The federal financial watchdog has given Canada’s big banks an extension to implement global reforms that establish more consistent disclosure rules to allow them to focus and devote the “significant level of effort required” to implement new international accounting standards for financial instruments.
The Office of the Superintendent of Financial Institutions (OSFI), globally renown as a dominant and strong regulator, originally adopted an aggressive timeline for the implementation of the revised Pillar 3 standards issued by the Basel Committee on Banking Supervision, an international banking regulator – and an equally aggressive stance towards the adoption of the International Financial Reporting Standard (IFRS) 9 Financial instruments accounting standard, according to financial services experts.
But the federal banking regulator recently softened its stance, and granted so-called domestic systemically important banks (D-SIBs) a year-long extension, until fiscal year ending October 31, 2018, to implement the revised Pillar 3 disclosure requirements. The leeway will allow Canada’s six major banks to focus on a “high quality implementation” of the International Financial Reporting Standard (IFRS) 9 Financial instruments accounting standard, said OSFI in a letter to all federally regulated deposit-taking institutions.
“I suspect what happened is that the IFRS 9 is a pretty significant project internally for a lot of these D-SIBs and a significant amount of their resources are being allocated to meet that requirement – and they probably needed more time to implement the disclosure requirements for the revised Pillar 3 standards,” said Pat Forgione, a Toronto financial services lawyer with McMillan LLP.
IFRS 9, finalized by the International Accounting Standards Board in July 2014, fundamentally rewrites the accounting rules for financial instruments, according to accounting giant Grant Thornton. It replaces International Accounting Standard 39 and introduces a new approach for financial asset classification, establishes a new hedge accounting model that allows entities to better reflect their risk management activities, and replaces the incurred loss impairment model with a more forward-looking expected loss model, added the accounting firm.
“There’s a whole bunch of lessons that came out from the financial crisis,” said Forgione. “With some of the more complex instruments that came out in the last 10, 15 years, one of the main goals behind IFRS 9 was to implement new guidelines that would be able to adequately disclose the actual risks that these new instruments may have. That’s why IFRS 9 has become such a big goal, not only in accounting circles but from a regulatory perspective.”
While the IFRS 9 accounting standard will be effective for annual periods beginning on or after January 1, 2018, OSFI issued an advisory informing D-SIBs that it should adopt the new accounting standard for their annual period beginning on November 1, 2017. All other federally regulated entities using an October 31 year-end are also permitted to adopt IFRS by the same date but are not expected to do so. “Interestingly enough, Canada is in front of the game in terms of IFRS implementation, and we are actually implementing them quicker than the rest of the world,” noted Toronto banking lawyer Peter Hamilton. “OSFI’s announcement to defer some of the Pillar 3 reporting requirements was done because it was simply too onerous for banks to do both at the same time.”
In the aftermath of the financial crisis of 2008–2009, the Basel Committee introduced a set of reforms, known as Basel III, designed to improve the regulation, supervision and risk management of the banking sector. Anchored by three complimentary pillars, the international regulatory accord is intended to strengthen global capital and liquidity rules with the goal of improving the banking sector’s ability to absorb shocks arising from financial and economic stress which in turn is expected to buffer the risk of spillover to the economy. Basel III spells out detailed capital requirements for credit and operational risk under Pillar 1 and supervisory requirements under Pillar 2. Pillar 3, which centers around the notion of market discipline, deals with enhanced and more consistent risk disclosure about capital and risk to allow stakeholders better understand and compare the risk profile of banks.
“The three Pillars of Base III work together,” said Hamilton, a partner with Stikeman Elliott LLP. “A lot of time and effort has been spent on Pillar 1 which is capital adequacy and liquidity and just as much time and effort was spent on Pillar 2 which deals with supervision. I suspect that most people would say that Pillar 3 takes third place behind capital adequacy and supervision.”
The premise behind market discipline is that public disclosures impose strong incentives on institutions to conduct their business in a safe, sound and efficient manner, said James Hubb, OSFI’s assistant superintendent. It also acts as an incentive for banks to maintain a strong capital base to act as a cushion against potential future losses stemming from risk exposures, added Hubb.
“The public disclosure of risk culture, risk appetite and risk activities acts as a mechanism to hold an institution accountable for its actions,” said Hubb in a speech. “Good behaviour is rewarded, while bad behaviour is questioned.”
The Basel Committee states the provision of “meaningful information” about common key risk metrics to market participants is a fundamental tenet of a sound banking system. But Hamilton questions whether the notion of market discipline is well-founded. “The theory is nice, and I’m not meaning to say that it won’t work but I think it is one of these things that is unknowable,” said Hamilton. “Maybe we will be asking ourselves that question when things go wrong. Clearly it was not a deterrence to risky behaviour before 2008, 2009.”
In a draft guideline on the revised Pillar 3 disclosure requirements published last January, OSFI acknowledges that in the wake of the financial crisis it became “apparent” that the existing Pillar 3 disclosures did not adequately promote the identification of material risks of international banks. Nor did the existing Pillar 3 requirements provide sufficiently comparable information to allow stakeholders to assess a bank’s overall capital adequacy and make comparisons with other banks. The revised Pillar 3 disclosure requirements are expected to remedy that situation, according to the federal bank regulator, which published its draft guidelines in response to the revised requirements issued by the Basel Committee on January 2015. OSFI expects to publish the final guideline this year.
In prior versions of the Pillar 3 disclosure requirements, the guiding principles were only briefly described and included general comments on encouraging market discipline and consistency, noted Forgione. The revised Pillar 3 disclosure requirements are far more fleshed out, added Forgione. In the revised version, the Basel Committee introduces five guiding principles that banks are expected to keep in mind: disclosures should be clear, comprehensive, meaningful to users, be consistent over time, and be comparable across banks. Moreover, the revised Pillar 3 disclosure requirements introduce multiple templates for banks to follow and varied schedules that banks must adhere to depending on the type of disclosure.
The revised Basel Pillar 3 standards however provide a framework that can be tailored by national regulators to meet the reality and “particularities” of their own each jurisdiction, said Forgione.
“The Pillar 3 disclosure requirements provide a template that certainly seems to foster additional disclosure, and just as importantly, clear and consistent disclosure,” said Forgione. “So they are trying come up with a more structured disclosure requirement. But the regulators in each country are certainly going to have a role in determining how the Pillar 3 disclosure requirements are going to be satisfied.”