FINA Committee Meeting

37th PARLIAMENT, 1st SESSION

Standing Committee on Finance

EVIDENCE

CONTENTS

Thursday, April 25, 2002

À

1035

The Chair (Mrs. Sue Barnes (London West, Lib.))

Mr. Bryon Wilfert (Parliamentary Secretary to the Minister of Finance)

The Chair

Mr. Bryon Wilfert

The Chair

Mr. Bryon Wilfert

À

1040

À

1045

The Chair

Mr. Richard Harris (Prince George--Bulkley Valley, Canadian Alliance)

Mr. Bryon Wilfert

Mr. Richard Harris

Mr. Bryon Wilfert

Mr. Richard Harris

Mr. Bryon Wilfert

The Chair

Mr. Denis Normand (Senior Chief, Payments, Financial Sector Policy Branch, Department of Finance)

À

1050

Mr. Richard Harris

Mr. Doug Wyatt (General Counsel, General Legal Services, Department of Finance)

À

1055

Mr. Richard Harris

The Chair

Mr. Scott Brison (Kings--Hants, PC)

Mr. Bryon Wilfert

The Chair

Mr. Doug Wyatt

Mr. Scott Brison

Á

1100

Mr. Bryon Wilfert

Mr. Denis Normand

Mr. Scott Brison

Á

1105

Mr. Denis Normand

Mr. Bryon Wilfert

Mr. Scott Brison

The Chair

Mr. Mac Harb (Ottawa Centre, Lib.)

Mr. Denis Normand

Mr. Mac Harb

The Chair

Ms. Maria Minna (Beaches--East York, Lib.)

Á

1110

Mr. Bryon Wilfert

Mr. Denis Normand

The Chair

Mr. Bryon Wilfert

The Chair

Mr. Luc Bertrand (President and CEO, Bourse de Montréal)

Á

1120

Mr. Richard Harris

Á

1125

Mr. Luc Bertrand

Mr. Richard Harris

Mr. Luc Bertrand

Á

1130

Mr. Richard Harris

The Chair

Mr. Scott Brison

Mr. Luc Bertrand

Á

1135

Á

1140

Mr. Scott Brison

Mr. Luc Bertrand

The Chair

Ms. Sophia Leung (Vancouver Kingsway, Lib.)

Mr. Luc Bertrand

Á

1145

Ms. Sophia Leung

Mr. Luc Bertrand

Á

1150

The Chair

Mr. Luc Bertrand

The Chair

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CANADA

Standing Committee on Finance

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NUMBER 094

l

1st SESSION

l

37th PARLIAMENT

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EVIDENCE

Thursday, April 25, 2002

[Recorded by Electronic Apparatus]

À  (1035)  

[English]

    The Chair (Mrs. Sue Barnes (London West, Lib.)): Welcome, everyone.

    The order of the day is Bill S-40, an act to amend the Payment Clearing and Settlement Act. Appearing is Bryon Wilfert, parliamentary secretary to the Minister of Finance, accompanied by finance officials, who, Mr. Wilfert, I would ask you to introduce for us.

    When you are ready, commence.

    Mr. Bryon Wilfert (Parliamentary Secretary to the Minister of Finance): Thank you, Madam Chair.

    With me I have Denis Normand of thefinancial sector policy branch and Mr. Doug Wyatt as well.

    Before I begin, I want to thank the chair for having us appear today. This is a very short bill, and depending on what we hear and depending on the time, if the committee has no objections, we'll be prepared to deal with clause-by-clause today. Although I know you've technically scheduled it for Wednesday, I think I can answer the one question on the CBA for you. Beyond that...that was the hope we had in order to deal with it.

    The Chair: I can answer that very briefly. I did not schedule clause-by-clause today because this is the first day of witnesses and it's my wish that on the first day we always see a lot of people. So far we've had no appearance from any party other than the witnesses scheduled for today. We had already agreed in steering, and we do not have the numbers today, so there will be clause-by-clause on Wednesday afternoon. We will deal with it very expeditiously on that day.

    Thank you very much.

    The order of the day is an act to amend the Payment Clearing and Settlement Act.

    Mr. Bryon Wilfert: I'll take that as a no, then.

    The Chair: Yes.

    Mr. Bryon Wilfert: Thank you, Madam Chairman, for the opportunity to appear today to discuss Bill S-40, which amends the Payment Clearing and Settlement Act to cover securities and derivatives clearing houses. Bill S-40 ensures that Canadian securities and derivatives clearing houses will have legal protections, similar to what is in place for their counterparts in other countries, in the event that one of their members becomes insolvent or declares bankruptcy.

    As honourable members of the committee know, the Canadian securities and derivatives industry, its exchanges and clearing houses, play a key role in Canada's financial sector, and ultimately in the overall economy. The industry provides a mechanism for raising capital and hedging financial risks through derivatives contracts.

    The industry's three clearing houses--the Canadian Depository for Securities, the Canadian Derivatives Clearing Corporation, and the WCE Clearing Corporation--enable consumers and businesses to clear and settle securities and derivatives transactions in a timely manner and at a reasonable cost. They accomplish this by acting as a central counter party to securities and derivatives transactions on Canada's four major exchanges: the Toronto Stock Exchange; the Canadian Venture Exchange in Calgary, recently renamed the TSX Venture Exchange; the Bourse de Montréal; and the Winnipeg Commodity Exchange.

    An ongoing concern of these clearing houses is the risk that one of their members may default before a transaction is settled, thereby resulting in a financial loss to both the clearing house and its members. At the same time, factors that increase the cost of operation of these clearing houses naturally impact on securities and derivatives markets by reducing their efficiency and increasing trading costs.

    Securities and derivatives markets rely on the centralized services provided by clearing houses for a number of reasons. For example, securities and derivatives markets provide opportunities for individuals and businesses to raise capital for investments and hedge financial risks. In addition, they rely on clearing houses for the efficient and timely clearing and settlement of transactions.

    Further to their role as a central counter party, securities and derivatives clearing houses take measures to reduce risks and costs in the settlement of transactions by requiring members to post collateral and to net their payment and delivery obligations with the clearing houses.

    In recent years, the Canadian securities and derivatives industry has had to face the challenges of globalization, rapid technological change, and consolidation. Canadian exchanges are also operating under intense competitive conditions.

    This changing environment has resulted in a significant portion of Canadian securities and derivatives trading now taking place in the United States, making it imperative that changes be made to ensure that our industry can compete with systems in place in other countries. Otherwise, more trading will occur outside of Canada, particularly in the United States, where bankruptcy and insolvency laws generally exempt securities and derivatives clearing organizations from court-ordered stays and allow them to net the obligations of members and realize their members' collateral.

    Recent changes in Europe also point to the need to make our securities and derivatives industry more competitive. The 1998 Settlement Finality Directive requires member states in the European Union to ensure that securities settlement systems can net obligations, and that the netting is legally enforceable and binding on third parties in the event of insolvency. The directive also provides for collateral to be realized in a timely manner in any winding-up procedure.

    Laws in Canada do not fully protect netting agreements and collateral posted with securities and derivatives clearing houses to the same extent. Current federal bankruptcy and insolvency legislation does not prevent court-imposed stays from securities and derivatives clearing houses realizing collateral in the event that one of their members becomes bankrupt or insolvent.

    Stakeholders have expressed concern that Canadian laws add to the costs of their clearing house operations and to their members by increasing the costs related to a failure of one of their members. As a result, stakeholders have requested that the Payment Clearing and Settlement Act be amended to cover securities and derivatives clearing houses. They point to the difficulty of attracting large, international dealers to trade here if Canadian clearing houses face higher costs because they cannot enforce their netting and collateral agreements with members in the event of the insolvency of one or more members.

À  (1040)  

    What the Canadian securities and derivatives industry needs is a competitive legal regime that lowers settlement risks and the associated costs with clearing houses. Such a change would make Canadian clearing houses more efficient and competitive with those in the United States and other G-7 countries and help to keep trading activity here at home.

    Madam Chair, Bill S-40 addresses these problems by amending the Payment Clearing and Settlement Act to include legal protections for securities and derivatives clearing houses for their netting agreements and collateral posted by their members.

    The bill protects netting agreements and prevents stays imposed by a court on the ability of securities and derivatives clearing houses to realize collateral in the event that one of their members declares bankruptcy or becomes insolvent. These legal protections will allow Canadian securities and derivatives clearing houses to lower their settlement risk and costs and thereby make them more efficient and internationally competitive.

    In considering this bill, I would urge honourable members to keep three points in mind. First, these amendments are in line with recommendations made by the important international forum, the Bank for International Settlements, regarding security settlement systems. Second, they are supported in Canada by the financial sector participants and their associations, by provincial governments, and by the insolvency community. And third, these amendments help to meet a throne speech commitment to keep Canadian laws competitive.

    Madam Chairman, it is essential that Canada's financial sector remain strong and efficient. The amendments in Bill S-40 will help to ensure this. A competitive legal regime will help keep securities and derivatives trading in Canada and assist the industry in attracting international dealers and brokers.

    As I've indicated, Madam Chair, officials from the Department of Finance have joined me here today, and we welcome any questions the honourable members may have with regard to this bill. I should have said, however, Madam Chair, that there is a test after my speech, and I expect that all of you will pass after you've now heard all of my comments.

    Thank you so much. I'm now at the pleasure of the committee.

À  (1045)  

    The Chair: Thank you.

    Mr. Harris, would you like to question officials or Mr. Wilfert on this bill?

    Mr. Richard Harris (Prince George--Bulkley Valley, Canadian Alliance): I sure would. As you probably know, we're going to be supporting this bill, so these questions are probably for my own learning experience on this issue.

    First of all, how is the collateral calculated? Is it based on the trading that a member would do? Is there a set formula on how the clearing house would calculate collateral?

    Mr. Bryon Wilfert: Madam Chair, I would point out to you that in fact there are experts here who can answer that better, but representatives from the Bourse on issues--

    Mr. Richard Harris: I just realized that perhaps I should hold that question for a little bit later.

    Mr. Bryon Wilfert: Yes, if you could, Mr. Harris, we would appreciate that.

    Mr. Richard Harris: All right, that's fine.

    Can you or your officials then address the concerns we had from the Canadian Bankers Association? I'm sure you're aware of that. Just what does it mean in relationship to the bill, and are they on the mark on it?

    Mr. Bryon Wilfert: I'll have Mr. Normand respond to that. As I indicated at the previous steering committee meeting, officials were looking at that. They have now sent a written response to the CBA, and since Mr. Normand is the author of the letter, I'll have him address that directly.

    The Chair: I think that's appropriate because the steering committee was an in camera meeting, so for the record, Mr. Normand.

    Mr. Denis Normand (Senior Chief, Payments, Financial Sector Policy Branch, Department of Finance): First off, we did in fact consult directly with the CBA back in February. We had consulted with a broad group of people, and the CBA at the time was quite supportive of this action. They have also--at least some of their members--had an opportunity to look at previous drafts of the legislation, so it was a bit of a surprise to us that if there had been a concern, it didn't come a bit sooner. The basic issue is that we do not think it is a significant problem, certainly not one to slow down the bill.

    The amendment we're talking about today is an amendment dealing with securities and derivatives clearing houses, and it doesn't deal with the participants of a designated system. Just to back up a little bit, the Canadian Bankers Association was concerned that CDS, which has its debt-clearing service...that debt-clearing service is designated under the Payment Clearing and Settlement Act as a systemically important payment system, so there are already certain protections for that system under the Payment Clearing and Settlement Act. They've said that by introducing the amendment we did, because the language wasn't identical to the provisions dealing with the debt-clearing system, it could weaken the interpretation a court would take of the designated system. As I indicated, we don't think this was a significant point.

    The new amendment deals with securities and derivatives clearing houses, not the participants. It allows the clearing houses to net and to realize collateral. We think it's somewhat of a stretch that the courts would actually say that they would in essence read down from proposed section 13.1, look at section 8, and say, well, we think 13.1 overrides in some respects section 8 in dealing with designated systems.

    We think it is an issue we'd be prepared to look at in the future, but we don't think that the correct response is the amendment to proposed section 13.1. I think the problem, if there is one, is in section 8 and with CDS moving forward with a new debt-clearing system. We think it would be appropriate to look at it at that time.

    I should add while we have the Bourse here--and they will be testifying--CDS was also looking for this type of amendment to protect themselves in terms of their settlement activities. They're very supportive of the bill. We've had discussions with them about the section, and they concur with us that it's a very remote problem, something we don't have to worry about at this stage. We might want to look at it at some stage later on to clarify section 8, but not indirectly through this bill.

À  (1050)  

    Mr. Richard Harris: Let me ask one small question. If the suggested amendment that was put forward by the CBA--and I see it in the letter here--was in fact implemented, would it affect in any way the original amendment under Bill S-40? Would it detract from the benefit of the settlement in clearing houses, the benefit they're seeking through this amendment?

    Mr. Doug Wyatt (General Counsel, General Legal Services, Department of Finance): The short answer to that is no. I should add that I think there are lots of problems with the amendment they put forward, both the wording and the fact that in reality it constitutes an amendment to section 8, which is the worst type of legislative drafting.

    If I could just add my comments, I professionally just don't agree with the CBA. However, I should add that normally when we draft legislation we just don't rely on one person's views; we try to work out a compromise. The problem here, of course, is the time to come forward would have been in February.

    I think what's happened is they've taken a worst-case scenario: for a judge to ignore the object of the act, as we like to say, and the context, which of course is the importance of designated systems, and to reach out to another provision, which doesn't even deal with the extenders of credit, and somehow read down subsection 8(3), which is their concern.

    Subsection 8(3) is not ambiguous. It says the participant may realize in the collateral. So I'm not quite sure how that would ever occur. However, I would never say anything's impossible in this world. Had they come forward, as I say, in February, we might have found some sort of compromise. But the amendment they've put forward now is not just poorly drafted; it constitutes an amendment to section 8, which of course was beyond our mandate to begin with.

    I think the best way to go at it is not to do drafting in haste now--and in some respects section 8 was done in haste back in 1996--but to go back and look at it in the context of what CDS is doing and whether we can improve on the wording.

À  (1055)  

    Mr. Richard Harris: Okay.

    The Chair: Thank you.

    Mr. Brison.

    Mr. Scott Brison (Kings--Hants, PC): Thank you, Madam Chairman.

    Thank you for appearing before us today.

    We're supportive of Bill S-40. We understand the concerns of the Canadian Bankers Association. In response to Mr. Harris' question as to whether addressing those concerns now, as we finalize this legislation, would compromise the intention of Bill S-40, your response was essentially no, it wouldn't.

    I think, Mr. Wilfert, that the government ought to seek to address these concerns, given that our friends from the department have indicated there wouldn't be a compromising of the intentions of the legislation. I'd appreciate your response to that, Mr. Wilfert.

    Mr. Bryon Wilfert: Madam Chairman, as clearly indicated to the Canadian Bankers Association in a letter that was sent to their senior vice-president, Mr. Law, there's no policy intent to weaken the existing protections for participants under part I of the PCSA. And it was the view of the department that this bill does not do so.

    As was indicated by both Mr. Wyatt and Mr. Normand, in fact section 8 may need to be reviewed. I think we have indicated that in the future--and there certainly could be an undertaking to do that at some point--in light of the contemplated changes to CDS, to determine if.... And as Mr. Wyatt said, in terms of the drafting, I guess originally it was drafted a bit in haste in 1996, so certainly there could be an undertaking to review that, to reflect maybe better the policy goals. We certainly could commit that maybe in the future that could be done. But in terms of the specific legislation before you now, there is no policy intent to weaken the existing provisions.

    I don't know whether either colleague would like to add to that.

    The Chair: Mr. Normand, did you wish to add something? No?

    Okay, Mr. Brison.

    Mr. Doug Wyatt: Perhaps, Madam Chair, I would just add one thing.

    The Chair: Okay, Mr. Wyatt.

    Mr. Doug Wyatt: My view, again professionally, is that if we did this amendment we'd be back changing section 8 anyway. We'd have to go back and revise it, in any event. I think it's better to tackle section 8 as a whole, given what's going to happen in the future, rather than to do it now and just have to revise it again.

    Mr. Scott Brison: We don't have a desire to hold up passage of this legislation, but again, it strikes me as being so simple for us to address it.

    There almost seems to be an opposition within the bureaucracy because of the timing issue of this, that somehow the department is off-put by the fact that the CBA didn't make these suggestions earlier. I would hope that would not be the case.

    I have a general question to Mr. Wilfert about securities regulations in Canada and our security regulatory regimes. He mentioned the importance to the Canadian economy of having a competitive securities regulatory regime. I couldn't agree with him more. We're the only industrialized country that does not have a national approach to securities regulation. We have 10 securities regulatory agencies in Canada and a hodge-podge of policies. It's a nightmare trying to raise capital in Canada for emerging companies, and it's one of the structural impedimenta we have to competitiveness, particularly in early-stage companies.

    What is the government doing to address that issue, and are efforts being made to work with the provinces to develop a uniform approach to securities regulation, with the ultimate goal being one regulatory agency in Canada for securities regulations, recognizing, of course, the constitutional quagmires that we get ourselves into sometimes with these things? There's no reason we can't at least go in that direction, and I'd like to know what the government is doing to get us there.

Á  (1100)  

    Mr. Bryon Wilfert: Madam Chairman, first of all, as a quick comment through to Mr. Brison, certainly you can be assured that there is no intent by the department, regardless of whether the Canadian Bankers Association amendment came in late in the game or not.... We have an excellent working relationship with the CBA and will continue to do so. In fact, because of the undertaking, we will look at that issue in the future, so you can rest assured on that point.

    On your other point, I want to have the officials reply directly, but you've almost answered your own question. It seems we are the most overgoverned country, practically, in the world, and this isn't just one example. You can think of drugs as an example for patents, where they have to be approved by the federal government and then all the provinces, and the cost involved and the duplication.

    I think you raise a good point, that in fact we have duplication here, and we are trying to be competitive internationally. We are trying to make sure. We realize in particular...and part of the motivation for this bill is the issue of the regimes to the south and what in fact we have in the United States.

    Certainly the government is prepared, and I think has clearly has demonstrated that it is prepared, to work with its provincial counterparts to try to streamline a system that in fact the industry would like to see streamlined as well. There are often discussions in many of these areas to try to advance that end objective.

    As to specific steps being taken by the department or by the government presently, maybe either Mr. Wyatt or Mr. Normand would want to take a venture at that.

    Mr. Denis Normand: It is indeed a very important issue from the economy's perspective, broadly speaking, and from the federal government's perspective. It's an issue that has started again to be raised in various circles. Barbara Stymiest of the TSE has been very vocal, and the IDA.

    I think there is still a development in industry of various ideas, and that development needs some further discussion and thinking. It doesn't seem at this stage that industry has come up with a model that it thinks will solve the problems and reduce regulatory burden, reduce costs, and make our securities markets efficient.

    There is harmonization, the questions of whether one can harmonize, whether there should be a national securities regulatory seating of responsibilities, and there are also other approaches, where some provinces will take the lead in some areas.

    So there are a number of issues, a number of approaches, that are still under discussion and debate.

    Mr. Scott Brison: If I could make one final point, Madam Chair, I take exception to the notion that industry hasn't been specific. I think the IDA has been quite specific in terms of proposing constructive steps that could be taken.

    I don't think we're going to see provinces really move on this without some federal leadership. Some leadership will be demonstrated by the provinces, but I really believe that with our capital markets as small as they are, to divide them by ten is one of the craziest public policy mistakes we can continue to make in Canada. I think we're contributing significantly to the ongoing diminution of Canadian capital markets. This is something the federal government ought to approach in a very serious way and on which they should demonstrate leadership.

    Industry has been very specific in terms of offering suggestions and constructive ideas on how to approach this.

Á  (1105)  

    Mr. Denis Normand: I apologize. I should have added that the federal government, as many people probably are aware, attempted an approach several years ago with the national securities regulator. That did not work at the time.

    We remain open to looking at options. Discussions with provincial counterparts about these types of issues are always going on. I think it's very useful that this whole issue has come to the fore and has been raised by a number of parties. I think that's a very constructive development. We certainly support that, and we are being active as well.

    Mr. Bryon Wilfert: Madam Chair, I think Mr. Brison's comments are most constructive, and I will pass them on directly to the minister. Again, I think this is an area where it would be helpful to all of us if we could streamline the regime.

    Mr. Scott Brison: It's Canadian companies trying to raise capital and Canadian investors that are paying the price for this. I really hope the government gets behind doing something on this.

    The Chair: Thank you, Mr. Brison.

    Mr. Harb.

    Mr. Mac Harb (Ottawa Centre, Lib.): The question that is on the minds of a lot of people is, have we done any studies in order to find out the positive impact on industry and how it would help industry increase their level of activities and business?

    Mr. Denis Normand: There are two points I'd like to make on that. The first one is that I believe Luc Bertrand of the Bourse de Montréal will be giving comments after us, and he will be explaining how important that is from their perspective in terms of the development of their trading platform. I believe they'll be able to indicate how that is going to help them.

    In terms of more broadly, as we've indicated before, CDS is a very large depository and has a central role in terms of the clearing and settlement of securities in Canada.

    There's a move afoot in the industry, and governments are involved, including the Department of Finance, to move to a day-after settlement for securities trade. It's called the T plus 1. It's an initiative that the Americans are moving forward with by 2005, and our industry is looking to move as well. As part of that, CDS is centralizing their systems a little more, and they need these types of changes for them to go forward into this T-plus-1-type environment, the day-after settlement. That's another initiative that will reduce settlement risks, because everything will be settled and paid for within 24 hours. So it's an attempt by our industry to be at the leading edge of efficiency in terms of how quickly trades can be effected and settled.

    Mr. Mac Harb: Thank you.

    The Chair: Mr. Harb, I'm sorry, but Ms. Minna is going to take the other half of your time.

    Mr. Mac Harb: Sure.

    Ms. Maria Minna (Beaches--East York, Lib.): Thank you, Madam Chair.

    I just wanted to ask this very briefly. Under the current system, the clearing houses face additional risk, which also exposes the dealers using the services to greater risk. Under the system, who's really bearing the risk, the dealer or the clearing house?

Á  (1110)  

    Mr. Bryon Wilfert: What's important is that when these clearing houses take on the risk that one of their members may default before a transaction is settled, they take on a financial loss, both for the clearing house and obviously for its members. So the securities and derivatives clearing houses take measures to reduce settlement risk and its associated costs by requiring members to post collateral and their net payment and delivery obligations within the clearing house.

    As I indicated in my introductory comments, these amendments will protect the netting agreements of the securities or derivatives clearing house in case of bankruptcy or insolvency by any of its members. What's important is that it will prevent these court-ordered stays on securities and derivatives clearing houses, which delay them--I had mentioned the difference in the United States--from realizing the collateral bankruptcy of insolvent members. It also provides the minister with the authority to designate, in the public interest, any other securities and derivatives clearing houses that come into existence as well. Hopefully that will benefit the three securities and derivatives clearing houses I had mentioned before the committee earlier.

    I don't know if there's anything else that maybe our officials could add.

    Mr. Denis Normand: Again, I think representatives from the Bourse de Montréal could explain this much better than I can. Ultimately, any costs that the clearing house has to incur, either through taking out loans to cover off shortfalls in terms of timing of being able to get collateral, or other costs that might be incurred by it in terms of its central role, are going to be passed on to the participants, the members of the clearing house. It's going to be through higher fees, so those costs will be recovered.

    The direct impact is on the clearing house and the secondary impact is on the participants and members.

    The Chair: Thank you very much, Mr. Wilfert. Maybe you and your officials can stay while we hear from our next witness, if you have the time.

    Mr. Bryon Wilfert: On behalf of both Mr. Normand and Mr. Wyatt, I'd like to thank you and the committee for your questions and your attention. Thank you.

    The Chair: I would like to welcome Mr. Luc Bertrand, who is the president and CEO of the Montreal Stock Exchange, to the table.

    Mr. Luc Bertrand (President and CEO, Bourse de Montréal): Honourable chair, ladies and gentlemen, thank you very much for providing us with an opportunity to present the views of the Bourse de Montréal and the Canadian Derivatives Clearing Corporation on Bill S-40, an act to amend the Payment Clearing and Settlement Act.

    The Bourse and the CDCC compete for investment dealers' business with the derivatives exchanges in Europe and the U.S. At present, clearing houses in these jurisdictions offer greater legal protection to investment dealers than do the Bourse and the CDCC. The amendments proposed in Bill S-40 are required to put our exchange on an equal footing with our international competitors. These changes must be passed quickly.

    I will put these comments into context by telling you about what the Bourse does and the role of CDCC in its operations.

    Canada's capital markets now compete for investors on a global basis. In this light, in 1999, the Vancouver, Alberta, Toronto, and Montreal exchanges implemented a restructuring program along the lines of specialization. The Bourse, as you know, emerged as Canada's only exchange that trades in financial derivatives contracts.

[Translation]

    Since then, the Bourse has made many structural changes in order to better position itself with respect to its international competitors. In 2000, we demutualized. Now, the Bourse de Montréal is a private enterprise which is naturally trying to become cost-effective. We are accountable to our shareholders for how we manage. However, we have better access to sources of capital and, at the same time, much greater flexibility in adapting to global pressures.

    Last year, for instance, we became the first traditional derivatives stock exchange in North America to become fully automated. Our trading floor is closed. All operations of the Bourse de Montréal are now carried out electronically. As I said, we are the only North American derivatives stock exchange with this capacity.

[English]

    Nevertheless, as you can see, we're doing a lot to stay ahead of our competitors, but there are some areas where we need to catch up. Specifically, this is why we need the changes proposed in S-40. An essential element of any trade is to ensure that it will clear. The CDCC is the clearing house for the Bourse. This means that the CDCC makes sure the buyer pays the amount he has agreed to pay. The seller, of course, receives payment, and both meet their obligation under the derivatives contract they have traded.

    CDCC is a wholly owned subsidiary of the Bourse de Montréal. This is by virtue of the 1999 restructuring program of the Canadian markets that the industry executed. It is the guarantor of interest rate, equity, and index derivative contracts traded on the Bourse. As such, the CDCC requires each of its members to maintain margin deposits to cover the market risks associated with each other's position. CDCC members must post collateral to mitigate the risk of insolvency.

    The Bourse competes directly with derivatives exchanges in Europe, but our biggest competitors, of course, are in the U.S., specifically the Chicago Board Options Exchange, the Chicago Mercantile Exchange, the Chicago Board of Trade, and I may add the American Stock Exchange, the Philadelphia Stock Exchange, and the Pacific Stock Exchange.

    To compete with these foreign exchanges, the Bourse and CDCC must provide its customers with the same protection from risk that our foreign competitors are able to offer. Currently, this is simply not the case. The Canadian bankruptcy laws put our clearing house at risk of insolvency with respect to large trades on which defaults may happen. This element of risk has been a big deterrent for our dealers. Bankruptcy laws in the U.S., on the other hand, afford exchanges greater flexibility to handle defaults, and dealers have therefore been opting to do business with our competitors in the U.S.

    I will illustrate my point with a hypothetical example. Let's assume a large U.S. dealer receives an order to buy a large order of call options on Canadian National stock. The dealer could do this either on the Bourse or on the Chicago Board of Options. Clearing of the transaction would be done by the clearing house for each exchange--CDCC in the case of the Bourse. The CDCC will guarantee both the buyer and the seller of the CN call options that their transactions will be successfully completed. The seller will receive payment in full for the options sold and commits itself to sell the CN shares on a term specified in the options contract. If the seller of the CN options were to go insolvent before fulfilling its obligation to sell CN shares, CDCC ensures that the buyer, in the case of the large U.S. dealer, receives delivery of the CN shares under the terms of the options contract.

    Because it provides this unconditional commitment, CDCC requires its members to deposit collateral, which it can liquidate to cover any losses if one of the CDCC members fails to live up to its commitment. However, under current Canadian bankruptcy laws, the courts could prevent CDCC from immediately liquidating the collateral of a bankrupt member to cover the losses associated with the CN options. CDCC would then have to come up with the money from other sources. If large losses are involved, there is a risk that the CDCC could itself face insolvency. CDCC's members must therefore take into account this risk when dealing with the Bourse and CDCC.

    Under U.S. law, the clearing corporation of the CBOE is exempt from such stays and can liquidate the collateral immediately to obtain the cash needed to clear the trade. So the large U.S. dealer buying its CN options has a choice: it can either use the CBOE, whose clearing house is exempt from stays, or the Bourse, where Canadian courts might prevent CDCC from immediately liquidating the collateral deposited by an insolvent member to cover losses. Clearly, this leaves the CBOE in a stronger competitive position.

    Bill S-40, by exempting the CDCC and other clearing houses from court-imposed stays, will eliminate this disadvantage. It will place them on an equal footing with their U.S. and European competitors.

    Why do we need this legislation passed so quickly?

    First, we are losing business every day. Potential customers are either using other exchanges or, in some cases, using other members of CDCC, who accept the additional risk for a fee. With the changes, the cost of trading on the Bourse and clearing through CDCC will be reduced. With its other advantages, there will be some real benefits to investment dealers--in particular, large foreign dealers--to use the Bourse.

    The Bourse has invested heavily in the latest technology, and as we noted earlier, is presently North America's only fully automated derivatives exchange. We have one of the most efficient training platforms in the world and need to be able to take advantage of this lead immediately, because it will not last for long in the highly competitive U.S. market.

    The Bourse is also ready to invest in CDCC to secure a top credit rating for it, once, of course, Bill S-40 is passed.

    The final result is that we will have both a leading-edge trading platform and a clearing system that provides its members with a very high level of protection. We believe this combination will help us to increase our market share of the global-exchange-traded derivatives market, and even to repatriate--I think this is very important--some of the business that Canada has lost over the years to other foreign exchanges.

    The benefits to Canada and Canadians are also quite clear. Canadian exchanges and clearing houses will be in a stronger position to create highly skilled specialized jobs in finance in Canada, to develop greater expertise and experience in exchange-traded derivatives and other financial products in Canada, and to attract more foreign dealers to use Canadian exchanges.

Á  (1120)  

[Translation]

     For more than a year now, we have been begging the government to come up with a solution to our problem. We ask you to help resolve it and to recommend that Bill S-40 be passed without amendment so that we may benefit as quickly as possible.

[English]

    So we are pressing the government, as we have for the last year and a half or so, to find a solution to this problem. We therefore urge you today to be part of the solution and to recommend that Bill S-40 be passed without amendment, so we can begin to realize as soon as possible the benefits that this will provide.

    Thank you very much.

    Thank you, Mr. Bertrand.

    Mr. Harris.

    Mr. Richard Harris: Thank you, Madam Chair.

    Thank you, Mr. Bertrand. One of the good things I like about the finance committee is that we get to hear on a regular basis from leaders in business and industry in every sector in Canada, and I appreciate you being here today.

    Mr. Luc Bertrand: Thank you.

    Mr. Richard Harris: Having spent my entire pre-life in small business, I never had much opportunity to talk to my customers about derivatives or call options and things like that, so this is a learning experience for me as well.

    I was doing some diagrams here when you were giving the U.S. example. Let me see if I got this right. The buyer and the seller, in the case of the CN call options, would be members of the CDCC, and the trading would be done through the Bourse.

Á  (1125)  

    Mr. Luc Bertrand: There are, of course, various instances in a transaction, and you have what we call the “end user”. The end user can be Fidelity in Boston or Caisse de dépôt in Montreal or teachers in Toronto, or it can be your retail investor in Calgary or in Anaheim, California. It can be anyone out there.

    Say, hypothetically, that that investor, whether they be retail or institutional, feels Mr. Tellier is doing such a fantastic job and he wants to have a good exposure to CN, and he really wants to do it in a way that is going to have an impact on his portfolio. And of course he's very knowledgeable about derivatives. He will perhaps decide to buy 100 calls of CN. Say this fellow is based in Toronto--I'm trying to make things simple. He would approach a broker-dealer, say Dominion Securities, Solomon Smith Barney, anyone of that kind, and place his order.

    The decision the dealer will make then is where to execute that transaction. Many things will dictate the decision, one being of course liquidity. You're going to go where they have the tightest spreads between your bid and ask on the instrument, where you can rapidly execute, where you can do it at the lowest cost, and so forth. That's what we call the front end of the transaction, properly the exchange part of the transaction. That's part one.

    Part two is who is doing the settlement on this transaction. In the U.S., there is only one clearing corporation for options. It's called the Options Clearing Corporation. It services all the options business in the U.S. OCC is exempt from stays. So if you're Solomon Smith Barney and you have 100 calls of CN to buy--which is a pretty sizeable order--what's going to be your decision? To execute on the CBOE and have the OCC protection from stays, or execute on the Bourse de Montréal and not have the protection from stays because its clearing corporation is under a different legal regime?

    Over the years, unfortunately, it has drained our liquidity. Our business at the end of the day, as operators of markets, is to create environments to facilitate liquidity, to facilitate transactions.

    Of what we call the “interlisted” business--CN would be a classic example; it's listed here on the Bourse and it's listed as well on the CBOE--we only have 9% of that business right now. These are Nortel, Research In Motion, JDS Uniphase, CN--all those big, important Canadian companies. Unfortunately, the bulk of the derivatives business has gravitated to the U.S.

    I sincerely believe that the protection offered to investors in the U.S, the fact that contracts traded and settled at the Options Clearing Corporation are exempt from stays, is a big factor. There's no question about that. If you're Merrill Lynch or you're Goldman Sachs and you're running multi-billion-dollar books of proprietary trading, the last thing you want is to be hindered by a clearing corporation where you're assuming counter party risk of another dealer. That's basically what it really comes to.

    Mr. Richard Harris: Thank you. I appreciate that.

    Do I have time for one more small one?

    The Chair: Certainly.

    Mr. Richard Harris: Could you enlighten me about how the collateral is calculated for the members?

    Mr. Luc Bertrand: I'll try to do it in a nutshell. Admittedly, it's very complicated. The first important thing to remember is that unlike a cash transaction, a margin in a derivatives transaction is a performance bond. It's not a down payment, as it is in the cash business. That's very important to remember.

    The next thing is that we share the same protocols of calculating the margin required. These are basically conventions we've agreed on as an industry. It's the same thing on the CBOE, AMEX, the Chicago Board of Trade, and the Chicago Mercantile Exchange. We're all using the same protocols. They're called TIMS and SPAN, without getting into technicalities.

    The reality of that is you have complicated software programs that on an hourly basis, literally, calculate the value of the underlying--CN stock would be the underlying for the call option of the CN call. Depending on the volatility of the underlying, it will adjust the collateral that the broker-dealer has to deposit.

    So we have flows of money going back and forth all day long between the clearing corporation and the dealer to cover the collateral position in keeping with the volatility of the underlying.

    I'll give you a concrete example. Yesterday Bell Canada was very volatile. It was active. It went up quite a bit. We traded 31,000 contracts of Bell Canada on our exchange yesterday, which is a huge volume. We have specialists who manage the systems in play with the clearing members. All day long there would have been funds flowing back and forth to adjust the collateral position. Because the stock was going up, there was probably a flow of funds out to the dealers, because the value was greater. Had it been the reverse, say the stock had gone to $18, then there would have been an inflow of funds.

    Where does this money go? It goes into what we call the clearing pool, which is the first level of defence in the event of an insolvency. For instance, if Bell had gone to $15 yesterday and one of our smaller clearing members would have been in trouble because of that, our immediate reaction.... We don't have three weeks to go in front of a court. We have less than three seconds to limit systemic risk. We have to be able to go into that clearing pool and seize a collateral on deposit to protect the position. If we don't have that ability, we're in serious trouble.

    With the way the clearing corporation has been managed in Canada for the last 25 years, we've never had that event. So some would argue, then why worry about it? The reason we worry about it is that you never know what the financial markets will bring to you from one day to the next. The reason we have such a strong clearing corporation is because we've operated it in a very strong manner and made sure that it's sound.

    But now we're at a point where if we wish to repatriate business from other markets, clearly the fact that we have only 9% of the interlisted business is a huge factor as to why we have to worry about the fact that the contracts are not exempt from stays.

Á  (1130)  

    Mr. Richard Harris: Thank you very much.

    The Chair: Thank you. I think we all gained something there.

    Mr. Brison.

    Mr. Scott Brison: Thank you, Madam Chair. I'll be brief.

    As expressed earlier, we're very supportive of this legislation.

    In a more general sense, this legislation seeks to address one of the structural disadvantages you have been operating under in terms of competing with other exchanges. One obvious one, which was mentioned in the discussion we were having earlier with Mr. Wilfert and our friends from Finance, is the duplication of and differences in the ten securities agencies in Canada. What are some of the disadvantages from a structural and regulatory perspective that we ought to be considering? I recognize that some are provincial, but I think we can take some leadership and work with....

    You're also in a very interesting position, representing an exchange in the province of Quebec. When previous efforts have been made to address these issues, I understand that difficulties came from Alberta and Quebec. But I've also been told that there's a greater level of flexibility and interest on behalf of the Quebec government in addressing some of these issues now.

    I'd appreciate your feedback.

    Mr. Luc Bertrand: Thank you for the opportunity to address that, because of course it's one that's very dear to our hearts as market operators.

    We are a highly regulated business, as you can imagine. When I look at the cost of legal fees in comparison to the overall cost of doing business, it always astounds me--and I'm fortunate in having excellent legal personnel. We have four individuals, inside legal counsel, and we've had the benefit of one of the larger legal firms in Canada being counsel to the Bourse for the last 20 years. So I say that against the backdrop that it's a very regulated business.

    To answer your question, perhaps if we can go back to 1999 when we initiated the restructuring program of the exchanges in Canada, at that time we had a fragmented market environment that was clearly inefficient, that was not competitive, and simply wasn't going to survive if we didn't do something quite radical.

    In 1998, the Bourse de Montréal hired McKinsey and we spent the next 12 to 16 months, actually up to the time of the restructuring, digging deeply into the whole thing. We came to the conclusion that we had to specialize the market environment along the lines of, ultimately, the way it was structured.

    So that brought us to sitting down with the Toronto Stock Exchange. At that time, Barb Stymiest was chairman of the TSE and I was chairman of the Bourse, and we were able to work out a deal. But the second phase of that was to get it accepted by the regulators. I would say, out of ten people we met on the street and explained to them our idea, nine of them would say “It will never fly; the regulators are not going to accept this”.

    We sat down with them in March 1999. We got them all into a room--Barb Stymiest was there and myself--and we just laid it out. We said, “Look, it's 5 minutes to 12 o'clock here for us as an industry. We're losing market share to the U.S. in a rapid way. There won't be a Canadian industry of any substance or any size if we're not rapidly proactive in getting things done.”

    Remarkably, we had four meetings in all--which I remember quite well--from March 1999 to November 1999, where we ironed out almost all the issues concerning this rather fundamental restructuring, this pretty big program. What came out of these themes and the concept that was evolving rapidly was the concept of lead regulation, which is one that I continue to believe in quite strongly.

    Of course, if we could have a national regulator--I don't know if you'd have to redo the Constitution and get everybody to agree on this--it would be great, but as a businessman I need solutions now, and this process can take a long time.

    So some of us started reflecting on the concept of lead regulation, and it has worked for us at the Bourse where we literally have moved to get the OSC to delegate to the CVMQ the oversight of new products, derivative products, that often can be very technical.

    We launched sponsored options, for instance, in January. It took 12 months to get those approved by the regulators. At one point, I sat down with David Brown and said, “Look, David, just delegate the stuff to the QSC; they have a whole bunch of people working on it.” So they did, and as a result, we had to work with only one set of regulators to get it through. I give that as an example.

    The other example I will give is, when we demutualized in the summer of 2000, it took us four months. It was the fastest demutualization of any exchange--I don't know any other exchange that was able to demutualize so quickly--and here again it was a matter of the market operator being very proactive and sitting down with the regulators in the same room and saying, “Look, these are the issues; let's argue them out right now or we're not going to go a step further.”

    So if we build on the concept of lead regulation, the model I've been advocating is that the Quebec Securities Commission takes the lead in derivatives products, the Ontario Securities Commission takes the lead in senior equities, and the western provinces, B.C. and Alberta, would take the lead in junior equities.

Á  (1135)  

    My sense is that--and many will argue it's not the best model, and fine, I will not dispute that--from a market operator's point of view, if we can encourage, at the very least, and use more suasion on securities regulators to push this lead regulation model....

Á  (1140)  

    Mr. Scott Brison: There's one more thing. I agree what you're proposing is a step in the right direction, but as long as we have every province with its own securities commission and the rest of it, we're going to continue to see an awful lot of inefficiency and duplication and individual fiefdoms.

    Part of the problem, and one of the challenges, is that many of these securities commissions are cash cows for the individual province. In the case of Nova Scotia, the provincial government brings in about $6 million a year in revenue out of the Nova Scotia Securities Commission. Their costs are about $1 million. I think it's a cash cow for about five million bucks a year.

    I think the federal government, in recognizing the importance of this to the country, may have to demonstrate not just leadership on it, but work with the provinces, and provide some cash to make things move more quickly as well.

    Just from an Atlantic Canadian perspective, ACOA's budget every year is around $360 million. For probably around $10 million you could compensate the provinces for the losses of giving up their individual securities commissions. Probably one securities commission for Atlantic Canada would do more for the region than ACOA in the long run in improving market and capital market efficiencies down there. That's just an observation.

    Mr. Luc Bertrand: The Bourse is in a bit of a unique situation, because, like the IDA, we're still in the member regulation business. The TSE has exited the member regulation business, and the Alberta and Vancouver Stock Exchanges, before they became CDNX, had also gotten out of that area. For us it's a real issue. We have to think of how we're going to find a solution to the problems we are faced with.

    The two main problems are, of course, member regulation and market supervision. The Bourse has been working on a model we will be proposing in the near term to the regulators that would go even a step further. It would include registration of the broker-dealers, the clearing of prospectuses--really the hot buttons in the business that are costly, time consuming, and inefficient. Unfortunately, though, I think that's as far as we can go as an industry. Beyond that, they're political decisions.

    We've been working very hard on this model. The Bourse hasn't participated in the big debate Barb Stymiest commenced, because we feel it is a constitutional/political thing. There's nothing we can provide in terms of making it go forward; it has to come from your side.

    But from a business point of view, what can we do? We'll be advancing this model in the next month or so, which hopefully will force the regulators to recognize the efficiencies of consolidating into one body--what I call a super SRO, a super self-regulatory organization--those functionalities that are irritants right now.

    With regard to what you're saying, unfortunately that's an issue where we have no leverage.

    The Chair: Ms. Leung, please.

    Ms. Sophia Leung (Vancouver Kingsway, Lib.): Thank you, Madam Chair.

    Mr. Bertrand, you gave a very interesting presentation.

    Mr. Luc Bertrand: Thank you.

    Ms. Sophia Leung: You mentioned that Canadian clearing houses cannot compete and that they also lose business to the U.S. and Europe. My question is in two parts. Number one, do you have any estimate or data to indicate the extent to which we are losing business to our competitors?

    Number two, there seems to be a general attitude that Canadian securities do not attract a great deal of interest. Do you feel investment is a very important area for us to compete in with other countries?

    Can you speculate as to the reason, and is there any other way we can strengthen it? Nortel, of course, is such a flop now, and the CN and BCE all have a lot of attraction, but it doesn't appear like that in the world market.

    Mr. Luc Bertrand: Thank you very much for your question.

    First of all, perhaps the most compelling statistic is the very low percentage of what I defined earlier as the interlisted business. In the last numbers that were available, we hardly had 9% of that business. Those are Canadian companies that have derivatives contracts--options--on both U.S. and Canadian exchanges. And we have only 9% of that business in Canada. So I think that's perhaps the most compelling piece of information that summarizes the state of affairs.

    What does that mean? It means that large users like teachers, owners, and caisses de dépôt--those large institutional users of options contracts and derivatives contracts--as well as many retail investors in Canada, are simply bypassing our market. That should be a matter of worry for us. We have to get that one back.

Á  (1145)  

    Ms. Sophia Leung: Is it because of lack of confidence?

    Mr. Luc Bertrand: The main reason at the outset is the fact that liquidity in the U.S. has been very strong. There's no question about that. It comes back as well to the dealer, who has to decide if he wishes to assume more risk by dealing with a clearing corporation whose contracts are not exempt from stays versus one that is. That is definitely a very strong factor in the decision made by the dealer as to where to trade.

    There are many other factors, mind you, for why the liquidity has gravitated towards the U.S. I think we've gone a long way at the Bourse to addressing that by implementing in the last year the most advanced electronic trading platform that's available now in the market.

    What we've done is recreate the market model. It's called a central limit order book. It's not what we call a specialist model; it's a market-making model where everyone has equal access to the trading platform. There's no difference between a specialist or a market-maker or a retail investor or an institutional investor. Everyone's treated on the same basis in our new model.

    That is not the case in the U.S. now. In the U.S. you have what we call a specialist system, which makes prices on options. The specialist has a huge advantage over the one providing the order, the person wishing to execute. As the order comes to the floor on the Chicago Board of Options, the specialist gets ten seconds to look at that transaction before he executes. Ten seconds in our world is an eternity.

    What we've done at the Bourse de Montréal is scrap that whole model in the last year. We got the regulators to approve a totally new market model. The market model we have structured is, as I said, based on what we call a central limit order book. When you, as a user, look at the bid and ask of an option trading on the Bourse de Montréal, if you hit that bid, you own it. If you hit the other side, you're long or you're short, depending on what you're doing, whereas before there was delay. The delay was to permit the specialist to decide how to execute the transaction.

    I think the success of our platform was immediately evident when we were approached by the Boston Stock Exchange and by a company called Timber Hill, which is the largest market-maker of options in the world, to recreate our platform in the U.S., which we are currently doing. We signed a partnership agreement with Boston and Timber Hill and Bourse de Montréal and have applied at the Securities Exchange Commission to launch this new electronic options market in the U.S. We hope to have it up and going by the end of the year.

    What is interesting here is the fact that the market will be operated in Montreal. The machine, the infrastructure, the technology, the individuals who will be the backbone, if you will, of the operations will all be based in our facilities. The Boston Stock Exchange will be what we call the SRO, the self-regulatory agency, that will be reporting to the Securities Exchange Commission.

    I say that because I think what we've done here is move very rapidly in a direction to create an environment for the Canadian capital markets such that liquidity can be rapidly enhanced with the most recent technology and the most advanced market models. Candidly, what we've done is look at what happened in Europe. The European theatre is totally different from the North American situation. They're years and years ahead of us in terms of market models and technology. In fact, our own technology comes from France. It simply did not exist here in North America.

    Bourse de Montréal has taken very seriously the role and the responsibility, as it was given to us in 1999 in the restructuring program of the exchanges, to elevate exchange-traded contracts, derivatives contracts, to the level they should be at in relation to the size of the Canadian economy. If you compare exchange-traded business in derivatives in Canada to what it should be in comparison with the U.K. or France or Germany, we don't even rate. We're not even on the radar screen.

Á  (1150)  

    For us today, Bill S-40 is one big part of that whole restructuring process we commenced in 1999, and that needs to be addressed immediately. You have to appreciate that once we've passed this, we have Moody's and Standard & Poor's waiting in the background with us. We've already had discussions with them to get us a credit rating. Once we get the credit rating from either one of them, depending who we choose, we're going to get what we call an insurance wrapper, which is another level of protection above and beyond that clearing pool I was referring to earlier where the collateral goes.

    With those two levels of protection, we'll probably be one of the most advanced clearing corporations in the G-7 in terms of providing collateral protection to the clearing members. That is our objective. As we've done in our trading platform, we want to mimic the same service and level of sophistication in our clearing corporations. I'm convinced this will attract significant business to Canada. That is good for the Bank of Canada and it's good for the capital markets in Canada. That's the direction we've taken.

    The advantage we have at the Bourse de Montréal is we're demutualized, unlike our competitors in Chicago, which are still under the old mutual structure where decisions take a long time. We are a for-profit entity with shareholders. We have good sponsorship from them, and we are able to move very rapidly. I'm sure you appreciate that it's a rapid world. For us, every day there's something new. We have to seize the opportunities, and this is a crucial part of the overall picture for us.

    The Chair: Thank you very much.

    I'd like to thank you, Mr. Bertrand, for joining us today and putting your testimony on the record. It's always helpful for all of us.

    For the rest of the committee, at the steering committee no other witnesses were put forward by any of the members. I had the clerk circulate to all of you the letter that I, as chair, received from the Canadian Bankers Association. I also had the researcher check with the CBA to see if they wish to appear as witnesses. They have advised us today that they do not. It is my intention to instruct the clerk this afternoon to put out the notice for clause-by-clause on Wednesday.

    Thank you very much.

    Mr. Luc Bertrand: Thank you. I wish to thank the committee for its time.

    The Chair: We are adjourned.