Innocent Bystanders

PART XIII’S SILVER LINING

Canada’s (re)insurance community should not be relying on the Office of the Superintendent of Financial Institutions (OSFI) to interpret on its own behalf the meaning of Part XIII changes to be implemented in 2010, a lawyer told a KPMG ‘Regulatory Update’ seminar.

Instead, foreign (re)insurers with branch offices in Canada should be seeking their own legal opinions about whether the risks they are writing are in Canada, said seminar panelist Robert McDowell of Fasken Martineau LLP.

“You shouldn’t be in a position, I think, that you should be asking OSFI [how to interpret the test],” McDowell said. “I think you should be in a position where you come to your own views, with the assistance of legal advice as you see fit.”

OSFI’s regulations for implementation of amendments to Part XIII of the Insurance Corporations Act include a four-part test for determining whether risks are written in Canada.

McDowell acknowledged the current confusion surrounding the four-part test and how OSFI might ultimately interpret it. But even though he felt like he was “the least popular person” in the room for saying so, McDowell said he believed OSFI undertook a great deal of prior consultation on the matter and “did the best they could” with the new regulations.

He noted OSFI created its new test based on an extensive examination of legal principles and rulings that deal with the question of which courts or laws should apply to cases that span multiple geographical territories.

The test in these sorts of cases is whether the facts in the case have “the closest and most real connection” to the legal jurisdiction in which the case is tried.

McDowell cited numerous court cases and authorities in which various factors are outlined to help courts figure out which laws should apply to multiple-jurisdiction fact situations. He said these authorities laid the groundwork for OSFI’s four-part test as to where the business of insurance is located.

McDowell thought OSFI’s four-part test could be interpreted optimistically as providing (re)insurers leeway to determine for themselves whether particular business lines could or should be written inside or outside Canada.

“A foreign reinsurer or insurer may have the best of both worlds in this new policy, and I think this has to be regarded as a win,” McDowell said. “Wherein there was a lot of uncertainty before — of course there still can be in the examination of said facts — but now there’s a real opportunity to decide which lines of business or particular clients or particular products or deals are we going to do as a foreign insurer outside of Canada and which ones we’re going to do inside of Canada.”

FAIR VALUE AN INNOCENT BYSTANDER

Fair value accounting (FVA) is an innocent bystander in the current financial crisis and should not be blamed for perpetrating market volatility, panelists at a KPMG seminar said.

“Fair value is not responsible for where we are today,” panelist John Reucassel of BMO Capital Markets said. “To suggest otherwise is ridiculous.

“We are where we are today because people borrowed too much money and we’re going to have to pay that back.”

Reucassel was a member of the breakout panel that kicked off KPMG’s 17th Annual Issues Conference Regulatory Update held at the Metro Toronto Convention Centre. The panel discussed a number of topics around new international financial reporting standards, including what role, if any, fair value accounting plays in the current financial volatility of the markets.

Fair value accounting obliges companies to measure and report the “exit value” of their assets or liabilities. That is, companies must report the current market price the company would receive if it sold an asset, or the cost to the company if it is transferring a liability, at the time the value is measured.

Critics of fair value argue that the market values of assets or liabilities are unreliable in unpredictable markets such as this one. Some note the current value of a company’s assets or liabilities may be “unrealized,” in the sense that the company has not actually sold the assets or transferred the liabilities (and may have no intention of doing so). And yet, when current values are disclosed, shareholders might act hastily and unload or buy shares in the company, thus causing a company to sell their assets or transfer their liabilities earlier, thus potentially driving down the value of the company’s assets further. Thus, critics say, fair value accounting in a bad market cycle can result in snowballing, self-reinforcing write-downs, leading to further unpredictability in the market.

But blaming fair value for causing the current market difficulties is really just shooting the messenger, David A. Thompson of KPMG said in a separate panel on the new financial reporting standards.

Tricia O’Malley, the director of implementation activities at the International Accounting Standards Board, agreed fair value accounting is merely a reporting instrument, it doesn’t dictate business decisions. “I don’t think the accounting standards have ever caused anybody to sell something they didn’t want to,”she said.

“I will note in passing that nobody was objecting to implementing [FVA] when the markets were going up. In fact a whole bunch of those banks [now at the centre of the market volatility] adopted it early.”