1. Corporate Governance in Financial Institutions OCDE/IAIS/ASSAL Conference on Insurance Regulation & Supervision in Latin America Punta Cana, Dominican Republic 9 May 2003
Lonny McPherson
Senior Advisor
International Advisory Group

2. Discussion Points OSFI- background
The Importance of Corporate Governance in Financial Institutions
OSFI’s risk-based supervisory framework
OSFI’s Corporate Governance Guide
External Oversight Providers
Good afternoon Ladies & Gentlemen,
I would like to thank the organizers of the conference for the invitation to speak to you this afternoon I attended and spoke at the conference in Honduras last year and am happy to be here in Domincan Republic.
I have been asked to speak about Corporate Govrenance and will do so from a regulators persepctive .
Since I speak only a little spanish, my presentation will be in english, however I have arranged to have the slides translated into Spanish (copies in handout material). Please let me know if there are any errors on the slides as we are using a new translation service at OSFI . I also have some copies of the slides in english if anyone is interested.
The failure of high profile companies such as Enron and Worldcom have illustrated the rapid and serious impact of a loss of creditor and investor confidence in the marketplace and had focused attention on corporate governance processes and the integrity of financial reporting. Regulators around the world are looking closely at issues surrounding board effectiveness, the integrity of the audit process, the adequacy of accounting rules and financial disclosure. There are a number of topics regarding corporate govrenanceand in the next 25 minutes or so I would like to speak about what we as supervisors of Fincnail insutitions in Canada have been doing in this area: read slide

3. OSFI – Some Background
Canada’s primary regulator of financial institutions
Est – agency of Gov’t of Canada
independent – funded by Industry
Legislated mandate (OSFI Act)
Integrated supervisor
supervise/regulate all banks (54), and all federally incorporated or registered trust and loan companies (65), insurance companies (306), cooperative credit associations (7) and pension plans (1,189)
Prudential regulator
The office of the Superintendent of Financial Institutions (OSFI) is the prudentiaol regulator of federally registered insurnace companies, deposit taking insutitions (Banks and trust companies) and pension plans in Canada. Our madate is primarily to safeguard policyholders, depositors and pension plan members from undue loss.

4. OSFI’s Supervisory Approach
Reliance based
Relationship manager concept
Risk focused – judgment
Continuous monitoring
on-site/off-site
Interventionist
Consolidated supervision
Transparent
Adhere to Core Principles
We use a variety of superviosry methods, inclduing superviosry oversight, to help us meet our mandate. Within OSFI’s risk-based superviosry framework, insututions are evaluated according to a comprehensive set of criteria

5. Corporate Governance in Financial Institutions
OSFI definition
the oversight mechanisms, including the processes, structures and information used for directing and overseeing the management of a company.

6. The Importance of Corporate Governance in Financial Institutions
Encompasses the means by which the Board and Senior Management are held accountable for their actions and for the establishment and implementation of oversight functions and processes.

7. The Importance of Corporate Governance in Financial Institutions
OSFI regulatory framework has 3 components:
1) supervision by OSFI
2) direct oversight – Board/Senior management
3) independent oversight – external auditor, actuary
Components must work together

8. The Importance of Corporate Governance in Financial Insitutions
OSFI’s risk based Supervisory Framework consists of an assessment of:
risk profile
financial condition
risk management processes
compliance with applicable laws/regulations

9. The Importance of Corporate Governance in Financial Institutions
Effective corporate governance is essential to the safe and sound functioning of a financial institution
Board & Senior Management are designated as key control functions in OSFI’s Supervisory Framework

11. OSFI’s Corporate Governance Guideline
Focuses on issues relevant to financial institutions
Outlines OSFI’s expectations of boards and management
Provides information on factors to assess quality of governance
Not a checklist of criteria
OSFI had begun to increase its focus on corportate governance prior to the failures of high profile compoanies in the marketplace such as Enron and Worldcom; we issued a paper on corpoate governance in financial istitutions back in 2001, which was developed into a a guidelineand issued in January This guideline, titled Effective Corporate Governance in Federally Regulated Financial insitutions focuses on issues of relevance to FIs – not to unnecessarily duplicate the complete range of other good guidance being issued (e.g. the OECD paper on Corporate Governance, the IAIS Revised Core Principles which have been expanded for the ICP on Corporate Governance by stock exchanges, securities commissions or other governmental bodies.
-the guideline outlines OSFI’s expectations of Baords of Directors and senior management of financial inaitituions
-it provides information on the factors used to assess the quality of corporate governance . (Assessment Criteria for the Baord ans Senior Management, which are key risk management control functions
-should not be viewed as checklist requiring extensive documented policies/procedures – rather it outlines general attributes important for Board effectiveness
-I should point out that corporate governance and related matters are expected to remain on our federal governments’ policy agenda for the foreseeable future. In fact the Department of Finance issued a discussion paper in 2003 on corprate governance, which is directed more generally to coporataions, although there are sections related to FI’s such as policyholder rights in iinsurance companies. I can direct you to the Departmrent of Finance website if anyone is interested in obtaining a copy of the paper (

12. OSFI’s Corporate Governance Guideline –Key Provisions
Role of the Board in risk management
Role of the Board in internal controls
Role of the Board in independent oversight functions
Governance of subsidiaries
Board independence
How OSFI assesses effectiveness of corporate governance
The guideline focues on coproate goverannce principles of particlar importance to financial instituions, including the role of the Board of Directors in : risk management, internal controls and the the independent oversight functions: the internal and external audit and the actuarial function, which I will cover briefly.
Other areas covered in the guideline include: coporate goivernance of subsidiaries, and Board independence
We do not have time to cover all of these areas, a copy of the guideline is available on our website (english and french) and copy provided in your handout material.I will speak about the first three items :

13. OSFI’s Corporate Governance Guideline
Role of the Board in Risk Management
Understand the institution’s risk exposures
Review & approve overall risk philosophy & risk tolerance of the institution
Review & approve policies for accepting, managing & reporting significant risks
Review & approve organizational structure supporting risk management functions of the institution
The Board has a number of oversight responsibilities with respect to risk management; to be effective the Board should: Read slide -

14. OSFI’s Corporate Governance Guideline
Role of the Board in Risk Management
Require from management timely and accurate reporting on: significant risks; procedures & controls for managing risk; overall effectiveness of risk management processes
Assure itself that risk management functions have sufficient independence & are subject to periodic reviews
Effective Baord practices incldue that the Board: Read slide
For your information OSFI has also issued Standards of Sound Business Practice where we outline the role of the Board and Senior manamgent as risk manamgement control functions (available on the OSFI website)

15. OSFI’s Corporate Governance Guideline
Role of the Board in Internal Controls
Ensure management establishes and maintains a sound system of internal controls
Review internal control systems on a high level to ensure functioning as expected, including review of internal & external audit opinions on aderquacy of controls
Require management to take prompt corrective action on deficiencies
Internal controls encompass the policies, processes, culture, tasks and other aspects of an institution that support the acheivement of the institutions objectives. They facilitate the efficiency of operations, contribute to effective risk namangement, assist compliance with applicable laws and regulations and stregthen capacity to respond approriately to business opportunities.
The development and implementation of an adequate and sound system of internal controls is the reposnsibility of senior manangement. The Baord of Directors however is ultimately responsible for ensuring that such a system is established and maintained.

16. OSFI’s Corporate Governance Guideline
Role of Board -Independent Oversight Functions
Approve mandates and organizational structures of these functions, promote their capacity to operate effectively & independently, with access to the Board
Recommend appointment of external auditor and heads of internal oversight functions
Ensure the functions have resources & authority to perform duties
Establish committees, such as Audit Committee to oversee these independent oversight functions
In some of its oversight responsibilites, the Board relies on the advice and opinions of independent oversight functions (internal audit & compliance departments,the external auditor, the appointed actury for insurnace companies, and risk manamgemtn departments where such function exists sepoerately – we refer to these as Risk Management Control Functions in OSFI’s Superviosry Framework). It is recognized that individual institutions will adopt different approaches to Board oversight of independent oversight functions, taking into account the nature, scope, complexity and risk profile of their institutions.
To assure itself that these functions are in a position to suport the board as exepcted, the Board in general terms should:
READ Slide
Legislation in Canada requires that each financial sintitution establish an audit committee comprised of non-employee directos, a majority of whom are not “affiliated” with the company (they should be indepdendent). The guideline outlines OSFIs expectations of the tole of the aduti committee, including satisfying itself that the insuitutions audit plan is risk based and covers all relevant activites over a measurable cycle.

17. OSFI’s Corporate Governance Guideline
How does OSFI Assess the Effectiveness of Governance?
A variety of factors, the most important of which are findings from monitoring/on-site examinations
Board/Committee minutes
Increasingly involved in discussions with Board and Committees
Within OSFI’s risk- based Superviosry Framework, instituions are evaluated according to a comprehensivce set of critieria (Superviosry Assessment Guides on website, copy in handout of the example for Assessment of the Board of Directors) Key among them is the quality of oversight and risk management provided by the Board of Directors and Senior manamgement of the institution- the quality of corporate governance, in short.

18. OSFI’s Corporate Governance Guideline
How does OSFI Assess the Effectiveness of Governance?
Ratings Criteria for Boards
Composition
Role/responsibilities
Nature/operations of Board Committees
Board practices
Self assessment programmes
The Superviosry Assessment Guides outline a number of characteristics that OSFI looks for in the oversight function. For example r Board of Directors characteristics as assessed on the following elements: READ Slide
It is recognized that these characteristics contribute to, but do not guarantee, effective goverannce.

19. OSFI’s Corporate Governance Guideline
How does OSFI Assess the Effectiveness of Governance?
OSFI looks for indications that appropriate processes and procedures are in place to help the Board carry out its responsibilities AND
that these responsibilities, are in fact being carried out
Characteristics + Performance= Effectiveness
In assessing the effectiveness of governance, we use a two-fold approach: we conduct as assessment of the governance process against a range of characteristics; and as assessment of the insatitutions performancxe in carrying out its governance reponsibilities.

20. OSFI’s Corporate Governance Guideline
How does OSFI Assess the Effectiveness of Governance?
Effective Performance
appropriate organizational structures, policies and controls help promote good corporate governance but do not ensure it.
effective corporate governance is primarily the result of dedicated Directors and Senior Managers performing faithfully the duty of care

21. OSFI’s Corporate Governance Guideline
How does OSFI Assess the Effectiveness of Governance?
Effective Performance (cont’d)
what makes structures and policies work are knowledgeable and competent individuals, with a clear understanding of their role and strong commitment to, and in, carrying it out.

22. OSFI’s Corporate Governance Guideline
How does OSFI Assess the Effectiveness of Governance?
Remember “one size does not fit all”
OSFI takes into consideration that institutions will adopt different approaches to governance based on size, complexity and nature of their significant activities

23. External Oversight Providers
High quality checks/balances in the oversight of FIs are cornerstone of effective governance
this is why OSFI cares about quality of internal control and integrity of external oversight processes such as external audit or actuarial reviews.
New peer review process for reports of Appointed Actuaries (Canadian Institute of Actuaries)
Read slide
OSFI has issued a draft guideline in November 2002 to the industry that would require peer review of the reports of the appointed actuary every three years effective at the end of 2003 for all federally registered insurance companies in accordance with standards issued by the Canadian Institute of Actuaires (to be finalized).

24. External Oversight Providers
Canadian Public Accountability Board
Established to promote high quality, independent auditing of public companies in Canada
Superintendent is member of the Council of Governors
involves a materially enhanced practice inspection function and a significant degree of public oversight
will have specific authorities/responsibilities including ability to levy sanctions and impose discipline.
The integrity of the external audit process and related accounting and audit standards resluted in the creation of two new oversight bodies in Canada during OSFI represented the fedral governement in the creation of the Canadian Public Accountability Baord, which oversees the quality control of the audits of public companies in Canada. OSFI’s involvement reflects the fact that Canada’s large financial insititions are major public issuers and the federal government has a stake in the integrity of Canada’s financial markets.

25. External Oversight Providers
Accounting Standards Oversight Council
focuses inter-alia, on the implications of Enron for accounting and auditing standards
recently endorsed accounting standard setters proceeding to require expensing of stock options.
Superintendent is a member
An additional new oversight body created in 2003 was the Accounting Standards Oversight Council, of which the Superintendent is also a member. It is more focued on accounting standards, although I would like to point out that under the Insurnace Act in Canada, the Superintendent ratins the powere to issue directions on the apllication of generally accepted accocuntig principles to financial institions in Canada.

26. As many people are now aware, as depicted by this cartoon of a Compnay Executive in prision, after the high profile failure of companies such as Enron and Worldcom, the use of generally accepted accounting principles has received increased attention by the marketplace and regulators.

27. Corporate Governance in Financial Institutions
Conclusion
In the current environment, it is important that regulators and policy makers look to the lessons of Enron and other corporate failures, to enhance sound corporate governance practices, and also to ensure we can continue to rely on the work of those who provide independent oversight functions to corporations whose stakeholders rely on them

28. Thank you www.osfi-bsif.gc.ca