The federal Department of Finance Canada is in the midst of a consultation on possible reform to the legislation governing the financial services sector. In August, Finance Canada released its second consultation paper as part of a two-stage review, laying the groundwork for possible legislative change, which is due by the end of March 2019.

One of the central issues highlighted in Finance Canada’s paper is the state of innovation in the banking sector and the rise of financial technology (fintech) firms, which are developing new, high-tech ways of delivering financial services to consumers.

This trend is fodder for review because, under existing legislation, there are curbs on the types of activities that banks can engage in and on their involvement with fintech firms, which the banks would like to see eased.

The Canadian Bankers Association (CBA) argues in its response to the consultation that the current environment is unduly restrictive because it prevents certain relationships between banks and fintech firms, and impedes banks from investing in fintech firms. The CBA calls on the government to dismantle some of these barriers. (See story on page 14.)

“We are facing a defining moment for the future of financial institutions and the framework should ensure that banks are positioned to participate in fintech fully in this era of rapid technological [change],” the industry trade group states.

Investor advocacy group the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) argues in its submission to Finance Canada that the financial services sector already has shifted dramatically away from its basic function of taking deposits and providing loans, toward the sale of increasingly complex financial products and the provision of advice.

“The banks are in a unique position to have a significant impact on the long-term financial security of Canadians,” FAIR Canada’s submission states. “However, there has been little regulatory change to account for the increasing ‘holistic and advisory nature’ of relationships between employees and customers.”

Thus, FAIR Canada calls on federal policy-makers to introduce a “best interest” standard on financial services sector employees who provide advice to clients.

The prospect of a “best interest” standard is the subject of intense debate at the provincial level, where securities regulators in Ontario and New Brunswick are pledging to develop such a standard for the financial advisors they oversee. An expert committee in Ontario also is recommending that a “best interest” standard be introduced for all advisors and financial planners in the province as part of a broader effort to introduce regulation to the planning industry. FAIR Canada is now taking the debate to the federal level.

Significant step

“A best interest standard would combat the proliferation of harmful products, damaging sales practices and financial incentives not in the client’s best interest,” FAIR Canada’s submission says. “A best interest standard would be a significant step [toward] ensuring that Canadians do not receive mis-selling and compromised advice, and would require banks to adapt their business practices so that employees no longer prioritize sales over the interest of the client.”

Although the best interest debate addresses how human employees treat financial consumers, the growing role of technology in both the financial services sector and society generally raises questions about how the machines financial services firms employ treat clients. As firms collect more data about clients and develop increasingly powerful technology for analyzing and utilizing the data, their ability to drive consumer behavior grows stronger, too.

One way policy-makers are considering to push back against the growing power imbalance between the industry and consumers is so-called “open banking,” which involves requiring banks to share their consumers’ data with third-party firms. Already, some jurisdictions, such as Europe, are mandating open banking as a way of stoking competition and empowering consumers by pushing banks to share client data with other firms.

In theory, this shift would foster greater competition that results in consumers enjoying better financial products and services. But given generally low financial literacy, many people may not be in a position to judge whether they’re getting a good deal in financial services. The idea also carries privacy and security risks.

At this stage, the traditional industry players – big banks and insurers – are highlighting the risks and downplaying the possible consumer benefits that open banking could bring. They recommend that policy-makers take a slow approach in introducing open banking.

Apart from the issues related to the power imbalance between the financial services sector and consumers, the Finance Canada paper also tackles some higher-level corporate governance concerns, such as issues of gender diversity and shareholder democracy.

Gender diversity

For example, Finance Canada is proposing to introduce a “comply or explain” model, requiring federally regulated financial services firms to disclose their approach to gender diversity as a way of fostering greater diversity. Finance Canada also contemplates several shareholder-friendly requirements designed to combat director entrenchment, such as mandating annual director elections and requiring majority voting standards.

These proposals are getting a strong “thumbs up” from institutional investor groups such as the Pension Investment Association of Canada and the Canadian Coalition for Good Governance (CCGG). The latter group states in its submission that measures designed to encourage improvements in diversity and to enhance shareholder democracy “are critical to modernizing the financial sector framework.”

Shareholder advocates are calling on policy-makers to go further by introducing enhanced proxy access, which would give significant shareholders the power to nominate their own directors alongside managements’ candidates.

The CCGG’s submision says shareholders who own 3% of a company for at least three years should have the right to nominate up to 20% of the board, and that both the shareholder nominees and the management nominees should be placed on a universal proxy for shareholders to consider.

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