OTTAWA — Finance Minister Jim Flaherty is close to releasing new regulations to close loopholes that have allowed banks and securities dealers to sell a class of securities now worth more than $20-billion, while telling investors little about what they were buying.
Mr. Flaherty told an audience in Washington yesterday that he will be "moving forward" within the next couple of months with final regulations aimed at forcing clearer disclosure by sellers of principal protected notes, or PPNs.
PPNs act as a risk-free way to invest in mutual funds, baskets of stocks, commodities and hedge funds. Each PPN is backed by a guarantee from a bank that investors will do no worse than get their money back after a term of three to 10 years.
There is some evidence the assets are becoming a haven in turbulent markets. A total of $5-billion was invested in PPNs in the first nine months of last year, compared to $5.1-billion for all of 2006. Investors had plowed $22.3-billion into PPNs as of Sept. 30, 2007 from virtually nothing in 1999, according to research firm Investor Economics.
The startling growth of the market caught the attention of policy makers and regulators because the sellers of PPNs tended to obscure the relatively high administrative fees they attached to the assets.
Typically, there are commissions when an investor buys a PPN, and continuing fees that can cut into returns. Other criticisms are that PPNs are too opaque in terms of explaining how people can profit from the underlying investments in their notes, that it's too hard to monitor how PPNs are performing in the years before they mature, and that PPNs are hard to sell before maturity.
Mr. Flaherty, who first promised to tackle the regulation of PPNs in the 2007 budget, blames the current rules governing PPNs for the lack of disclosure.
He says the regulations are rule-based, so that sellers can easily find loopholes that allow them to hide information from investors without actually breaking the law.
Instead, he favours "principles-based regulations." Rather than a laundry list of things sellers must do to comply with the law, Mr. Flaherty's draft revision, first proposed in November, opts for broader statements that would force banks to do their best to honour the intent of the rules.
For example, the draft regulations require that disclosures "must be made in language that is clear and simple and in a manner that is not misleading."
"As these products grew more varied and complex, it became clear that the old disclosure rules were no longer adequate," Mr. Flaherty said in the text of a speech he gave at a conference on financial literacy.
Finance Department spokesman David Gamble declined to be more specific about when the final guidelines would be released. The government's goal is to have them in effect by July 1, Mr. Gamble said.
Mr. Flaherty's rules will apply only to banks and other sellers supervised by the federal government.
Canada's banks support the changes, according to their industry association.
"The Department of Finance consulted with the banking industry and others when developing the regulations and we were generally comfortable with the approach the government was taking," said Robin Walsh, a spokesman for the Canadian Bankers Association. "The banks have already begun enhancing disclosure on a voluntary basis to ensure consumers understand the fees, returns and risks of PPNs."
