The office of the superintendent of Financial Institutions seems a throwback to the days when a mere finger wag by a regulator was sufficient to bring market players to heel.
Increased disclosure and enforcement have since become standard for other regulatory realms, yet OSFI still has no plans to air the industry’s dirty laundry.

OSFI operates in the dark shadows compared with the securities commissions and other market cops. Canada’s chief prudential regulator, it focuses primarily on the safety and soundness of federally regulated financial institutions, such as the big banks and life insurers, and the overall financial system.

The mandate means most of its compliance and enforcement work is done behind closed doors. If it has a concern with something one of the big banks is doing, it directly asks for an explanation. It might request a change in practice, but it doesn’t trumpet the news to the market. When OSFI does publish a decision, the names of the firms involved are usually omitted.

The superintendent, Nick Le Pan, says such discretion is “essential if we want to have an early intervention regime. That mandate does not go along with naming and shaming.”

The potential for overreaction from the markets would be too big if OSFI ran around revealing every regulatory action it took, or concern it had, he says, particularly as its mandate deals with soundness, not mere market conduct. “We are not in the individual enforcement business … we are not in the prosecution business,” he explains. “We’re not in the same business as the securities regulators, nor should we be.”

Le Pan also has no desire to take such a route. He supports the idea of a national securities regulator, but is not interested in merging prudential and market conduct regulation, as happened in Britain. He says it makes more sense to have two distinct, focused regulators, and that the potential synergies between the two don’t warrant a merger.

While often tight-lipped about its activities, OSFI does have a range of regulatory weapons at its disposal. It uses the soft power of suggesting operational changes to the firms it regulates, but it can also levy fines and make orders. “In reality, we’ll never have to go to a formal enforcement authority to get a serious problem fixed,” Le Pan says.

He says institutions tend to follow OSFI’s suggestions voluntarily because they don’t want to face the potential fallout that could occur if they ignored the regulator and then had a real solvency problem as a result. “I believe that the senior management and boards of directors we deal with understand that they have a responsibility and I’m pretty comfy that they treat that responsibility very seriously,” Le Pan says.

However, there are a couple of forces nibbling away at the tradition of discretion.
For one, the new capital adequacy regime for large and globally active financial institutions, known as Basel II, contemplates a role for the market in ensuring solvency. The plan will require greater disclosure by banks. At the same time, market regulators appear to be creeping into prudential regulators’ territory with rules that require public companies to assess their internal controls and report any deficiencies to the market.

Ensuring the adequacy of risk controls, part of which are financial controls, at financial institutions is one of the prudential regulators’ chief tactics for securing solvency. Hence, if big banks start reporting internal control deficiencies under these controversial new rules — known as Sarbanes-Oxley 404 in the U.S., and a similar rule recently proposed by the Canadian Securities Administrators — then the work of safety and soundness regulators could come under scrutiny.

Le Pan maintains that he’s not worried.
“We’ll cross that bridge when we get to it,” he says. While this new initiative appears to be creeping onto OSFI’s turf, Le Pan doesn’t view it as encroachment, and stresses that steps to improve financial statements should be welcomed. “Anything that enhances the quality of financial statements is a good thing. We have to rely on those statements too. If we thought that the quality of financial statements had deteriorated to the point where we had to get into the auditing business, that would be a failure of our system,” he says.