Regulatory Over-reach

Legislative changes now being discussed need to address the ‘second’ regulatory system that has been improvised in our province.  BC credit unions now have ‘two’ regulatory systems; the second one has been implemented using ‘opportunities’ within the Financial Institutions Act (‘FIA’), to enhance the roles of the Superintendent (and FICOM management).  I do not think this second system was envisioned to evolve this way under the FIA.

System under the FIA

Let me explain.  The prevailing policy for regulating an industry has five elements; performance requirements, compliance reporting, enforcement, penalties/remedies, and an appeals procedures.  The BC Financial Institutions Act has an ‘architecture’ that is consistent with Canadian law in this regard, vesting different functions with different decision-making authorities.  This creates the checks and balances.  At the top, all authority rests with the legislature unless the law approved by the legislature delegates authority to an ‘administrative decision-maker’, the legislature distributes the authority to create checks on potential over-reach.

I recap the FIA system below, starting with our BC legislature in Victoria.  The LGIC is the Lieutenant Governor in Counsel, the formal designation of the ‘Cabinet’ or the Executive Council.  The Commission is the Financial Institutions Commission, under the FIA.  The Superintendent is the Superintendent of Financial Institutions under the FIA.  And the Financial Services Tribunal is a body created under the FIA to consider appeals of certain decisions.

Performance Requirements Legislature or LGIC:  The requirements are set out in the Act, and, where the Act authorises the LGIC to do so, by Regulation.
Compliance Reporting Superintendent: The Act gives the Superintendent powers to require regular reports, make inquiries, and to do onsite examinations, and ‘special examinations’.  The Superintendent also has the authority to undertake ‘investigations’ into irregular matters.
Enforcement Commission:  The Commission has powers to sanction a financial institution.  (Some of those powers may be delegated to the Superintendent.)
Penalties and Remedies Legislature or LGIC: The Act grants the Commission options to assess a financial penalty, to issue orders, to place conditions on a business authorization, to rescind a business authorization, and to place a credit union under supervision of the commission (‘replace the credit union board’).  The maximum size of ‘administrative penalties’ are set by Regulation, for each requirement. .
Appeals Financial Services Tribunal:  Many formal decisions of the Superintendent (S.242) may be appealed.  The Commission must review a disputed administrative penalty (S253.1).

System #2

Since 2013 a second ‘system’ has been evolving.  The second system has been built by FICOM, the administrative body that comprises both the Commission and the Superintendent (and the deposit insurer). Various initiatives have (1) added new performance ‘requirements’ (defining new practices or introducing new metrics/thresholds), (2) expanded the existing compliance program to cover these new ‘requirements’, and (3) implemented ‘penalties’ for non-compliance through Credit Union Deposit Insurance Corporation (‘CUDIC’) ‘risk-based’ assessments.

The beauty of this second system is that it evades the checks and balances in the FIA – the other authorities – who logically and legitimately should be involved when new performance requirements are placed on regulated entities.  These changes have been promoted as ‘risk-based’ regulation, and simply small administrative changes.  However, they are bigger than that.  The second system looks like this:

Performance Requirements Superintendent (or “FICOM”):  The Commission may play a small role, it is not clear.  The new ‘requirements’ are set out in ‘guidelines’, and also within the CUDIC risk scoring model.
Compliance Reporting Superintendent: The Act gives the Superintendent powers to require regular reports, make inquiries, and to do onsite examinations.
Enforcement Superintendent (or “FICOM”):  Credit unions are rated under a ‘framework’ devised and implemented by management to generate qualitative ‘ratings’. Year-end financial results are scored by CUDIC using a model devised by management and confirmed by CUDIC directors.
Penalties and Remedies CUDIC Directors: CUDIC has adopted a ‘risk-based assessment’ model that may require a credit union to pay up to an additional 200% in deposit insurance premiums.
Appeals None. Though a credit union may ask for reconsideration of ratings.

First observe, this second system involves a far smaller number of participants as ‘decision-makers’.  There are no checks and balances.  And, it is only circuitously accountable to government or the legislature.

The second system is innovative.  It has been built around a few ‘openings’ in the legislation.  First, it has unlimited scope for crafting new requirements.  Guidelines introduce new ‘expectations’ related to governance, mortgage lending, liquidity management, and more.  The CUDIC risk scoring model adds several new performance measures to those already in the FIA.  Second, enforcement does not involve an independent party, FICOM management is allowed to make its own assessment using rating schemes of their own design.  Third, the penalties are substantial – for a medium size credit union the increased deposit insurance assessment is many times the size of the ‘maximum’ fine for a breach of the FIA under the Administrative Penalties Regulation ($50k).  And, fourth, there is no real appeal mechanism; and if there was one, the administrative processes are so complicated and cloaked that it would be hard to find the decision point that might be challenged.

The potential size of the ‘penalties’ under this second system are unreasonable.  For a credit union with $500M in deposits, failing to meet the first CUDIC scoring threshold would cost an additional $200k in CUDIC assessments annually, scoring below 50% means an additional penalty of $800k!

Burdened and Bruised

In this view, this ‘administrative’ regulatory system starts to look unfair, and it is an over-reach by those responsible for administration of the Act.  In particular, I do not think that it was intended for CUDIC to be used in this way:

  1. Rather than propose changes to the Capital Requirements Regulation, FICOM has introduced a capital management guideline and a new key metric through the CUDIC risk scoring model with a minimum threshold (leverage).
  2. Rather than propose changes to the Liquidity Requirements Regulation, FICOM has introduced a new key metrics through the CUDIC risk scoring model with a minimum threshold (Liquidity Coverage Ratio, hot money).
  3. Rather than propose other changes to Regulations, FICOM guidelines create new annual reporting requirements, and new governance practices (e.g. Risk Appetite Statements).
  4. And, the CUDIC risk scoring model adds additional earnings and asset quality metrics and thresholds.  All of which become new defacto ‘targets’ for credit unions.

In effect, the FIA system is circumvented.  We now have a second ‘administrative’ regulatory system that is interventionist and broad in scope.  This is not as it should be.

This second regulatory system is the source of many of the concerns raised by credit unions in the last four years:

  • Ever increasing demands and costs (‘regulatory burden’)
  • A lack of transparency
  • No avenues of appeal
  • Actions that seem arbitrary and actors who are unaccountable

In my view, Finance Ministry policy representatives to date have not really grasped this ‘second system’.  While this second system has burdened all credit unions, it has pressured many credit unions into mergers.  This second system vests ‘FICOM’ with exceptional powers, but it does not appear that this was the intention under the FIA.  I think we need a fairer and better constructed regulatory model, based upon the architecture of the FIA itself.

As we consider legislative changes, this second system must be central to the efforts.  My humble suggestions are:

  1. The legislature should amend section 268 of the FIA to allow only for a flat deposit insurance assessment rate.  This would eliminate the opportunity to further use ‘risk-based’ assessments to enforce this second regulatory system.
  2. The legislature should amend the FIA to give the Commission greater authority to direct management and to hold them accountable, giving credit unions recourse in the event of disputes.
  3. The Commission should update/review all guidelines (a) to properly identify the responsible issuing authority (Commission or the Superintendent?), (b) to identify the section(s) of the legislation upon which the guideline is providing clarification or information, and (c) to confirm that a guideline does not constitute a required practice, but only guidance on what would meet the requirements of the Act, in the opinion of the authority.
  4. And, the legislature should only delegate ‘rule-making powers’ to the Commission in defined subject areas specified in sections of the Act, as is the case for powers granted to the LGIC (cabinet) to make regulations.

The debate between credit unions and the Ministry over ‘rule-making powers’ may well be moot if this second system remains in place.

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