Canadian Financial Services Sector: Capital

UNCLAS SECTION 01 OF 05 TORONTO 002705

SIPDIS

STATE FOR EB A/S TONY WAYNE
STATE FOR WHA/CAN, EB/IFD, INR
STATE FOR WHA DAS WHITAKER
USDOC FOR 3000/ITA U/S RHONDA KEENUM
USDOC FOR 432/ITA/IAA/BASTIAN/RUDMAN/FOX
TREASURY FOR U/S (INTERNATIONAL AFFAIRS) TIMOTHY ADAMS
TREASURY FOR U/S (DOMESTIC FINANCE) RANDY QUARLES
DEPT ALSO PASS USTR FOR J. MELLE AND S. CHANDLER
DEPT PASS SEC - MARISA LAGO
DEPT PASS FEDERAL RESERVE BOARD
DEPT PASS CFTC
WHITE HOUSE/NSC - KIM BRIER AND SUE CRONIN

SENSITIVE

E.O. 12958: N/A
TAGS: EINV EFIN PREL CA US
SUBJECT: Canadian Financial Services Sector: Capital
Markets Align with the U.S., Deplore GOC Void

Ref: (A) 04 Toronto 2007 (B) Toronto 1633
(C) 04 Toronto 2410 (D) Toronto 2638 (E) Toronto 2646
(F) Toronto 2697 (G) 04 Toronto 2528

Sensitive But Unclassified - Please Protect
Accordingly.


1. (U) This cable contains a request for SEC guidance,
see paragraph 14.


2. (U) This message is one in a series reviewing the
Canadian financial services sector from a cross-border,
North American integration issue perspective. In
September 2005 the Toronto Financial Services Alliance
sponsored roundtables for ConGen Toronto with industry
sector experts in venture capital (ref (D)),banking
(septel),securities, and insurance (ref (F)).

Summary and Comment
--------------


3. (SBU) The federal government has little
understanding of Canada's provincially governed capital
markets and, consequently, fails to represent the
industry adequately on international and cross-border
issues, senior representatives from the Investment
Dealers Association (IDA) and the Investment Funds
Institute of Canada (IFIC) argued at a September 19
roundtable for ConGen Toronto sponsored by the Toronto
Financial Services Alliance. The industry believes
that federal impetus will be key in establishing a
single commission and welcomes federal Finance Minister
Goodale's support as an overdue step forward.


4. (SBU) The IDA and IFIC support aligning Canadian
capital market governance structures with changes in
the U.S. The IDA confirmed that the securities
industry has substantially harmonized with U.S.-style
Sarbanes-Oxley (SOX) governance and disclosure
requirements, although Canada had decided to postpone
formal SOX 404 implementation past the financial year
ending June 30, 2006. The securities industry welcomes
new provincial legislation that will give Ontarians the
right to sue companies and directors for violations of
continuous disclosure obligations (taken for granted in
the U.S.).


5. (SBU) The industry is confused, however, over how
the SEC's recent adoption of a new category of issuers,
termed "well-known seasoned issuers," applies to large
Canadian firms listed in New York. Canada is
coordinating adoption of what will eventually be a
Straight-Through-Processing (STP) regime with U.S.
industry. Given that Toronto is considered Canada's
financial services capital, the NAFTA financial
services committee may wish to consider holding one of
its future meetings in Toronto. ConGen Toronto would
be pleased to offer support. END SUMMARY AND COMMENT.

GOC not Effective Spokesperson for Securities Industry
-------------- --------------


6. (SBU) As part of ConGen Toronto's "financial
services month" in September, the Toronto-centered
Canadian securities industry, represented by its main
trade associations and prominent private sector
stakeholders, offered its perspectives on key issues of
capital markets governance in Canada. A Senior Vice-
President of the Investment Dealers Association (IDA)
complained, and others present agreed, that because the
securities industry is provincially regulated, all the
expertise resides in provincial Finance Ministries and
Securities Commissions. "It's a considerable headache
for the industry that Ottawa is `clueless' with respect
to capital markets issues," he said. The industry
believes it does not have an effective spokesperson on
international and cross-border issues, where government-
to-government communication is critical in setting the
agenda and addressing industry concerns.

7. (SBU) Industry reps explained that a single
securities regulator would go some way towards giving
Canadian capital markets a national spokesperson (Ref
(C)). They applauded federal Finance Minister Ralph
Goodale's announced intention to issue a major economic
strategy paper before the next election (widely
expected by the spring of 2006),which will refer to
the "single" (not necessarily "federal") securities
regulator as a GOC goal under "smart regulation." They
agreed that the main alternative - the provincially
based passport system - would succeed in providing a
single point of entry into Canadian capital markets.
However, since the provinces would remain autonomous
under this scheme, the passport system would amount to
a "single point of entry into a market that would
remain internally discordant/balkanized" and, above
all, "would not give Canada a single voice on capital
markets issues."

Significant Mutual Fund Governance Reform Likely
-------------- ---


8. (SBU) The President and CEO of the Investment Funds
Institute of Canada (IFIC),Tom Hockin, said Canada's
retail investors had returned to the market following
the bursting of the tech bubble in 2000-01. He noted
that net assets under mutual fund management had now
surpassed their 2000 peak by some 25%. The industry
currently manages C$549 billion in assets, up from the
previous peak of C$427 billion in 2000. However,
despite strong recent growth, the Canadian mutual fund
industry is only 1/16 the size of the U.S. industry
which, in per capita terms, amounts to about 75% the
size of the U.S. industry. This reflects to some
extent lower per capita income and greater reliance on
public retirement plans, most notably the Canada
Pension Plan (CPP). According to Hockin, 85% of
Canada's mutual fund industry is concentrated in
Ontario, measured by the value of funds under
management.


9. (SBU) Hockin highlighted the virtues of Canadian
mutual fund regulation, mentioning that Canada had
avoided the fraudulent and illegal practice of "late-
trading" (Ref (A)). He emphasized the successful
policing function of FundSERV Inc., an independent
capital markets institution, established by the
industry, which time-stamps all mutual fund orders and
enforces a "hard" 4:00 PM close of business.


10. (SBU) Hockin acknowledged wide-spread criticism of
mutual fund governance in Canada, agreeing that the
mutual fund industry had not done enough to restore
investor confidence in the post-Enron era, hinting that
significant reforms could be expected over the coming
year. He deplored the fact that IFIC had never adopted
a real mandate and said he had admonished the mutual
fund industry to make investor protection its
fundamental raison d'etre. He also emphasized the need
for much tougher mutual fund regulation, specifically
pointing to the need for better regulation of the fund
manager (NOTE: The Canadian Securities Administrator's
"national instrument 81-107" calls for mutual funds to
be governed by an Independent Review Committee tasked
to investigate potential conflicts of interest of fund
managers. This proposal falls short of U.S.-style
governance proposals where a board of independent
directors would be tasked to stand up for investor
interests would have the power to terminate the fund
manager. (END NOTE.)

Brokerage Industry Buoyant on Energy/Resources
-------------- -


11. (SBU) Senior officials from Canada's Investment
Dealers Association (IDA),including the CEO Joe
Oliver, explained that capital markets have recovered
well from the high-tech sell-off at the beginning of
the decade because of the boom in commodities prices,
especially energy, driven by insatiable appetite for
Canadian raw materials in China and India. The broad
S&P/TSX index has staged a remarkable recovery since
2001, outperforming all other stock markets in the
developed world. The IDA believed Canada's stock
market boom was in part driven by record-high
conversions of publicly traded companies into "income
trusts" in recent years - a legal structure that
allowed public companies to exploit federal tax
advantages. The IDA projected that the federal
decision of mid-September to all but freeze income
trust conversions could significantly slow Canada's
stock market boom in coming years (NOTE: Industry
insiders believe that the federal government wants to
dampen the conversion trend because of the significant
fiscal impact of lost corporate income tax revenue. END
NOTE).

Brokerage Industry Wants More Harmonization with U.S.
-------------- --------------


12. (SBU) Oliver said Canada had largely harmonized
with U.S. regulatory requirements while making some
adjustments that take the small size of many Canadian
companies into account (Ref (B)). He explained that
Canada had decided to adopt a virtual carbon copy of
U.S. SOX 404 requirements. (NOTE: SOX 404 directs
companies to document their internal controls over
financial reporting and to provide evidence in the form
of detailed tests that their internal controls work and
produce only accurate disclosure. SOX 404 also obliges
external auditors to examine a company's internal
controls and give an opinion as to their effectiveness.
The needed tests are universally seen as tedious, time-
consuming, and expensive, making SOX 404 the most
controversial section of the Sarbanes-Oxley Act. END
NOTE).


13. (SBU) Oliver explained that Canada's Securities
Administrators decided in August 2005 to postpone for a
full year the implementation of the Canadian Securities
Administrator's "multilateral instrument 52-111" (the
Canadian equivalent of SOX 404). He said that several
aspects of SOX 404 implementation in the U.S. had
caused widespread confusion, forcing the SEC to issue
clarifying guidance to U.S. firms in May 2005. Canada
wanted to stand back and watch the debate over SOX 404
unfold in the U.S., draw lessons from the U.S.
experience, and then proceed with implementation in
Canada. As currently proposed, Canada's equivalent of
SOX 404 applies only to TSX-listed companies (the
senior exchange) and not to companies listed on the
Canadian Venture Exchange (the junior exchange).
Canada plans to start implementation of SOX 404 with
the financial year ending on or after June 30, 2006, we
were told.

Request For Guidance: "Well-Known Seasoned Issuers"
-------------- --------------


14. (SBU) A representative from one of Canada's large
financial institutions explained that the SEC, in the
summer of 2005, established a process designed to ease
and quicken public offerings for "well-known seasoned
issuers," listed on U.S. exchanges, effective December
1, 2005. (NOTE: Well-known seasoned issuers are large
companies with a market capitalization of over US$700
million, which are closely monitored by financial
analysts. END NOTE). Large Canadian companies that
list their stock on U.S. exchanges are unclear whether
and how they might qualify as "well-known seasoned
issuers" and would appreciate SEC guidance.
Other Regulatory Hot Topics of Cross-Border Interest
-------------- --------------

15. (SBU) Roundtable participants touched on several
other issues of cross-border interest in Canada-U.S.
relations:

--Civil liability for continuous disclosure violations:
Ontario passed provincial legislation, effective
December 31, 2005, giving investors the right to sue an
issuer, its directors and certain other officers for
continuous disclosure violations. This measure is a
significant step forward for Ontario in toughening
enforcement and giving small investors more options for
restitution. The legislation caps liability at 5% of a
defendant's market capitalization and includes features
to discourage frivolous lawsuits. The industry
believes that the legislation will help appease small
investor advocates who have campaigned tirelessly for
more restitution options (ref (G)). It is also seen as
contributing to an enforcement environment that
compares in every respect to the U.S., where the right
to sue for continuous disclosure violation is taken for
granted;

--Straight-Through-Processing (STP): Spurred by the
need to compete with U.S. markets, Canada's securities
industry is working thought the Canadian Capital
Markets Association (CCMA) to reduce the time it takes
to clear and settle trades. Currently, it takes up to
three business days (T+3) to settle trades. The
ultimate goal - straight-through-processing (i.e., real-
time settlement) - is proving elusive. But, the
industry hopes to move to T+1 (24 hour settlement) by

2007. This project is comparable in scope and
complexity to measures taken by the financial sector to
overcome computer Y2K incompatibility in the late
1990s, and will likely cost as much. Several self-
imposed deadlines for 2004 and 2005 have lapsed on both
sides of the border.

Comment
--------------


16. (SBU) The securities industry's overriding concern
remains to harmonize the regulatory environment with
U.S. governance structures in order to encourage the
further integration of Canada-U.S. capital markets.
One goal, widely accepted in Canada and currently an
agenda item under the Security and Prosperity
Partnership (SPP),is to move to free-trade in
securities by 2007 without compromising investor
protection. In the past, the Ontario Securities
Commission (OSC) has readily responded to industry
demands for coordination and has pushed the country as
a whole in that direction. Following David Brown's
resignation (Ref (E)),Scotia Capital's Chairman David
Wilson (who also holds the position of Vice-Chair for
the Scotiabank Group as a whole) will take the top job
at the OSC, effective November 1, 2005. We expect the
new OSC Chair to follow in the footsteps of David Brown
and will report in detail on developments in the coming
months. Given that Toronto is considered Canada's
financial services capital, the NAFTA financial
services committee may wish to consider holding one of
its future meetings in Toronto. ConGen Toronto would
be pleased to offer support.

Attendees
--------------


17. (U) The roundtable included the trade associations
of Canada's securities industry, the IDA and IFIC, the
Bank of Canada, and prominent industry stakeholders:
Joe Oliver, President and CEO, IDA; Ian Russell, Senior
Vice-President Capital Markets, IDA; Jon Cockerline,
Director, Capital Markets, IDA; Morag MacGougan, VP
Industry Relations, IDA; Tom Hockin, President and CEO,
IFIC; Susan Yellin, Director of Public Affairs and
Communications, IFIC; Ross MacKinnon, Director of
Financial Markets Department, Toronto Office, Bank of
Canada; Roman Dubczak, Canadian Imperial Bank of
Commerce; Tom Smee, Senior VP and Deputy General
Counsel, Royal Bank of Canada. Represented from the
Toronto Financial Services Alliance were its President,
Janet Ecker (former Finance Minister of Ontario) and
Susan Viegas, City of Toronto, Economic Development
Bureau. Represented on the U.S. side were Consul
General Jessica LeCroy, Pol/Econ Consul Sherri
Holliday, Pol/Econ Officer Tom Boughter, and Pol/Econ
Specialist Colin White.

LECROY