SOR/2016-297: Assessment of Financial Institutions Regulations, 2017
REGISTRATION OF FEDERAL REGULATION - VIA OIC DATABASE, PRIOR TO PART II OF THE GAZETTE
November 18, 2016
REGULATORY IMPACT ANALYSIS STATEMENT (This statement is not part of the Regulations.) Issues The Assessment of Financial Institutions Regulations, 2017 (the amended Regulations) replace the Assessment of Financial Institutions Regulations, 2001 (the current Regulations) and target three issues. 1. Best proxy of OSFI time and resources The policy objective supporting the design of the current asse... (Click for more)
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Published on November 18, 2016
SOR/2016-297: Assessment of Financial Institutions Regulations, 2017
REGULATORY IMPACT ANALYSIS STATEMENT (This statement is not part of the Regulations.) Issues The Assessment of Financial Institutions Regulations, 2017 (the amended Regulations) replace the Assessment of Financial Institutions Regulations, 2001 (the current Regulations) and target three issues. 1. Best proxy of OSFI time and resources The policy objective supporting the design of the current assessment methodologies is to allocate the expenses of the Office of the Superintendent of Financial Institutions (OSFI) among federally regulated financial institutions (FRFIs) in a way that accurately reflects the time and resources OSFI spends supervising individual institutions. When the current Regulations were developed in 2001, the size of a FRFI was viewed as a sound proxy by which to allocate OSFI’s expenses (i.e. the larger the FRFI, the larger the proportionate share of OSFI’s expenses allocated to that institution). More specifically, “average total assets,” “net premiums,” and “net revenues” were selected as the size-based units of measure on which to base assessments. OSFI has observed that the risk profile of a FRFI is a more significant driver of OSFI’s resource expenditures than the size of an institution. Therefore, an assessment methodology that reflects the risk profile of the institution better aligns with OSFI’s risk-based supervisory framework, which drives OSFI’s supervisory planning processes and resource allocation decisions. 2. Implications of the International Financial Reporting Standards The International Accounting Standards Board develops International Financial Reporting Standards (IFRS) that many countries have chosen to adopt, including Canada. As of January 1, 2011, in Canada, publicly accountable entities, including FRFIs, were required to adopt IFRS in favour of Canadian Generally Accepted Accounting Principles (CGAAP). IFRS is being developed and implemented in phases, some of which have yet to be finalized. The impacts of moving from CGAAP to IFRS vary depending on the type of institution and its activities. However, it is clear that IFRS affects reported assets and premiums — the two primary measures that form the basis of the current assessment methodologies. With respect to assets, the new accounting standards require that many Canadian securitizations and other off-balance sheet structures now be reported on the balance sheet, and permit fewer assets to be derecognized in comparison to those permitted previously under CGAAP. IFRS also affects the definition of an insurance contract, and has resulted in some contracts being accounted for as investments or services contracts, which affects the presentation and reporting of premiums. These accounting changes thus have the potential to adversely affect the distribution of OSFI’s expenses across FRFIs relative to the actual time and resources OSFI devotes to supervising these institutions. These impacts, and potential future impacts, could be mitigated if OSFI’s assessment methodologies are redesigned to be less prone to accounting and other changes to international standards. 3. Outdated minimum assessments Regardless of an institution’s size, OSFI performs a minimum amount of supervision for all financial institutions. The prescribed minimum assessment amounts have not been updated in 15 years, and have not kept pace with necessary increases in OSFI’s minimum supervisory expenses. Further, the current minimum assessment methodologies are unnecessarily complex, with many different minimum assessment categories. Background The Office of the Superintendent of Financial Institutions Act (OSFI Act) provides that before the end of each calendar year, the Superintendent shall ascertain the total amount of expenses incurred during the immediately preceding fiscal year in connection with the administration of the Bank Act, the Trust and Loan Companies Act, the Cooperative Credit Associations Act, the Insurance Companies Act, and the Protection of Residential Mortgage or Hypothecary Insurance Act. The OSFI Act also provides that the Governor in Council may make regulations prescribing the assessment methodology for each type of financial institution, and that each financial institution shall be assessed in accordance with the methodology prescribed by those regulations. The prescribed methodologies break assessments into two components for each industry sector: (1) minimum assessments, which prescribe the minimum amount to be assessed on each type of institution; and (2) base assessments, which currently rely on the size-based proxies to determine each FRFI’s pro-rata share of OSFI’s expenses. (1) Minimum assessments (a) Banks, authorized foreign banks, trust and loan companies, and cooperative credit associations The current Regulations prescribe the methodology for determining the applicable minimum assessment for FRFIs subject to the Bank Act and Trust and Loan Companies Act, whereby one of 10 different minimum assessments is applied in accordance with specified classes of average total assets. These minimum assessments range from $10,000 for a FRFI with average total assets equal to or less than $50 million to as much as $275,000 for a FRFI with average total assets greater than $50 billion. The current Regulations prescribe a minimum assessment of $10,000 for FRFIs subject to the Cooperative Credit Associations Act. (b) Insurers The current Regulations establish a minimum assessment of $10,000 for life insurance companies, property and casualty insurance companies, and foreign companies (i.e. foreign companies operating in Canada on a branch basis), and $1,000 for fraternal benefit societies and foreign fraternal benefit societies. (2) Base assessments (a) Banks, authorized foreign banks, trust and loan companies, and cooperative credit associations The current Regulations provide that the basis of calculation will be the following: • Banks and trust and loan companies — the average total assets during the fiscal year ending on March 31 of that year. • Authorized foreign banks — the average total assets in Canada during the fiscal year ending on March 31 of that year. • Cooperative credit associations — the average total assets during the immediately preceding calendar year. After having regard for minimum assessments, assessment surcharges, service charges, and other revenues relating to the administration of these statutes, the formulae calculate each FRFI’s share of the remaining expenses based on its pro-rata share of average total assets for each assessment sector. FRFIs subject to the Bank Act and the Trust and Loan Companies Act are grouped together as one assessment sector, and those FRFIs subject to the Cooperative Credit Associations Act are addressed distinctly as a separate assessment sector. The current Regulations do, however, limit the base assessment to $10,000 for a loan company and for an authorized foreign bank that is subject to the restrictions and requirements referred to in subsection 524(2) of the Bank Act (commonly referred to as a “lending branch”). A FRFI’s fixed minimum assessment is added to the base assessment to arrive at its total assessment for a fiscal year. (b) Insurers The current Regulations provide that the basis for calculating Green Shield Canada’s base assessment will be the total amount of the net revenue received during the immediately preceding calendar year from its prepayment plans, other than its “administrative services only” plans. For companies other than Green Shield Canada, societies, and provincial companies that are subject to the Insurance Companies Act, the current Regulations establish that the basis of calculation will be the aggregate of the total amount of net premiums received in Canada and an amount equal to 25% of net premiums received outside Canada, during the immediately preceding calendar year. The current Regulations also provide that the basis for calculating the base assessments for foreign companies will be the aggregate of the total amount of net premiums received in Canada during the immediately preceding calendar year. To determine an insurer’s total assessment, a separate minimum assessment premium threshold is established. This threshold varies each year as it is derived from total industry premiums and total OSFI costs. Institutions below the threshold are assessed the minimum charge, while those above the threshold are assessed an amount in excess of the minimum charge in accordance with the relevant formula. Insurers are either assessed a minimum amount or a pro-rata amount using the applicable proxy. This is a notable departure from the approach described above for banking institutions whereby they are assessed both a minimum amount and a pro-rata amount using the applicable proxy. Objectives The main objects of the amended Regulations are to address the three above-noted issues: Best proxy — implement a better proxy by which to measure OSFI’s time and resource expenditures to ensure a fair and accurate distribution of OSFI’s expenses across FRFIs. Greater stability — revise the assessment methodologies to make them less prone to major impacts resulting from future accounting and other changes to international standards. Update minimum assessments — update the minimum amounts assessed, ensure that they remain up-to-date over time, and reduce unnecessary complexity. Description The differences between the amended Regulations and the current Regulations can be grouped into four categories, each of which is summarized below. 1. Proxy for measuring OSFI time and resource expenditures The amended Regulations change the proxy that is used for determining each institution’s pro-rata share of OSFI’s expenses — from the size-based measures of “average total assets,” “net premiums,” and “net revenue” to the risk-based capital adequacy or capital equivalency measures applicable to the institution. More specifically, the new proxies for each type of FRFI are (a) in the case of a bank, a trust and loan company or a retail association, total risk-weighted assets; (b) in the case of an authorized foreign bank, the minimum capital equivalency deposit; (c) in the case of a cooperative credit association, an amount equal to 1/20 of the total borrowings; (d) in the case of an insurance company (including Green Shield Canada), society or provincial insurance company, the minimum required capital; and (e) in the case of a foreign insurance company, the minimum required margin of assets in Canada. Each of the above-noted measures is a risk-based capital adequacy or capital equivalency framework. These frameworks assess the risks associated with a FRFI’s business and operations and require institutions to meet minimum prudential solvency requirements to offset those risks. Different capital adequacy and equivalency frameworks are necessary given the different types and structures of FRFIs. For example, a foreign company that operates in Canada on a branch basis does not issue shareholders’ equity in Canada. Consequently, the applicable capital equivalency framework (e.g. the capital equivalency deposit for authorized foreign banks, or the minimum required margin of assets in Canada for foreign insurance companies) would require the institution to hold assets in Canada to offset the risks related to the institution’s Canadian business. For prudential regulatory purposes, these assets held in Canada by foreign companies are a form of capital equivalency. 2. Create a new assessment sector for mortgage insurers The current Regulations divide FRFIs into four assessment sectors: (a) banks, authorized foreign banks, and trust and loan companies; (b) cooperative credit associations; (c) life insurance companies and fraternal benefit societies; and (d) property and casualty insurance companies. The current Regulations do not differentiate between types of property and casualty insurers, which include mortgage insurers, when allocating OSFI’s expenses to the property and casualty sector. Since the risk-based capital adequacy requirements for mortgage insurers are markedly different than those of all other types of property and casualty insurers, the amended Regulations create a new assessment sector for mortgage insurers to ensure that these institutions are not assessed a disproportionately higher share of OSFI expenses relative to their property and casualty peers. 3. Update minimum assessments In addition to modifying the proxies for calculating base assessments, the amended Regulations update the minimum assessments as summarized below. (a) Reduce the number of minimum assessment categories — the amended Regulations reduce the complexity of the Regulations by decreasing the number of minimum assessment categories for banks, authorized foreign banks, and trust and loan companies from 10 to 2. (b) Update minimum amounts assessed — the amended Regulations increase the remaining minimum amounts assessed to recover OSFI’s expenses at current market rates. The minimum assessments of banking institutions, other than lending branches, cooperative credit associations, and trust companies whose activities are limited to fiduciary activities, are increasing from $10,000 to $30,000. The minimum assessments for lending branches, cooperative credit associations, and trust companies whose activities are limited to fiduciary activities, are increasing from $10,000 to $15,000. The minimum assessments of life, property and casualty, and foreign companies are increasing from $10,000 to $15,000, and the minimum assessments of fraternal benefit societies and foreign fraternal benefit societies are increasing from $1,000 to $2,000. (c) Index minimum assessments — to ensure that the proposed minimum assessments keep pace with increases in overall assessments, the amended Regulations annually index the minimums in accordance with increases in the Consumer Price Index. 4. “Housekeeping” amendments The amended Regulations clarify the application of assessments to newly established institutions, and in relation to troubled institutions that are subject to additional assessment surcharges, which surcharges are designed to reflect the increasing intensity of supervision. More specifically, the housekeeping amendments clarify the following: New FRFIs that have not yet commenced business during an assessment year shall not be assessed. The assessment surcharges applicable in paragraphs 8(1)(a) and (b) of the current Regulations [paragraphs 10(1)(a) and (b) of the amended Regulations] are, respectively, for each month, $3,000 and an amount equal to 1/12 of 10%, and $5,000 and an amount equal to 1/12 of 15%. As currently drafted, some FRFIs have inappropriately interpreted the $3,000 and $5,000 components of the surcharges to only be charged once (i.e. in the first month). In cases where no base assessment was levied against a FRFI in the preceding fiscal year (e.g. the institution did not exist), all calculations performed under section 8 of the current Regulations (section 10 of the amended Regulations) should use the minimum assessment that would have otherwise been applicable for that year. “One-for-One” Rule The “One-for-One” Rule does not apply to the amended Regulations. Assessment-type fees are not considered to be a form of administrative or compliance cost. Small business lens The small business lens does not apply to the amended Regulations, as there are no costs on small business. Consultation The amended Regulations were subject to two distinct public consultation processes: (a) OSFI issued two public consultation papers to introduce the amendments to the assessment methodologies and discuss anticipated impacts; and (b) as part of the formal regulation-making process, OSFI sought public comment on the draft Regulations as prepublished in the Canada Gazette, Part I. Each consultation process is discussed below. (a) OSFI public consultation papers OSFI has published two consultation papers on the amendments to the assessment methodologies — one consultation paper for each of the banking and insurance sectors, which can be found at the following links, respectively: http://www.osfi-bsif.gc.ca/Eng/fi-if/in-ai/Pages/DTI-ACP.aspx http://www.osfi-bsif.gc.ca/Eng/fi-if/ic-sa/Pages/inscnsregs.aspx These two consultation papers provided a brief overview of the current assessment methodologies for FRFIs; identified and discussed key considerations in developing new assessment methodologies; proposed new measures on which to base assessments; proposed updates to the minimum assessment methodologies; and summarized the aggregate impact of the proposed changes on FRFIs. Further, to facilitate understanding and discussion of the anticipated impacts of the amendments, OSFI provided individual FRFIs with their anticipated institution-specific results under the new assessment methodologies, which were modelled over a historic two-year period and were contrasted with actual assessment results for the same period. Generally, the majority of FRFIs are expected to benefit from the amendments, with approximately two-thirds of institutions projected to experience decreases in their assessments. Institutions whose assessments are projected to increase did not challenge the underlying policy objectives of the amendments (i.e. best proxy, stability of proxy, and ensuring that the regulations remain up-to-date), nor the move to a risk-based proxy. Some respondents did propose modifications to the new methodologies to address perceived concerns. What follows are highlights of industry comments and OSFI’s responses, the latter of which were communicated to individual institutions. Banking sector consultation The 45-day banking sector consultation was launched in October 2013, and a total of eight submissions were received. Noteworthy industry comments include the following: Risk-based methodology — Many respondents expressed support for all aspects of the move to the risk-based assessment methodology. Standardized versus Advance Internal Ratings Based (AIRB) banks — Small- and medium-sized banks measure credit risk and calculate their corresponding capital requirements using a standardized approach, which approach uses assessments from qualifying rating agencies to determine the risk weights for certain assets. Conversely, larger banks that have received supervisory approval of their AIRB approach may rely on their own internal estimates of risk components to determine the capital requirements for a given exposure. Two banks expressed concerns that OSFI may not achieve its policy objective to link assessments to risk. They submitted that greater risk lies within the larger AIRB banks and yet standardized banks calculate higher risk-weighted assets (i.e. required capital) than AIRB banks for similar credit exposures. OSFI acknowledged that standardized banks are required to calculate higher risk-weighted assets for credit risk; however, AIRB banks are also subject to additional capital charges for market risk, which additional capital charges contribute to a significant increase in AIRB banks’ share of total sectoral assessments. OSFI thoroughly assessed the appropriateness of the companies’ anticipated increases relative to actual time spent supervising the institutions, and relative to their peers, and concluded that the increases fairly reflect the time and resources spent on the institutions. Minimum assessment — Two small trust companies advocated for a smaller increase in the minimum assessment. The companies expressed concern that the increase in the minimum assessment from $10,000 to $30,000 would have a significant impact on their bottom lines. They further argued that, since their activities are limited to fiduciary activities, OSFI’s resource expenditures should be less, on average, than that spent on other banking institutions that, for example, take deposits. OSFI considered the companies’ concerns in detail, reviewing all time logged against all trust companies over a three-year period. The data clearly illustrated that OSFI spends less time on trust companies whose business activities are limited to fiduciary activities. Therefore, OSFI reduced the minimum assessment from $30,000 to $15,000, which is now the same as the new minimum for other types of limited service banking institutions, such as lending branches. Insurance sector consultation The 45-day insurance sector consultation was launched in July 2012. A total of nine submissions were received. Noteworthy industry comments include the following: Risk-based methodology — Respondents generally expressed support for the move to a risk-based assessment methodology. Foreign premiums — One internationally active life insurance company expressed concern that the new methodology does not differentiate between foreign and Canadian business, as is the case under the current premiums-based assessment methodology. The current methodology only captures 25% of net premiums received outside of Canada — an attempt to recognize, for assessment purposes, that there is some OSFI reliance on foreign supervisors. The company suggested that the anticipated increase in its assessment, which does not recognize the limited extent of its domestic operations, is inappropriate. OSFI thoroughly assessed the appropriateness of the company’s increase relative to actual time spent supervising the institution, and relative to its peers, and concluded that the anticipated increase fairly reflects the time and resources spent on the conglomerate group. OSFI supervises FRFIs on a consolidated basis, and the international scale of the insurance group introduces additional risk and necessitates additional OSFI effort that should be appropriately captured under any assessment methodology. It is OSFI’s view that an insurer should not benefit from a reduced assessment simply because its domestic presence may be small relative to its global operations. Capital deduction for substantial foreign business — A life insurance company suggested that it may now be disadvantaged relative to its peers because it has scaled back its foreign operations to a point that they now comprise less than the 25% threshold that would qualify the company for a capital deduction under OSFI’s capital rules. Loss of the deduction would increase the company’s required capital and thus increase its pro-rata share of OSFI’s expenses under the new assessment methodology. OSFI is of the view that it is a business decision to allow a company’s foreign business to fall below the threshold to gain a capital credit, and one that is likely not influenced nor dictated by the impact it may have on assessments. Further, if there is less reliance by OSFI on a foreign supervisor, the company should not benefit from an adjustment that impacts the allocation of assessments. Conservative reserving — Three companies suggested that the new methodology would penalize those insurers that have more conservative reserving practices. OSFI has reservations about the degree to which conservative reserving would have a material impact on one company’s assessment relative to its peers. Further, being too conservative can introduce risk, something that OSFI and company auditors assess when reviewing the appropriateness of reserves. The opportunity cost of excess capital held as reserves is likely greater than the incremental assessment charge. OSFI does not expect companies to adopt less conservative reserving practices as a result of the amendments to the insurance assessment methodology. Excess capital — To avoid penalizing a company for investing excess capital, an insurance company recommended that OSFI consider an assessment methodology that allocates OSFI’s expenses based solely on the capital required to support liabilities (versus the capital required to support both liabilities and assets). OSFI believes that since its supervisory framework appropriately captures risks on both sides of the balance sheet, so should the assessment methodology. Further, if companies are investing excess capital in high-risk assets, such investments are likely to require additional due diligence from OSFI, which should be reflected in the new assessment methodology through higher required capital. (b) Prepublication in the Canada Gazette, Part I The amended Regulations were prepublished in the Canada Gazette, Part I, on May 28, 2016, followed by a comment period of 30 days. OSFI concurrently published notice of the consultation on its website, and sent an email to subscribers of OSFI’s email notification service. OSFI received two formal submissions as part of the Canada Gazette consultation. Consolidated or unconsolidated proxy — One submission sought confirmation on the calculation of assessments in the circumstance where there is more than one FRFI in a conglomerate group. More specifically, the institution sought clarity on whether the applicable risk-based proxy in the amended Regulations (e.g. required capital) is based on an institution’s consolidated figure (i.e. aggregating the amounts reported by its subsidiaries) or its unconsolidated figure (i.e. subtracting the amounts reported by its subsidiaries). OSFI confirmed that, pursuant to the OSFI Act, it must assess each institution individually. OSFI further confirmed that both the current and amended Regulations must therefore be administered using unconsolidated figures, as applicable. Standardized versus AIRB banks — The second respondent offered its perspective on the differences in the measurement of risk and calculation of capital requirements between standardized and AIRB banks. The institution expressed the same views during OSFI’s 2013 consultation. The institution’s perspective and OSFI’s response remain unchanged — both are summarized above under the subheading “Banking sector consultation.” Rationale The amended Regulations do not fundamentally change the main steps involved in administering OSFI’s assessments. OSFI will continue to allocate expenses to each sector, and will then assess each institution based on a proxy that measures each institution’s pro-rata share of applicable sectoral expenses. The amended Regulations achieve each of the stated objectives, directly addressing the identified issues. More specifically, the amended Regulations will achieve the following results: The capital adequacy and capital equivalency requirements are risk-sensitive measures that are aligned with OSFI’s risk-based approach to supervision and, therefore, serve as a better proxy for the time and resources OSFI dedicates to supervising individual institutions. Compared to the current assessment measures of assets, premiums, and revenue, OSFI’s risk-based capital adequacy and capital equivalency frameworks are largely unaffected by adverse developments in international standards. Any future adjustments to these frameworks would only serve to better refine the allocation of OSFI’s expenses. The minimum amounts assessed have been updated to reflect current market rates, will remain up-to-date through indexing, and have been simplified by reducing the number of minimum assessment categories. There are no foreseeable or anticipated impacts on other sectors. The amended Regulations do not impose standards on industry to regulate a particular risk; they prescribe the methodologies by which OSFI can recover its expenses from industry. The amended Regulations do not impose any additional regulatory cost or administrative burden on industry. While FRFIs are assessed to recover OSFI’s expenses, the amended Regulations are binding on OSFI as it administers the assessment framework. It is important to highlight that the amended Regulations only impact the allocation of OSFI’s expenses across institutions and not the total amount assessed by OSFI. Therefore, the amended Regulations do not generate additional revenue for OSFI. The amended Regulations may result in modest savings to government by reducing the likelihood/need for future regulatory amendments (i.e. by moving to a more stable proxy better insulated from future accounting and other changes to international standards, and by indexing the minimum assessments). Implementation, enforcement and service standards The amended Regulations come into effect on April 1, 2017, which allows OSFI to apply the new assessment methodologies to recover its 2016–2017 expenses. Contact Darren Gault Manager Legislation and Policy Initiatives Legislation and Approvals Division Office of the Superintendent of Financial Institutions 255 Albert Street Ottawa, Ontario K1A 0H2 Telephone: 613-998-9868 Email: [email protected] Footnote a S.C. 2001, c. 9, s. 473(2) Footnote b S.C. 2001, c. 9, s. 477 Footnote c R.S., c. 18 (3rd Supp.), Part I Footnote 1 SOR/2001-177
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