Canada to Increase Regulation of Over-the-Counter Derivatives

Canada will give banking regulators more power to oversee derivatives trading as part of a series of steps to shield the nation’s financial industry.

The government will amend the Bank Act to create “explicit regulation-making authority” over banks that trade standard derivatives, Finance Minister Jim Flaherty said in his budget released today in Ottawa. The move may broaden the powers of the Office of the Superintendent of Financial Institutions, which currently regulates some aspects of derivatives trading.

Canada is trying to prevent improper trading in the nation’s financial markets and reduce risk in its housing market and banking industry, which has already been ranked the world’s soundest by the World Economic Forum. The government is also trying to promote competition by bolstering smaller banks.

Canada plans to eventually assign oversight of derivatives trading to its proposed national securities regulator. The changes will make it easier for Canada to bring its regulations in line with foreign agencies such as the U.S. Commodities Futures Trading Commission, according to the budget.

“This is a sign of things to come, as Canada and other jurisdictions try to impose more transparency on the darker corners of derivatives,” said David Tulk, chief macro strategist for TD Securities. ”It does ultimately reinforce the stability of the financial system.”

The government said it will step up regulation of financial benchmarks set by banks, a change that could affect how the Canadian dollar offered rate, also known as CDOR, is set. The rate is based on submissions by banks and is used as a benchmark for derivatives.

Rules, Regulations

Canadian banks shouldn’t have difficulty adjusting to the new rules given the international financial regulations with which they’ve already complied, Tulk said today in Ottawa.

The budget also takes more steps to insulate taxpayers from a downturn in the nation’s housing market. The Bank of Canada has identified record household debt as the biggest domestic risk to the financial system.

Canada Mortgage & Housing Corp., a government-owned housing agency, will reduce the amount of portfolio mortgage insurance it provides this year to $9 billion ($8.1 billion) from C$11 billion, according to the budget. CMHC will also pay guarantee fees to the federal government starting this year to compensate for mortgage insurance risks. Private insurers already pay these fees.

CMHC insures mortgages against default, and its insurance is fully backed by the federal government. By law, Canadian mortgages that have less than a 20 percent down payment must be insured.

Mortgage-Backed Securities

Financial institutions often buy such insurance in bulk so they can repackage home loans as securities for investors.

The government said it will reduce the amount of mortgage-backed securities it guarantees from C$135 billion last year to C$120 billion in 2014.

Canada will also review its deposit-insurance system, according to the budget. Currently, the Canada Deposit Insurance Corp. covers up to C$100,000 of an individual’s savings in the event a bank fails.

In addition, the government will introduce legislation to crack down on money laundering and terrorist financing through the use of unconventional currencies such as Bitcoin.

To boost competition in the finance industry, the government will make it easier for small banks to access funding from CMHC. The budget also proposes steps to make it easier for new banks to be established and to ease mergers of credit unions.

To contact the reporter on this story: Andrew Mayeda in Ottawa at amayeda@bloomberg.net

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net

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