Opening Remarks by Deputy Superintendent Mark Zelmer to the Accounting Standards Oversight Council, Toronto, Ontario, October 23, 2015


“OSFI has chosen to rely as much as possible on accounting information prepared in accordance with generally accepted accounting principles when we set out our capital and liquidity requirements in our industry-wide guidance and in our institution-specific supervisory expectations. This reliance-based approach enables us to leverage the high-quality information contained in financial institution financial statements. We know audited financial statements go through rigorous internal governance and external audit processes that are underpinned by high-quality international accounting standards.”


Thank you for inviting me to meet with you today.

We, at OSFI, welcome your initiative to prepare a draft strategic plan and for giving us an opportunity to give you some feedback on it.

OSFI is the prudential regulator for banks, other federally-incorporated deposit-taking institutions, federally-incorporated insurance companies and pension plans that fall within the federal sphere. Our mandate is to protect depositors, policyholders, financial institution creditors and pension plan members, while allowing financial institutions to compete and take reasonable risks.

Let me begin by offering you some insight into how we use accounting information in the conduct of our work. That will set the stage for some comments that I have on your draft strategic plan and the general financial reporting environment. I will then conclude with some comments on two new accounting standards that are particularly important for OSFI and the financial institutions that we oversee, namely: IFRS 9 Financial Instruments and IFRS 4, Phase II Insurance Contracts.

Why Accounting is important to OSFI

Accounting information is very important in our oversight of the financial condition of financial institutions.

Section 485 of the Bank Act and Section 515 of the Insurance Companies Act of Canada give the Superintendent the power to set capital and liquidity requirements for banks and federally-regulated insurance companies. In setting those requirements we need reliable information on the financial condition of those institutions.

OSFI has chosen to rely as much as possible on accounting information prepared in accordance with generally accepted accounting principles when we set out our capital and liquidity requirements in our industry-wide guidance and in our institution-specific supervisory expectations.

This reliance-based approach enables us to leverage the high-quality information contained in financial institution financial statements. We know audited financial statements go through rigorous internal governance and external audit processes that are underpinned by high-quality international accounting standards.

It also enables us to focus on what we do best: assessing the financial condition, governance and risk management practices of the financial institutions that we supervise, while deferring to others that know better how to report financial information.

And, it promotes a more transparent process surrounding our prudential requirements while reducing regulatory burden on the financial institutions that we oversee. The latter are saved from having to carry two sets of books: one for public reporting purposes and another for the regulator.

Our reliance-based approach means that we have an active interest in the evolution of accounting standards, notably the International Financial Reporting Standards that Canada has subscribed to.

We have a keen interest in understanding how those standards are evolving over time and how we can leverage them for our own prudential purposes. Ideally, we would like to minimize any adjustments that we believe should be made to accounting information for purposes of computing regulatory capital and liquidity positions.

We recognize that here in Canada the AcSB under Linda Mezon's leadership has played an important role in ensuring that international accounting standards are formulated in a way that makes them easier to adapt in the Canadian environment.

Similarly, my colleagues at OSFI under Karen Stothers leadership have been actively engaged in trying to influence the development of accounting standards that are important for our work, both directly with the AcSB and the IASB, as well as indirectly through the Basel Committee on Banking Supervision (BCBS) and the International Association of Insurance Supervisors (IAIS).

Our aim is to promote accounting standards that serve the interests of prudential supervisors like us while recognizing of course that those standards also need to meet the needs of the broader user community.

We certainly appreciate that there can be differences between the financial reporting needs of various user communities and our own prudential requirements, but we try to align our needs as much as possible.

Where our needs differ we address our prudential requirements directly in our regulatory expectations. An example would be the Basel and OSFI regulatory capital requirements around credit valuation adjustments (CVA) and funding valuation adjustments (FVA). They do not change how the accounting is done. Instead, they take the accounting as given and set out the Basel requirements for adjustments in the computation of regulatory capital.

On rare occasions the Superintendent has exercised his or her powers to set accounting specifications for the financial institutions we oversee. Let me mention two examples:

On the IAS 39 option to designate financial instruments at fair value, OSFI has specified that mortgages and loans should not be at carried at fair value due to the challenges of reliably valuing these level 2 and 3 estimates of FV.

We have occasionally specified when FRFIs can or should early adopt IFRS standards. When IFRS are adopted in Canada, OSFI promotes consistent implementation of new standards across the institutions that we oversee. This makes it easier for stakeholders to compare the financial performance of regulated financial institutions, which fosters market discipline, and facilitates our own monitoring of the Canadian financial system.

Canadian Accounting Standards Board Strategic Plan

Let me now turn to your draft strategic plan. OSFI supports the Canadian Accounting Standards Board proposal to continue incorporating new or amended IFRS into Canadian accounting standards after completing its own due process. In our view continued use of IFRS enables Canada's internationally-active financial institutions to produce high quality financial statements that are comparable to those of many of their international peers. This helps to promote level playing fields internationally.

An important issue from our perspective is to minimize the risk of Canada being the "crash test dummy" when other jurisdictions delay adoption of new IFRS standards. We support your monitoring of the effective dates set by other jurisdictions. And, we strongly support your plans to impress upon the IASB, securities regulators and standard setters in other jurisdictions the benefits of a single date for the global adoption of new IFRS.

When it comes to setting effective dates for IFRS in Canada, we generally support your desire to set effective dates in Canada that are aligned with annual reporting periods or within the same time frame as other major jurisdictions. But in doing so we need to carefully manage situations where some reporting entities like the major banks in Canada that have non-calendar year-ends but which compete against other institutions with different year-ends. Thus, we encourage you to refrain from considering blunt instruments like outright prohibitions on early adoption in order to give yourselves maximum flexibility to manage such situations.

OSFI also supports your plans to explore ways to better support the implementation of new IFRSs through the identification and discussions of issues in Canada and other jurisdictions and to monitor the need for authorative and non-authorative guidance on IFRSs; especially your efforts to identify IFRS application issues and your plans to encourage the IASB to address such issues.

OSFI Views on Specific IFRS Standards and Projects

Let me now turn to OSFI's views on two important IASB projects: IFRS 9 and IFRS 4/Phase II.

IFRS 9 Convergence Efforts

OSFI recognizes and appreciates the immense efforts put forth by the IASB and the AcSB in your attempts to achieve convergence with the Financial Accounting Standards Board in the USA on this standard.

While convergence was not achieved, OSFI is happy to see that the IASB finalized an Expected Credit Loss (ECL) model for loan impairment.

Prudential regulators have long supported the move to an ECL model and we continue to encourage the IASB in its efforts to support a consistent application and interpretation of this accounting standard through initiatives like the Impairment Transition Resource Group.

IFRS 9 Adoption Timetable for Canadian DSIBs

After much analysis, discussion and consultation, OSFI issued its advisory "Early adoption of IFRS 9 Financial Instruments for Domestic Systemically Important Banks" in January 2015.

This requires D-SIB banks in Canada to adopt IFRS 9 for the financial year beginning November 1, 2017, whereas their major global bank peers will adopt for financial years beginning January 1, 2018.

This decision was not taken lightly. OSFI believes early adoption of this standard by the six major banks in Canada is necessary to meet our mandate of protecting depositors and put them on a comparable footing with their IFRS peers whose financial years begin January 1, 2018.

If Canadian D-SIBs did not early adopt, the adoption burden in Canada would have fallen first on smaller Canadian banks that have December 31 year-ends; something that we do not think makes sense. The six major banks are better placed to work with the accounting profession to determine the interpretations and implementation of the new ECL model.

OSFI consulted on this proposal before it was finalized and there was support for our early adoption plans.

That said the Canadian D-SIB banks have raised some concerns about the risk of them going first, especially if there are implementation delays in other jurisdictions. As a result, OSFI was careful to note in the Advisory that we will monitor the endorsement processes of other jurisdictions, including the EU, during the implementation period. But we also encouraged those banks to take full advantage of the time available for implementation and not delay their efforts due to uncertainty regarding endorsement timetables in other jurisdictions.

We also understand the need to obtain some greater clarity about how this new standard will be implemented in practice. As a result, OSFI has taken the lead in the BCBS to develop guidance on Expected Credit Loss - Loan Impairment, to effect a consistent implementation and interpretation of IFRS 9 ECL requirements across jurisdictions. The final version of this guidance has been approved by the BCBS and will be issued shortly.

OSFI Decisions on IFRS 9 Expected Credit Loss

For ECL, OSFI will look at its existing accounting guidelines C-1 and C-5 and regulatory returns that collect information on allowances.

Our draft proposal is to require full application by the 6 major banks of the new Basel ECL guidance given they are systemically-important and internationally-active. Given they already use credit risk models for capital that should make it somewhat easier for them to adopt the new ECL accounting model.

OSFI is sensitive to the impact of supervisory expectations on smaller institutions and their ability to compete. Thus, we will not be expecting those institutions to adopt the full Basel guidance, but instead will tailor our expectations to take account the size and complexity of those banks' lending operations.

OSFI's Decisions on IFRS 9 Fair Value Option and Guideline D10

OSFI is concerned with the reliability of fair values when observable market prices are not available. As a result, we are proposing to retain Guideline D-10, which limits the use of FV for retail loans and mortgages but will allow an exemption for life insurers' mortgages and loans classified as Fair Valued through Other Comprehensive Income (FVOCI).

Under IFRS 9 insurers will likely need the FVOCI classification for the invested assets which will create an accounting mismatch because fair value changes in the assets will be recorded in OCI while changes in insurance liabilities are recorded in profit and loss (P&L), both under the Canadian Asset Liability Method (CALM) and under the future insurance contract standard, IFRS 4 Phase II.

To address OSFI's concerns with fair value reliability, OSFI will review life insurers' fair value practices and develop regulatory capital adjustments to address quality of capital concerns for loans measured at fair value.

IFRS 4/Phase II

Insurance and banking operate under different business models and Canada's approach to the accounting for insurance contracts under CALM differs from that of other countries. OSFI supports the IASB's effort to develop a global set of accounting standards for Insurance Contracts as we believe consistency across jurisdictions could help investors and other stakeholders obtain a better understanding of insurance risk.

That said we appreciate that the Canadian model has served us well and that the proposed changes must work for Canadian insurers. Thus during each step of the IASB consultations, OSFI was engaged in extensive discussions on the potential impacts with various stakeholders including the insurance industry, external auditors, the actuarial profession, analysts, and other domestic and international insurance regulators.

OSFI is developing a new regulatory capital framework for life insurers and had initially intended to align the implementation date of the new regulatory framework with IFRS 4/II in 2018. But this is no longer possible with the delays in the finalization of the IFRS standard. OSFI has consequently decided to move ahead with its capital framework based on CALM and will adjust it to IFRS 4/II after the latter is finalized and implemented.

The IAIS is also developing a set of global insurance capital standards. One challenging area is the valuation basis for insurance liabilities given the delay of IFRS 4/II, and the lack of convergence between IFRS and US GAAP in this area. OSFI encourages the IASB to finalize a high-quality accounting standard for Insurance Contracts as soon as possible.

Aligning the Implementation of IFRS 9 and IFRS 4/II for Insurance Companies

I know that on 23 September the IASB issued a press release stating that it will consult on a package of temporary measures that would give companies whose business model is predominantly insurance based the option to defer the effective date of IFRS 9 until 2021 when IFRS 4/II is expected to be adopted.

While I understand the logic behind the IASB decision, it is premature for me at this stage to offer any views as to how OSFI will respond to this news until we see the actual consultative proposal. In taking any decisions we will be mindful of the fact that some insurance companies in Canada are part of banking groups while others are clearly insurance based.

Closing Comments

I hope my opening remarks have helped to deepen your understanding of how OSFI approaches accounting issues from a prudential perspective, and our views on some current live issues.

I look forward to your questions and discussion.