OSFI was established on July 2, 1987, by the Office of the Superintendent of Financial Institutions Act (OSFI Act). This legislation created a single regulatory agency responsible for the regulation and supervision of all federally chartered, licensed or registered banks, insurance companies, trust and loan companies, cooperative credit associations, fraternal benefit societies and private pension plans.
How OSFI came to be
OSFI was created through the merger of its two predecessor agencies – the Department of Insurance (DOI), and the Office of the Inspector General of Banks (OIGB).
The name Office of the Superintendent of Financial Institutions was chosen by combining the names of its two predecessor organizations: The opening was derived from The Office of the Inspector General of Banks, while the Department of Insurance was led by a Superintendent. It would appear that because the type of regulated entities went beyond only banks and insurers, the term financial institutions was an appropriate choice to complete the name for the new agency, the Office of the Superintendent of Financial Institutions.
The DOI was established at the turn of the 20th century, largely in response to problems experienced in the industry. The role of the DOI was to oversee federally licensed life insurance and property and casualty insurance companies, trust and loan companies and pension plans, and to provide actuarial services to the government.
The OIGB was established in 1925 as a result of the failure of the Home Bank, with the mandate to regulate Canada’s chartered banks. At that time, the notion of a government "inspection system" for banks was not widely embraced – there were concerns about cost, efficiency and duplication of work being performed by internal and external auditors. In response, the new regulatory system was patterned on the one in use in the United Kingdom, which did not include on-site examinations and placed a great deal of reliance on self-regulation. For this reason, and as a result of the then small number of Canadian banks and the relative stability of the Canadian banking system, the OIGB operated with a very small staff. (As late as 1974, for example, the total staff complement was only four. When OSFI was created in 1987, 285 employees had to be brought together – 225 from the Department of Insurance and 60 from the Office of the Inspector General of Banks. By contrast, in 2017, OSFI employed about 700 people in offices located in Ottawa, Montréal, Toronto and Vancouver.)
In general terms, little attention was paid to matters of financial sector regulation for quite some time. Two Royal Commissions – the Macmillan Commission in the early 1930s and the Porter Commission in the early 1960s – explored developments in the Canadian financial system. The Macmillan Commission restricted its role to matters of banking and currency, while the Porter Commission had a broad mandate to make recommendations concerning structural and operational issues affecting the financial system and financial institutions.
Many view the Porter Commission report as a key influence on the process of financial sector reform. Porter concluded that the financial system was sound, but that developments had moved beyond the current state of laws and regulatory practices. Porter argued that the public could not be insulated from loss in dealing with public institutions and markets. The Commission called for a system that would provide for adequate disclosure and set high standards of self-regulation, backed up by strong government supervision and powers to enforce proper practices. Many of the recommendations of the Porter Commission found their way into future reform initiatives, starting with the 1967 revision of the Bank Act.
Also, in early 1967, Minister of Finance Mitchell Sharp introduced legislation that established the Canada Deposit Insurance Corporation (CDIC) to ensure the safety of deposits and to bring about a gradual improvement in the minimum financial standards of deposit-taking institutions in Canada.
In 1976, Minister of Finance Donald Macdonald released a discussion paper on revisions to the Bank Act. These revisions, which gave rise to the 1980 Bank Act, were most notable for proposing that subsidiaries of foreign banks be permitted to operate in Canada and for significantly upgrading and modernizing the corporate law provisions of the Act. The 1980 Bank Act eventually became the template for the structure of the other financial industry statutes.
By 1984, the government had stated its intention to undertake a comprehensive review of Canada’s financial system. As a result of rapid change in the financial marketplace, both at home and abroad, the long-standing separation between the "four pillars" of the financial system – banks, trust companies, insurance companies and securities dealers – was closing. In April 1985, the Minister of State for Finance Barbara McDougall released a discussion paper entitled The Regulation of Canadian Financial Institutions. Among a number of key matters relating to industry structure and powers, the paper (commonly known as the "Green Paper") raised the question of whether the OIGB and the DOI should be consolidated.
The failures of the Canadian Commercial Bank and the Northland Bank in 1985, which involved the unprecedented compensation of both insured and uninsured depositors, served to focus thinking on Canada’s regulatory structure and created a significant impetus for action.
In November 1985, the House of Commons Standing Committee on Finance, Trade and Economic Affairs weighed into the debate created by the Green Paper with a report entitled Canadian Financial Institutions. Among other matters, the report recommended the creation of a National Financial Administration Agency (NFAA) to administer all consumer protection plans (including CDIC) and to act as the regulatory and supervisory agency for all federal financial institutions and certain provincial institutions (where appropriate for consumer protection plan purposes.) In May 1986, the Senate Committee on Banking, Trade and Commerce released its own report in response to the Green Paper, entitled Towards a More Competitive Financial Environment. Contrary to the House Committee’s views, the Senate Committee opposed the consolidation of the regulator and CDIC, arguing that consumer protection and solvency would be served best by keeping the four key regulatory components – prudential regulation, deposit insurance, auditing and the corporate governance process – separate. In April 1986, Minister of State for Finance Barbara McDougall released the results of a study prepared by Coopers and Lybrand, entitled A Study to Assess the Current Mandate and Operations of the Office of the Inspector General of Banks. The report on this study, which was undertaken in response to the Canadian Commercial Bank and Northland Bank failures, contained three key conclusions: first, that the OIGB should expand the scope of its inspection work; that the OIGB should be strengthened through improving the qualifications and experience of staff; and that the chain of accountability among management and internal and external auditors should be strengthened.
The report resulting from the enquiry into the Canadian Commercial Bank and Northland Bank failures written by Justice Willard Estey, released in August 1986, further highlighted the need to ensure a sound approach to risk management associated with the financial marketplace. The Estey enquiry report concluded that the OIGB and the DOI should be consolidated with CDIC into a new Canada Deposit Insurance Commission. After extensive consultation on the proposals contained in the April 1985 Green Paper and, taking into account the results of the Coopers and Lybrand study, the Estey enquiry and the Senate and House Committee reports, Minister of State for Finance Thomas Hockin released in December 1986 a policy paper entitled New Directions for the Financial Sector. The policy objective of this paper (commonly known as the "Blue Paper") was to provide a framework for an effective, dynamic and sound financial system to contribute actively to economic renewal and to benefit Canadians. On the supervisory side, this paper recommended the merger of the OIGB and the DOI, largely on grounds that the activities of the different types of regulated institutions were converging and that the supervisory system should be similarly integrated. Increased cooperation among the various agencies responsible for financial sector issues was also recommended.
OSFI Is Created
In 1987 the government introduced a bill to create the Office of the Superintendent of Financial Institutions, merging the OIGB and the DOI under one entity - the OSFI. In addition, this legislation established the Financial Institutions Supervisory Committee (FISC), composed of the Superintendent of Financial Institutions (as chairperson), the Governor of the Bank of Canada, the Deputy Minister of Finance and the Chairman of the CDIC. FISC was created to allow the confidential exchange of information among its members on all matters related to the supervision of financial institutions. Other legislation followed closely, permitting federally regulated financial institutions to own securities subsidiaries, granting OSFI the power to halt unsafe and unsound business practices, and raising the financial standards of federally incorporated insurance companies. Both pieces of legislation were passed in late June 1987 and they received Royal Assent July 2nd of that year.
Also in 1987, The Office of the Chief Actuary (OCA) was created as an independent unit within OSFI’s organizational structure. Prior to the joining of the Offices, the function of Chief Actuary was executed under the auspices of the Department of Insurance.
The OCA’s mandate is to conduct statutory actuarial valuations of the Canada Pension Plan (CPP), the Old Age Security program, federal public sector employee pension and insurance plans, and the Canada Student Loans Program. These valuations estimate the financial status and viability of these plans and programs as required by legislation.
OSFI – The Early Years
Under the leadership of its first Superintendent, Michael Mackenzie, OSFI’s early years were characterized by continuous pressures and numerous economic events that seriously affected Canadian financial institutions. The first few years were focused on consolidating OSFI’s newly merged activities, while balancing the effects of significant events such as the financial market downturn of October 1987, the LDC (lesser developed country) debt problem, and the adoption of the international Basel Capital Accord in July 1988.
From a regulatory standpoint, Michael Mackenzie was a strong proponent of a "tripartite oversight" concept. This involved boards of directors of federally regulated financial institutions, external auditors and actuaries, along with OSFI, participating in the development of a thorough and balanced oversight system. Close relationships and frequent communication among these parties continue to be among the strongest tenets of OSFI’s practices.
By 1990, OSFI was developing and implementing a range of procedures and approaches designed to detect early signs of trouble in federally regulated financial institutions and pension plans. These measures included stronger regulatory capital rules, the development and application of rigorous and sound accounting rules, the enhancement of OSFI’s relationship with CDIC and regulators at the provincial and international levels, and the development of a more risk-based focus for OSFI’s examination framework.
In 1992, OSFI’s external environment was marked by a number of high-profile financial institution interventions and challenges, prompted by the sweeping reform of the federal financial institutions statutes, which was completed in June 1992.
By 1993-94, the meltdown of real estate markets following the boom years of the late 1980s, and total financial institution loan losses of almost $30 billion in the five-year period from 1989 to 1993, continued to cause concern for Superintendent Mackenzie, although he remained, to the end of his term, confident in OSFI’s ability to meet the challenges of regulating in a dynamic environment.
The Next Seven Years
During 1994-95, under the leadership of newly appointed Superintendent John Palmer, OSFI was reorganized into three sectors – operations, policy and corporate services – to make more effective use of its resources while enhancing visibility, access and service. In February 1995, roughly a decade after the completion of the original policy work that had led to the creation of OSFI, the Secretary of State for International Financial Institutions Douglas Peters, released a discussion paper entitled Enhancing the Safety and Soundness of the Canadian Financial System, which again raised – and again dismissed – a new regulatory structure involving a possible merger with CDIC. The government decided to retain the existing system of supervision – relying on OSFI, corporate governance, and external auditors and actuaries as the three main elements of the supervisory process. Productive checks and balances created by the continued separation of OSFI and CDIC were noted as positive, and no merger or other restructuring was suggested. It was also proposed that OSFI be provided with a legislated mandate to clarify its role and accountability. The recommendations of the policy paper formed the basis for legislation, which was enacted in the summer of 1996.
A Legislated Mandate
The legislated mandate made it clear that OSFI’s primary responsibilities were to help minimize losses to depositors and policyholders and to contribute to public confidence in the Canadian financial system. At the same time, it was recognized that OSFI cannot, and should not, be expected to prevent all financial institution failures. The mandate also recognized the important role and responsibility of boards of directors and management of financial institutions in ensuring that risks are managed properly. The mandate stressed the importance of early intervention to carry out OSFI’s objectives and established the framework to serve as the basis for OSFI’s strategic goals and priorities.
To meet these goals, OSFI developed a number of best practices, guidelines and other related materials. In 1997, the Regulatory and Supervisory Practices Division began working on the development of a new Supervisory Framework. The Framework, which outlined a comprehensive, risk-based methodology for the supervision of federally regulated financial institutions in all industries, was approved for implementation and put into practice in 1999. (A revised version of the Framework was released in 2011.)
Under the new methodology, OSFI began focusing on the assessment of an institution’s material risks and the quality of its risk management practices, rather than applying a functional or rules-based approach when conducting examinations. This approach provided for a more effective use of OSFI’s resources. In turn, this enabled some institutions to benefit from a reduced regulatory burden, when able to demonstrate that their risks were compensated for by strong internal controls.
Internationally, OSFI was working with the Basel Committee on Banking Supervision to improve the regulation and supervision of financial institutions in Canada and abroad. In January 2001, this work resulted in the release of a proposal and consultative package for a new Basel Capital Accord (commonly called Basel II). Once finalized, the new Accord was meant to replace the 1988 Basel Accord, which set out minimum capital standards for banks. (Basel II was implemented in November 2007.)
The Changing of the Guard
In September 2001, following the retirement of John Palmer, Deputy Superintendent Nicholas (Nick) Le Pan was appointed Superintendent, having served with the Office since 1995 and previously with the Department of Finance. Mr. Le Pan’s efforts to improve transparency led to the publication, for the first time, of OSFI rulings, aimed at promoting a better understanding of how it applied and interpreted the financial institutions legislation it administered. In December 2001, Mr. Le Pan was asked to lead the Accord Implementation Group for the Basel Committee on Banking Supervision, a body created to serve as a forum where supervisors could share information related to the implementation of the Accord.
In October 2001, Bill C-8, An Act to Establish the Financial Consumer Agency of Canada, and to Amend Certain Acts in Relation to Financial Institutions received Royal Assent. The Financial Consumer Agency of Canada (FCAC) was created to consolidate and strengthen the oversight of consumer protection measures in the federally regulated financial sector, and to expand consumer education.
The Act effectively removed from OSFI’s mandate the responsibility for overseeing consumer protection. The Commissioner of the FCAC became a member of the Financial Institutions Supervisory Committee, to facilitate effective information sharing.
In 2002, OSFI began providing federally regulated financial institutions with a Composite Risk Rating (CRR) to reflect its assessment of their safety and soundness. The sharing of these ratings with the individual institutions enhanced the effectiveness of the supervisory process.
In 2004, OSFI established its Risk Tolerance Framework. This framework set out the broad governing principles involved when assessing the levels of risk tolerance of financial institutions.
Changes in the Pension Industry
In 1998, the Pension Benefits Standards Act, 1985 (PBSA) was amended to remove the Superintendent's duty to examine each pension plan filed for registration and to put more responsibility for compliance on plan administrators. These changes enabled OSFI’s Private Pension Plans Division to move from a rules-based to a full, risk-based, supervisory approach for both monitoring and on-site examinations.
In 2010, OSFI held its first annual Pension Industry Forum to give plan administrators, their advisors and consultants an opportunity to find out about OSFI’s expectations. These forums also provide an update on legislative and regulatory developments.
The November 4, 2010 Supreme Court of Canada’s decision in NIL/TU,O Child and Family Services Society v. B.C. Government and Service Employees’ Union provided direction on the jurisdiction applicable to labour matters in respect of First Nations. Consequently, OSFI began identifying First Nations pension plans subject to the PBSA that might be affected and transferring the supervision of those plans to the relevant provincial jurisdictions.
A New Superintendent for Challenging Times
Following the resignation of Nicholas Le Pan in October 2006, Deputy Superintendent Julie Dickson was appointed Acting Superintendent and, in July 2007, Superintendent. The beginning of her tenure was marked by a significant downturn in the U.S. subprime mortgage market in late summer of 2007, which quickly spread to financial markets around the world.
In 2007, OSFI provided input, with a number of other stakeholders, to the International Monetary Fund (IMF) Financial Stability Assessment Program (FSAP) review of Canada’s financial system. The FSAP report, released in February 2008, concluded that “Canada’s financial system is mature, sophisticated and well-managed. Financial stability is underpinned by sound macroeconomic policies and strong prudential regulation and supervision.” The timing of that assessment was fortuitous given the events taking place around the world as governments provided assistance to troubled financial institutions to avert systemic problems.
When European and North American banks teetered on the brink of meltdown in 2008, requiring bailouts and extraordinary central bank intervention, Canadian banks escaped relatively unscathed. While much has to do with history and how the Canadian banking system was set up, there are many other reasons to explain why Canada fared well during the crisis. Much has been written about this extraordinary period.
In the immediate aftermath of the financial crisis, a downturn in economic activity led to the Great Recession of 2008–2012 and contributed to the European sovereign-debt crisis.
In the years that followed, the impacts of the crisis continued to be felt and were characterized by historically low interest rates, a sluggish global economy and a myriad of financial regulatory reforms. Canadian financial institutions continued to perform reasonably well but there were signs emerging that low interest rates were affecting the pricing of financial assets and the risk appetites of financial institutions and pension plans. Persistent low interest rates not only created more risk in the system as some financial institutions went in search of better returns, but Canadian consumers continued to take on even more debt, often in the form of real estate.
During this period of uncertainty, OSFI continued to work closely with its federal regulatory partners – the Department of Finance, the Bank of Canada, the Financial Consumer Agency of Canada (FCAC) and the Canada Deposit Insurance Corporation (CDIC). This collaboration was instrumental in maintaining Canada’s financial system relatively strong and stable in comparison with that of many other G20 countries.
OSFI also maintained an active role in international forums, including the Financial Stability Board (FSB) (http://www.fsb.org), the Basel Committee on Banking Supervision (BCBS) (www.bis.org/bcbs), the Senior Supervisors Group (SSG) and the International Association of Insurance Supervisors (IAIS) (www.iaisweb.org/home). Through participation in these groups, OSFI ensured it was well positioned to learn from, and contribute to, discussions on enhancements to global financial regulatory frameworks. It also allowed OSFI to provide guidance to help the institutions it regulated integrate the Basel Capital Framework into their processes, thereby enhancing their risk management practices
The G20 retained its focus on international regulatory reform in order to better insulate the global financial system from future shocks. The FSB was tasked with developing a comprehensive set of reforms to address the weaknesses that became apparent during the crisis.
OSFI and other international regulators helped to develop a series of enhanced rules and standards to strengthen global financial stability, including the Basel III bank reforms on capital and liquidity, enhanced disclosure practices, and recovery and resolution planning.
Specific initiatives included OSFI’s work on the global thematic review of risk governance conducted by the FSB; co-chairing the BCBS review of risk weights used by banks for their trading book assets; ongoing peer reviews by the FSB and the BCBS, and chairing the FSB Supervisory Intensity and Effectiveness (SIE) group, which explored the tools and methods used in the supervision of systemically important financial institutions.
One of the key controversies arising from the crisis was whether institutions could be “too big to fail.” Many informed observers believed that in the event a large systemic institution was to fail, governments would come to its rescue with a bail out. In response, the FSB established criteria to determine what constituted a global systemically important financial institution (G-SIFI). Institutions meeting the criteria would face greater supervisory scrutiny, enhanced disclosure rules and be required to hold more capital in the form of a surcharge. A further concern arose about whether disclosing the names of these systemically important institutions could create moral hazard – that is, if markets assume that the designated institutions had been deemed systemically important to the world financial system, they may also assume such institutions are safe havens for investors and others who would be protected in the event of a failure.
With an international standard in place, it was FSB member countries’ turn to designate domestic systemically important banks (D-SIBs) in their respective jurisdictions. In March 2013, OSFI designated the country’s six largest banks as D-SIBs: the Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and Toronto-Dominion Bank.
These institutions now faced greater scrutiny, enhanced disclosure rules and additional capital requirements.
Although the size, scope and complexity of large Canadian banks had increased, no Canadian bank had made it to the FSB’s list of global systemically important bank at the end of 2016.
To counter the risk of moral hazard, the FSB was clear that institutions must be allowed to fail. If they are kept open by governments because of their systemic importance, then their management, shareholders, and investors must bear consequences as part of that arrangement. This is why the FSB and the Basel Committee agreed that all non-common types of bank capital had to be issued in the form of contingent capital, which could be written off or converted to common stock, as necessary, to prevent the issuer from becoming insolvent. Thus, contingent capital allowed governments to impose costs on those responsible.
In Canada, OSFI had developed its own version called non-viable contingent capital (NVCC). NVCC is a security that converts to common equity or is written off where a bank’s non-viability is imminent and regulatory authorities are of the view that the conversion or write-off would help to restore the bank’s viability and enable it to continue operating.
Throughout and following the crisis, OSFI’s view was that although Canadian financial institutions managed their risks quite well, particularly when compared with many of their international peers, there was a risk of complacency. Its message to industry, repeated often, was that institutions must not become complacent. The “new normal” as Superintendent Dickson characterized the times, demanded a much greater awareness and better management of risk. Financial institutions in all sectors were encouraged to continue to invest in their risk controls and systems, governance and information systems.
One of the many early lessons of the financial crisis was the need for better risk management. Some of the actions taken by OSFI included increasing its focus on financial institutions’ stress-testing capabilities. Also, to further support strong prudential practices at financial institutions, OSFI introduced annual risk management seminars for chief risk officers of the various industry sectors to communicate its expectations and provide an opportunity for dialogue with OSFI supervisors and regulators.
In 2011, to reflect more than a decade of experience, changing risks in the financial environment and international developments, OSFI reviewed and renewed its Supervisory Framework, first introduced in 1999 to guide supervisors in their day-to-day reviews of financial institutions.
Throughout the post-crisis period, OSFI introduced or finalized a number of guidelines that were intended to promote and maintain confidence in Canada’s financial system.
One key guideline was on corporate governance that focused solely on the fundamental aspects of governance pertinent from a prudential regulatory perspective. It included the critical role of the board of directors (its composition and competencies), risk governance (with a requirement for institutions to have a risk appetite framework), and the essential role of the audit committee.
At the end of 2016, OSFI announced a review of its expectations of boards of directors. The goal was to ensure clarity in OSFI’s expectations; to enable directors to focus their efforts and resources in effectively executing their role; and to apply OSFI board requirements in a more proportional manner, taking into consideration the size, complexity and nature of individual institutions’ operations. Consultations began in early 2017 with selected boards and stakeholder groups.
Given the rising record levels of household debt in Canada, and that real estate-based lending represented a significant portion of banks’ balance sheets; OSFI also focused its attention on the issues of residential mortgages and home equity lines of credit. While real estate based lending had contributed to the profitability of the Canadian banking industry, it had left many households vulnerable to adverse economic shocks. In an effort to prevent these vulnerabilities from evolving into problems for the financial system, OSFI issued a Guideline on Residential Mortgage Underwriting Practices and Procedures in June 2012. The guidance built on OSFI’s domestic supervisory work, and reflected and expanded upon the FSB’s Principles for Sound Residential Mortgage Underwriting, which was released in fall 2011.
At the end of 2016, OSFI released the final version of new capital requirements for mortgage insurers that aimed to ensure these firms can withstand a major downturn in the housing market. The new requirements were more risk sensitive and incorporated key characteristics such as borrower creditworthiness, outstanding loan balance, loan-to-value ratio, and remaining amortization. They also intended to ensure a level of conservatism in the protection provided to policyholders and other creditors of mortgage insurers.
OSFI was also given the authority to examine Canada Mortgage and Housing Corporation (CMHC)’s commercial programs. However, because CMHC is a Crown corporation, it is the government that establishes rules governing CMHC’s activities, such as its size and shape, and sets the rules on insured mortgages. OSFI’s role is to report its findings and recommendations to the CMHC board of directors and to the relevant federal ministers for their follow up.
The federal government also continued to implement measures designed to contain risks in the housing market and adjust the rules for new government-backed insured mortgages. These ranged from lowering the maximum amortization period and increasing minimum down payments to limits on refinancing of property values and higher eligibility loan criteria.
In 2013, Canada was subject to another International Monetary Fund (IMF) Financial Sector Assessment Program (FSAP) review. The FSAP report identified OSFI’s close touch supervision, its clear and straightforward mandate, and its ability to attract and retain financial sector specialists as some of the factors that helped Canada withstand the crisis well. OSFI increased its efforts to hire and retain talent with the technical skills and industry experience necessary to deal with the rapidly changing and complex environment.
In late 2013, a Small- and Mid-Sized Advisory role was created with the objective of strengthening communication with small- and mid-sized financial institutions to ensure OSFI maintained a current understanding of common industry concerns; and to review OSFI’s internal processes and communications to identify areas where the compliance effort could be reduced without increasing risk by compromising key controls.
Bill C-25, An Act relating to pooled registered pension plans, was tabled in Parliament in November 2011 and received Royal Assent in June 2012. This new piece of legislation established the federal regulatory framework for those plans.
A pooled registered pension plan (PRPP) is a type of pension plan that is similar to a defined contribution plan; however, employer contributions are not mandatory. A PRPP pools contributions together to achieve lower costs in relation to investment management and plan administration. PRPPs can be offered to employers and to self-employed persons under federal jurisdiction and administrators of federal PRPPs must hold a licence issued by the Superintendent.
Property and Casualty (P&C)
While the lessons from the global financial crisis were a contributing factor and sparked a number of regulatory initiatives internationally as well as here at home, in the case of the P&C industry, most of the changes to prudential requirements were introduced to address domestic developments and help ensure that OSFI guidance kept pace with industry.
A significant new guideline introduced for insurers was the Own Risk and Solvency Assessment (ORSA), designed to strengthen the insurance industry’s enterprise-wide risk management process. An ORSA is a comprehensive approach to the analysis and management, by an insurer, of its capital requirements. Its purpose is to provide a more effective means for insurers and insurance regulators to be able to effectively monitor insurance risk and capital requirements on a prospective, rather than retrospective, basis. In keeping with OSFI’s preference for principles-based regulation, institutions would consider the nature, scale and complexity of their business lines in developing an ORSA.
With several major fault lines in Canada, earthquakes are risks that can be catastrophic. And since the P&C industry in Canada underwrites this risk, it became an area of focus for OSFI and a revised version of Earthquake Exposure Sound Practices (Guideline B-9) was published in February 2013. The guideline required insurers to have comprehensive policies and procedures in place to deal with the complexities of managing earthquake exposures, along with an appropriate level of oversight. Indeed, catastrophic losses from earthquakes pose a threat to the financial well-being of many P&C insurers. As such, this guideline could also be used as the foundation for a comprehensive approach to catastrophe risk management more broadly.
In the world of insurance, reinsurance is a common strategy to mitigate risk and exposures. But it can also lead to greater risks. In 2013, OSFI issued Guideline B-3 that provided valuable considerations on reinsurance risk management practices such as the importance of diversification of reinsurers and robust, frequent credit evaluation of reinsurers. Risk management practices would also be applied to reinsurance provided by institutions’ affiliates.
A few years later, in 2016, OSFI noted a trend in the use of reinsurance by some P&C insurers of insuring risks in Canada and transferring a significant portion of the risk offshore to affiliated unregistered reinsurers. This model introduced concentrated counterparty credit risk and operational risk in distressed situations within a group of related companies and there was a need to review the practice to better identify the extent of risks as well as assess whether there is the potential for systemic risk. Accordingly, OSFI worked to ensure that its reinsurance regulatory and supervisory framework remained relevant, reflecting the current risks involved in transferring business to reinsurers.
Cyber-attacks on insurance firms can result in significant, tangible damages such as fines, legal fees, lawsuits and fraud-monitoring costs. A less obvious but no less significant impact may be the loss of policyholders’ trust. Since the insurance business relies on trust, a major breach can have a very real impact on an insurer’s brand.
But it’s not only the insurance sector that dealt with these risks. Financial institutions in all sectors faced increasing operational risks from cyber threats and attacks, which became more complex and sophisticated, potentially affecting the safety and soundness of the institutions OSFI regulates.
In response, OSFI released cyber security self-assessment guidance in October 2013 to assist institutions in assessing their own cyber risk and preparedness. Cyber security would be an issue of continuing focus for OSFI in the following years.
In June 2014, Superintendent Julie Dickson’s term ended. During her tenure from 2007 to 2014, the world went through one of its most difficult financial crises, the effects of which would be felt years later. The Canadian financial system pulled together to work its way through the numerous challenges that were presented. Regulators, lawmakers and financial institutions all played a role in Canada emerging in a strong position when compared to other parts of the globe.
New challenges for a new Superintendent
In June 2014, following the end of Julie Dickson’s term, Jeremy Rudin was appointed Superintendent. Mr. Rudin assumed leadership of OSFI after a 20-year career in government, mostly at the Department of Finance, culminating as Assistant Deputy Minister of the Financial Sector Policy branch, which prepared him well for his new role. Among his many contributions at Finance was leading development of policy measures to support access to credit during the financial crisis. He represented Canada on standing committees of the FSB, including the Resolution Steering Group and the Standing Committee on Standards Implementation. He also held a senior position in the Economic and Fiscal Policy Branch, and for several years, was Director, Funds Management in the Financial Markets department at the Bank of Canada.
With a view to reinforcing prudent mortgage insurance underwriting, in November 2014, OSFI issued a revised Residential Mortgage Insurance Underwriting Practices and Procedures guideline. It strengthened disclosure practices for mortgage insurers and outlined sound risk management principles, including setting prudent requirements for lenders and applying appropriate due diligence to their practices. This was particularly true in the low interest rate environment; given the potential impact rising rates could have on household debt levels and the exposure this presented to lenders.
The financial crisis underlined the importance of the need for institutions to have enough quality capital and liquidity to absorb severe losses. OSFI responded by issuing new or updated guidelines on leverage requirements and liquidity adequacy requirements for deposit-taking institutions, Minimum Continuing Capital and Surplus Requirements for life insurers, and the Minimum Capital Test for property and casualty insurers.
In August 2015, OSFI issued a draft Operational Risk Management guideline for public consultation. The guideline recognized that regulated entities have different operational risk management practices depending on such factors as size, ownership structure, complexity of operations and risk profile. This principles-based approach to regulation gives Canadian financial institutions some flexibility in how they manage their risks, supporting effective competition while reducing compliance costs.
It is generally agreed that Canada’s strong regulatory regime is a result of the cooperation and collaboration that exists among the federal regulatory players. This collaboration was highlighted again in the 2014 report of the IMF’s Financial Sector Assessment Program review of Canada, which spoke favourably of the effectiveness of the oversight of Canada’s financial system.
The financial crisis revealed that even the world’s largest insurers, such as AIG, risk insolvency. There were other examples of high risk products and options, such as segregated funds with guaranteed minimum withdrawal benefits, which caused significant drops in income during market declines and periods of severe market volatility.
In considering the underlying causes of the financial problems from the crisis, it became clear that at a number of organizations’ enterprise-wide risk management practices and policies were deficient; there was weak governance at various levels; and, oversight functions were ineffective.
In September 2012, OSFI issued a Life Insurance Regulatory Framework to provide life insurance companies and industry stakeholders with an overview of regulatory initiatives that OSFI would be focusing on over the next few years. It outlined how the regulatory framework would evolve to ensure Canadians continued to benefit from a strong life insurance industry. The Framework addressed issues such as corporate governance and risk management, evolving regulatory capital requirements, and promoting transparent information on the financial condition of life insurance companies.
In 2016, OSFI developed the Life Insurance Capital Adequacy Test (LICAT), a capital adequacy guideline for federally regulated life insurance companies, which takes effect in 2018. The LICAT is the culmination of over a decade of work undertaken to replace the Minimum Continuing Capital and Surplus Requirements guideline, which has been in place since 1992. OSFI developed the LICAT to better align capital and risk measures with the economic realities of the life insurance business, while taking into account international advancements in the development of solvency frameworks. It takes into account the current economic realities of the life insurance business, recent developments in actuarial and financial reporting standards as well as economic and financial practices, and international trends in solvency frameworks.
During the financial crisis, a number of banks in other countries became financially distressed and either failed or received financial support from their governments so they could continue operating. Since then, a series of new rules have been put in place to help strengthen the global financial system and to reduce the risk a bank would fail and the potential impact of a failure.
One of the measures that Canada and countries around the world are implementing is what is known as a ‘bail-in’ regime. Essentially, this involves converting certain debts of a large bank into equity in the event the bank depleted its capital and was in danger of failing. Similar to contingent capital, it is designed so that bank shareholders and creditors would be responsible for recapitalizing a bank rather than the government, taxpayers or depositors.
Bi-laterally, OSFI worked with the Bank of Canada to conduct macro stress-tests; and with the Canada Deposit Insurance Corporation and the Department of Finance on the bail-in regime. These strong relationships with regulatory partners continued to support Canada’s robust financial system.
Federal credit unions
Over the past few years, significant consolidation occurred with the ten largest credit unions representing about 40 per cent of system assets. Until 2016, credit unions were regulated exclusively by the provinces.
To promote the continued growth and competitiveness of the sector and enhance financial stability, the federal government introduced amendments to the Bank Act and other federal acts to enable credit unions to incorporate and continue federally. The legislative model was based on the framework applicable to banks. The model wove in unique cooperative elements for federal credit unions and established transitional elements to facilitate the migration of credit unions to federal jurisdiction and subject to OSFI’s regulation.
What will the future hold for OSFI and federally regulated financial institutions?
Along with the continued low interest rates, a stubbornly slow recovery from the financial crisis and continued geopolitical uncertainty, OSFI and financial institutions will need to focus on a wide range of risks. These include consumer debt and housing prices, potential instability in the Eurozone, challenges in emerging markets, trade disruption, stagflation, counterparty credit and cyber risk. A little further down the road, climate change and environmental issues will pose new risks.
In the banking industry, implementation of new Basel III rules aimed at increasing the stability and resilience of global banking are being phased in and will be in force by 2019; non-conforming capital instruments are to be phased out by 2023. OSFI had already asked Canadian banks to hold enough capital to meet the 2019 requirements (seven per cent core common equity) by the first quarter of 2013. Canada’s banks have met or exceed this expectation.
Perhaps one of the most significant regulatory changes in the life insurance sector will be the Life Insurance Capital Adequacy Test (LICAT), which takes effect in 2018. In introducing the new LICAT guideline, Superintendent Rudin said that it represents an important evolution in OSFI's regulatory capital expectations and provides a risk-based capital framework that will continue to protect policyholders, while allowing the industry to compete and take reasonable risks.
In the P&C sector, the emergence of a new international capital standard for internationally active companies is almost certain. The International Association of Insurance Supervisors (IAIS) is actively working on a new standard and OSFI is engaged in that work. A new international standard is expected to be in place by 2020, and is not expected to affect capital requirements for the Canadian P&C insurance industry. The progress to date suggests it is unlikely to improve upon OSFI’s MCT requirements.
OSFI will also continue to focus on making sure that insurer’s governance and risk management practices are commensurate with their investment strategies. More generally, technology, environmental and social issues, changes in catastrophe exposures arising from more extreme weather events, a cyber-related catastrophe, driverless cars, expanded flood coverage are all factors that will require the industry and OSFI to be vigilant. OSFI expects its regulatory framework will continue to evolve as the industry evolves.
2017 marks OSFI’s 30th anniversary and the approach that has guided our work – working together with government partners and various stakeholders to strike an effective balance between allowing financial institutions to manage their risks and supervising them so as to protect the rights and interests of their depositors, policyholders and creditors – has served Canada’s financial system well. Working with domestic and international stakeholders alike, OSFI will continue to meet its mandate, and contribute to public confidence in the Canadian financial system.