Summer 2016

Enabling More Effective Governance of Canadian Financial Institutions - Remarks by Superintendent Jeremy Rudin

On June 14, 2016, Superintendent Jeremy Rudin gave a speech to the Global Risk Institute in Toronto, on governance and Canadian financial institutions. The following are some key excerpts:

The financial crisis that erupted in 2008 exposed weaknesses in the risk management and oversight practices of some of the world’s financial institutions, pointing to failures in corporate governance in the global financial sector. Post-crisis, regulators around the world, OSFI included, responded by introducing new regulatory requirements and enhanced supervision of corporate governance, raising the bar for boards of directors. Boards of Canadian financial institutions have responded, becoming more engaged on risk issues and exerting more oversight over senior management.

While OSFI recognizes the progress that boards have made since the crisis, many boards need to make further improvements in their performance. But before we challenge boards to raise their game in this area, OSFI needs to ensure that we have created the conditions for their success.

To enable more effective governance of Canadian financial institutions, OSFI will streamline our expectations of boards, and make them better adapted to the size, complexity and risk profile of the institutions. This will create better opportunities for boards to concentrate on the prudential responsibilities that truly matter. And it will create opportunities for OSFI to set, and achieve, high standards for effective risk governance by boards.

OSFI’s Corporate Governance Guideline

In 2013, OSFI issued an updated Corporate Governance Guideline, revised based on the lessons learned from the global financial crisis. The guideline contains a concise set of principles-based expectations for boards based on what OSFI believes are the essential elements of a board’s prudential responsibilities.

The guideline focuses on the critical role of boards and provides OSFI’s expectations around what an effective board should look like in terms of its skills and competencies, as well as what OSFI expects an effective board to do with those skills and competencies.

It sets out markers about the responsibilities of boards, distinguishing what items boards must “approve” (those are the issues where we expect the board to take full responsibility) and what items the board should “review and discuss” (those are the issues where we expect the board to play an advisory role to senior management).

More specifically, the guideline specifies that the board should approve the institution’s overall strategy, and oversee the institution’s senior management and internal controls. This includes approving the institution’s risk appetite, major acquisitions and divestments, the internal control framework, and the appointment and compensation of the CEO and (often) other senior officers. Senior management, on the other hand, is accountable for implementing these decisions, and is responsible for directing and overseeing the institution’s operations.

The Path Forward

OSFI is currently in the midst of a review of our approach to corporate governance that will prune away some of the growth in the requirements that we have placed on boards of directors of banks and insurers over the years. We will be streamlining, we will be simplifying, and ultimately, we will be presenting boards with a more focused and effective approach to governance. 

Our revised approach to corporate governance begins, not surprisingly, with our existing Corporate Governance Guideline. Our view is that the current guideline needs only minor changes as it continues to cover what we see as the most important parts of a board’s prudential responsibilities.

However, when it comes to all the other pieces of OSFI guidance, and the specific instructions that we have given to particular institutions, there are some steps we are going to have to take.

Our first step to re-establish the conditions for success will be to gather all our expectations for boards into OSFI’s Corporate Governance Guideline; removing all references to regulatory requirements for boards of directors that appear in other OSFI guidance. This will create what we call a one-stop shop approach.

The one-stop shop approach will minimize confusion and maximize consistency of messaging, making it easier for both boards and senior management to better understand the requirements, and the reasons behind them. 

We will ensure that our approach is tailored to the size, nature and complexity of the various financial institutions as we recognize that there are clear differences between OSFI’s expectations of large, complex institutions and smaller institutions.

At this stage, we are reviewing the list of items that should be included in this annex. This will involve dropping specific requirements that may have previously existed in other guidance, modifying other requirements and ensuring the resulting list is focused and geared to the “right” prudential issues.

The next step in bringing this about will be for OSFI to consult with industry, outline how we propose to amend the current Corporate Governance Guideline, and set out how we plan to reshape the ensemble of these requirements as well as the necessary amendments to our other guidelines.

We plan to begin consultations in fall 2016, and as the revisions will affect a number of guidelines, we will provide a longer-than-usual time period for stakeholders to prepare their comments and suggestions.

View the full remarks. 

OSFI Tightens Supervisory Expectations for Mortgage Underwriting

On July 7, 2016, OSFI released a letter to all federally regulated financial institutions (FRFIs) reinforcing its expectation that they engage in prudent underwriting of residential mortgage loans.

With Canadian household debt levels at all-time highs, persistently low interest-rates, and rapid house price increases in some areas, the prudential risks and vulnerabilities for financial institutions have increased.

Given this environment, OSFI has enhanced its supervisory oversight and identified a number of issues that warrant close attention by mortgage lenders. OSFI will continue its scrutiny in the areas of income verification, non-conforming loans, debt service ratios, appraisals and loan-to-value (LTV) ratio calculations, and institutional risk appetite.

“With rapid price increases in some areas and current exceptionally low interest rates, the risks are getting larger,” said Superintendent Jeremy Rudin. “OSFI wants to see sound mortgage underwriting procedures in place that adapt to the ever-changing circumstances in this area”.

OSFI will be placing a greater emphasis on confirming that controls and risk mitigating practices at mortgage lenders and mortgage insurers are sound and consistent with the principles underpinned by OSFI Guideline B-20 — Residential Mortgage Underwriting Practices and Procedures and OSFI Guideline B-21 — Residential Mortgage Insurance Underwriting Practices and Procedures.

OSFI is also moving forward with initiatives announced in a December 2015 letter aimed at strengthening the measurement of capital held by the major banks and mortgage insurers.

View the entire release.   

Overview of the 2015-2016 Deposit-taking Institutions Sector Consultation Findings

In 2015-2016, OSFI commissioned The Gandalf Group, an independent research firm, to conduct a confidential consultation with Chief Executive Officers, Chief Financial Officers and other senior executives at deposit-taking institutions, to help OSFI monitor its effectiveness in discharging key elements of its mandate.

The Deposit-taking Institutions Sector Consultation comprised a series of confidential one-on-one interviews with executives representing a cross-section of the deposit-taking institutions regulated by OSFI. The final sample of participants was selected and interviewed by The Gandalf Group independently of OSFI. The results are qualitative and presented in summary form to ensure the anonymity of participants.

The overall results are positive: OSFI is perceived to be professional, open, transparent and dialogue-based.

OSFI appreciates the feedback provided by participants in this consultation and anticipates repeating this consultation every three years to continue monitoring our effectiveness.

View the executive summary.   

OSFI issues the final version of its guideline on Operational Risk Management

On June 29, 2016, OSFI released a final version of the Operational Risk Management Guideline (Guideline E-21) following a public consultations process. The Guideline outlines OSFI’s expectations for the management of operational risk and is applicable to all federally regulated financial institutions (FRFIs).

OSFI considers effective operational risk management essential to the safety and soundness of an institution and expects all FRFIs to have a framework for operational risk management. The guideline formalizes OSFI’s operational risk management expectations for FRFIs and outlines principles for effective operational risk management. The guideline promotes industry best practices and reflects international standards in operational risk management. It is principles-based so expectations can be scaled to reflect the nature and complexity of institutions in the course of supervisory oversight.  

The Guideline contains a principles-based approach to regulatory requirements that reflects the nature, and complexity, of the institutions OSFI supervises. OSFI also expects FRFIs to demonstrate effective and comprehensive adherence to the four high-level principles outlined in the guideline no later than June 2017.

View the final Guideline.

OSFI issues final guideline on IFRS 9 Financial Instruments and Disclosures for FREs

On June 21, 2016, OSFI released its final guideline on IFRS 9 Financial Instruments and Disclosures. The Guideline provides guidance to Federally Regulated Entities (FREs) on the application of International Financial Reporting Standard 9 Financial Instruments (IFRS 9).

In July 2014, the International Accounting Standards Board (IASB) finalised its project to improve the accounting for financial instruments with the publication of IFRS 9. This new accounting standard replaces the International Accounting Standard 39 (IAS 39) and will be effective for annual periods beginning on or after January 1, 2018.

IFRS 9 is an improvement to the previous standard and has led OSFI to consider changes to our own related prudential expectations. The proposals contained in the guideline have been tailored to the size, nature and complexity of FREs. For example, more detailed requirements for the application of the IFRS 9 expected credit loss framework are proposed for banks that are systemically important in Canada based on the recent guidance issued by the BCBS. By contrast the proposals for other deposit-taking institutions are more tailored for the size, nature and complexity of those institutions.
In addition to new guidance on expected credit losses, OSFI proposes, the following seven guidelines be revised or replaced and consolidated into a single IFRS 9 Financial Instruments and Disclosures guideline.

• C-1 Impairment – Sound Credit Risk Assessment and Valuation of Financial Instruments at Amortized Cost;
• C-5 Collective Allowance – Sound Credit Risk Assessment and Valuation Practices for Financial Instruments at Amortized Cost;
• D-1, D-1A, D-1B Annual Disclosures;
• D-6 Derivatives Disclosures;
• D-10 Accounting for Financial Instruments Designated as Fair Value Option.

The Guideline incorporates several revisions resulting from comments received during the public consultation process, which began in March 2016. OSFI would like to thank all those who participated in the consultation process.

View the final Guideline. 

LICAT Webcast Information Session

On April 26, 2016, OSFI held a webcast information session on the draft Life Insurance Capital Adequacy Test (LICAT) guideline.

The webcast information session provided an overview of the LICAT, its development, and next steps. There was also an opportunity to ask questions on the LICAT immediately following the presentation. Released on March 31, 2016, the draft LICAT guideline will replace the current life insurance capital test, the Minimum Continuing Capital and Surplus Requirements (MCCSR) guideline, in place since 1992.

View the webcast.

InfoPensions – Issue 15 – May 2016

On May 19, 2016, OSFI released its electronic biannual newsletter on pension issues.InfoPensions includes announcements and reminders on issues relevant to federally regulated private pension plans as well as descriptions of how OSFI applies selected provisions of the Pension Benefits Standards Act, 1985, the Pooled Registered Pension Plans Act, their regulations, directives, and OSFI guidance. Plan administrators should obtain appropriate legal and actuarial advice on how the legislation and guidelines affect their particular pension plan.

Issue 15 contains information about amendments to the Pension Benefits Standards Regulations, 1985, estimates for solvency ratios on the approximately 400 defined benefit pension plans OSFI supervises, plus important dates.

View the newsletter.

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The OSFI Pillar is published by the Communications Division of the Office of the Superintendent of Financial Institutions Canada.

For more information on the articles in this issue, or to provide feedback, please e-mail OSFI Communications at: communications@osfi-bsif.gc.ca.

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