell me the role the banks are playing with you? How much investment and so on comes from the banking end of the industry here?

• 1700

Mr. John Palmer: Ms. Wayne, is your question about how much of our supervisory effort is devoted to the banks?

Mrs. Elsie Wayne: Yes.

Mr. John Palmer: I think, off the top of my head, probably about 40% of our resources focus on the deposit-taking sector. That's how we've organized ourselves. That would include the banks, both the Canadian ones and the foreign-owned banks. It would include the trust and loan companies as well. We also do some cooperative credit organizations. But the banks, of course, and one large trust company, dominate that sector, and they would represent a fair chunk of that 40% of our resources.

Mrs. Elsie Wayne: Thank you.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you very much.

Mr. Desautels, I wonder if you could think about the cooling-off period. It might be something that the committee might be asking about.

Mr. Palmer, just in closing, you mentioned that you are not technology experts. I appreciate that, but as banking and financial transactions become more technology-driven, you're obviously going to have to get to be more of an expert than you are.

The question I have as well is, have you given any thought of being able to carry out your mandate if we have an amalgamation of any of the banks. Also, what kind of implications might that have?

Mr. John Palmer: On those two questions, the issue of technology and our lack of, what shall I say, detailed technological expertise is a concern.

We do need more specialized expertise than we have. We will be creating, as part of our reorganization, what we call a specialist sector. We will be building about eight specialist groups. We will be attempting to recruit some people from outside to help us get these up and running.

Technology is one of the groups we hope to have in place this year.

What kind of expertise we can recruit, given the amounts we're able to pay, is a question, but we do accept that we need to beef up our expertise in this area, and we're certainly going to make an effort to do so.

Now, your second question had to do with the supervisory implications of bank mergers. Our focus there is to ensure that, assuming the government is prepared to accept major bank mergers—that issue has not yet been decided—we need to be sure that the merged entity will be financially strong and capable of supporting the depositors' money that's placed with those institutions.

To do that, we will look at the capital levels. We'll look at the basis of the transaction. We'll look at the capital levels after the transaction. We'll look at their business plans.

We'll also look rather critically at their plans for merging the entities, because it's not always the case that two and two make four when you combine two large entities. Mergers are complicated; they are not free of risk. In mergers, two and two can make three, two and a half, or sometimes two.

So we'll be taking a careful look at business plans, merger plans, to be sure that the merged entity is a safe and sound vehicle.

The Vice-Chairman (Mr. Andrew Telegdi): One of the rationales for doing the merger is to better be able to compete internationally, which means that they'll be doing more international business.

Would you have to beef up your office to be able to monitor somebody on the international scale?

Mr. John Palmer: That's a good question. That links to another of the recommendations in the Auditor General's report, with which we agree.

At the present time, we have not yet had to do a great deal of work reviewing the activities of our financial institutions abroad, but that's changing as Canadian financial institutions become more active overseas, have more assets, or take more risk in other countries.

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The most cost-efficient way to deal with that is to be able to rely on the work of other regulators, but we can't always do that. We don't know enough about the quality of work of other regulators. We do know that many regulators and supervisors around the world are not very good.

We need to have a basis for exchanging information with regulators before we can really rely on them. We need to enter into formal memoranda of understanding that set out very clearly their responsibilities, our responsibilities, and where we can rely on one another. We're in the process of putting this framework together, but it's a very long process. This framework does not exist in the regulatory world to any extent at the moment. People are beginning to think about what it would look like, are beginning to talk about the principles that would underlie such a framework, but it does not exist as we speak.

So the short answer is that we're probably going to have to be more active ourselves in going offsite, going to where our institutions are in other countries, going to where they have material activities, in order to assess the risk ourselves and, at the same time, to assess our ability to rely on foreign regulators.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you.

Mr. Mayfield.

Mr. Philip Mayfield: Thank you very much, Mr. Chairman.

You just opened up the question that I wanted to come to. I want to deal with a facet of that, and that is relationships with other regulators. I believe you've indicated that this is big, it's new, and you're just getting involved in it. But it seems to me that with the way international trade is expanding, this would be probably a fundamental issue for you to be considering.

Despite the fact that it is big, I see the Auditor General mentions something in paragraph 39.96 about OSFI finalizing and implementing its plan to strengthen relationships. Does “finalize” mean “to formalize”? Is that what you had in mind when you wrote that, sir?

Mr. Denis Desautels: I would say so, yes.

Mr. Philip Mayfield: All right, then. Do you have a timetable for this as well? It is so big and so important. I'd like to have you put on the committee record if you have a schedule, if you have a timeline for this, if you're formally looking at this with a view particularly to some or all other regulators.

Mr. John Palmer: This is a very important recommendation, and it's one that has been receiving a good deal of attention already. I regret to say that it is a very long-term proposition. It is difficult now to enter into an agreement with another regulator upon which one could rely under all circumstances. The reasons for this are that very few precedents exist, and very few formal memoranda of understanding between regulators exist at the moment. There are letters and there are informal protocols, but there are very few formal memoranda of understanding, and even those are not what would be needed to fully depend on another regulator to advise you of when trouble is brewing.

One of the reasons that it's going to be difficult to solve this quickly is that the insolvency rules differ from country to country, and they tend to give preferences to the nationals of that country. What this means is that when trouble brews, when trouble is in the offing, regulators tend to want to protect the depositors and policyholders in their own country first. When the chips are down, they tend not to share information—and there are lots of bad examples of that kind of thing.

As I mentioned earlier, a lot of regulators around the world are not very good. In fact, most regulators around the world are not very good. That's not a criticism; it's simply to say that they are in emerging economies, emerging countries, where they're trying to develop the infrastructure of the kind of free-enterprise system that we in western countries have developed over a number of years. So we're not sure of our capacity to rely on other regulators even if we could enter into satisfactory agreements.

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We're working on a number of fronts. We're trying to enter into formal memoranda of understanding with the regulators we believe to be competent. We're trying to develop methodology for assessing the quality of other regulators, and at the same time we're very active in, as the Auditor General acknowledges, working with international regulatory and supervisory organizations to develop standards of supervisory practice, standards of good regulation, and to develop better linkages amongst regulators.

John Thompson has been personally very active in this role. He is the chairman of the International Association of Insurance Supervisors, which came into being in 1992 with a very heavy involvement from Canada. That group has been developing supervisory standards for insurance companies and has been very active.

So we're talking about a long-term project here. There's no quick fix, we simply have to keep pushing and working away on this.

Can we make faster progress? Mr. Martin has talked about the possibility of a supervisor of supervisors, some central coordinating body to build on the work that the International Association of Insurance Supervisors and other groups have done. It would try to speed up the pace and provide some oversight over the regulatory community, and that's something we would certainly support.

Mr. Philip Mayfield: Mr. Chairman, I'm wondering whether I can ask the Auditor General if he would care to expand on his recommendation in light of the conversation we've just had on this issue.

The Vice-Chairman (Mr. Andrew Telegdi): I'll ask him to do that, and then he can wrap up.

Mr. Philip Mayfield: Thank you.

The Vice-Chairman (Mr. Andrew Telegdi): Mr. Desautels.

Mr. Denis Desautels: Mr. Chairman, do you want me to respond to Mr. Mayfield, then?

The Vice-Chairman (Mr. Andrew Telegdi): Yes, respond and wrap up.

Mr. Denis Desautels: In response to the last question by Mr. Mayfield on what Mr. Palmer just said, we agree basically with what we've just heard. I think it makes eminent sense.

I would also add, though, that in our recommendation on 30.96 we did mean finalize. As Mr. Palmer indicated, things take a long time in that area. That's why the word “formalize” would still be applicable, no doubt about it. So we agree with what Mr. Palmer just said.

We would hope—and it's reflected in our recommendations—that the plans OSFI has to strengthen its relations in that area be brought to a more definite stage as early as possible.

Mr. Chairman, if you ask me for my general comments, I'm quite pleased with the direction that OSFI has taken, particularly since we reported to Parliament on this part of their operations. I personally believe OSFI is not a big organization but an extremely important one; that's why we go and visit them with such regularity.

Mr. Palmer has offered to provide the committee with a more detailed report of initiatives under way and planned that relate to our recommendations. I feel it would be quite helpful to the committee if this report included specific target dates for completion, and expected outputs from this implementation.

Finally, Mr. Chairman, as is our practice we are planning to do a follow-up on this audit. In this case we'll begin this follow-up work after the government has had a chance to consider the results of the task force that we referred to earlier, the MacKay task force.

I think it will be at least a year from now before we can hopefully start that follow-up and then we will be reporting back to the House sometime in the year 2000. By that time we feel the government will have had a chance to react to the recommendations of the MacKay task force, and OSFI will have had more time to implement the recommendations we heard about today.

Thank you.

The Vice-Chairman (Mr. Andrew Telegdi): Thank you very much. I guess if OSFI expands into overseas monitoring, you might have an easier time recruiting people: “Join OSFI and see the world”.

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We're going to have a briefing meeting April 2. It's going to be a follow-up report on Corrections Canada.

Thank you. The meeting is adjourned.