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Canada’s magazine of Corporate Finance

Banking and Financial Services Report: Federal policies are changing the future of credit unions

Executive Profile: Summer 2014 • www.canadiantreasurer.com

In conversation with Duane Gomes of Everlink

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Staying upright on a Sea of Change Complying with Canada’s AML laws HR management and the skills gap

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Canada’s magazine of Corporate Finance

Table of Contents SUMMER 2014 • www.canadiantreasurer.com

Departments & Columns 4

Industry Watch

Features 8

Staying Upright on a Sea of Change Leveraging the forces of change when the external environment is roiling can be the key to successfully navigating the tumult.

Seven Federal Policies that are Changing the Future of Credit Unions What happens in Ottawa matters and these seven policy issues are only the tip of the iceberg of what issues will affect credit unions

Profile

In Conversation with Duane Gomes The vice-president of finance at Everlink talks about the changing role of financial executives

Departments

In the next issue: Best practices for data incident management, risk analytics, and asset management, as well as the information you need to know to establish or renew a group employee benefits package.

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Governance Handing Over the Reins

Regulatory Accounting for the Purchase and Sale of Lease Portfolios

HR Management Skills Gap Widens as Finance Oversight of HR Increases

Compliance Important Changes to Canada’s AML Laws: Here We Go Again

Your Team Do You Need an Internal Auditor?

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Industry Watch

CFOs increasingly optimistic about economic growth, spending more on technology and workforce There is a surge in both economic optimism and capital spending plans among middle market and large corporate finance executives, says the ‘Annual CFO Survey’ by the TD Bank. Among the CFOs surveyed, nearly 60 per cent are optimistic about U.S. economic growth this year, compared to 46 per cent last year, and half expect to increase capital expenditures due to stronger revenue growth. The top areas for increased spending include technology (64 per cent), existing facilities (42 per cent), and workforce hiring (40 per cent) in 2014. The percentage of respondents who intend to hire additional workers rose significantly – nearly 15 per cent – through 2013. “The increased appetite for capital investments confirms our view that businesses are finding ways to thrive in the ‘new normal’ economy,” says Greg Braca, executive vice-president and head of corporate & specialty banking at TD Bank. “Increased spending at the corporate level bodes well for the longterm acceleration of growth and M&A, with companies recognizing that now is a great time to make a move before interest rates creep higher.”

Summer 2014 Volume 25 Number 11 President Steve Lloyd steve@canadiantreasurer.com Editor Karen Treml karen@canadiantreasurer.com Contributors Dr. Marc-Andre Pigeon, Director of Financial Sector Policy at Credit Union Central of Canada Robert D. Katz, CTP, CPA, MBA, Executive Sounding Board David Chaiton, a former director of the CFLA and member of its legal committee

Duane Gomes, Vicepresident of Finance, Everlink Payment Services Dawn Jetten, Partner and Co-chair, Jacqueline D. Shinfield, Partner, and Vladimir Shatiryan, Associate, Blake, Cassels & Graydon LLP

Creative Direction / Production Jennifer O’Neill jennifer@canadiantreasurer.com Photographer Gary Tannyan Corporate Sales Manager Mark Henry mark@canadiantreasurer.com

Despite optimism, concerns linger Although the majority of finance executives surveyed are optimistic about the outlook for the U.S. economy and their own companies, government regulation and political gridlock over the budget deficit and tax policy continue to top their list of concerns: ◉◉ ◉◉ ◉◉ ◉◉ ◉◉

Government regulation (22 per cent) Competitive environment (22 per cent) Political gridlock over U.S. budget deficit and tax policy (15 per cent) Global volatility (14 per cent) Cost of doing business (10 per cent)

“While there’s still unease about the business environment, CFOs are much less concerned than they were even just a few years ago,” says Fred Graziano, executive vice-president and head of regional commercial banking for TD bank. “Only the competitive environment was viewed with increased concern over 2013, but that’s a good thing. Competition exists because the overall business climate has improved, which the Fed has confirmed by seeking to raise interest rates sooner than initially expected.” The full results of TD Bank’s ‘Annual CFO Survey’, including regionally specific findings from the Carolinas, Florida, Massachusetts, Metro D.C., New Jersey, New York, and Pennsylvania, can be found at https:// mediaroom.tdbank.com/surveys.

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Industry Watch

Middle market sees more potential for growth Eighty-one percent of respondents expect their companies’ revenues to increase in 2014, a 10 per cent increase from 2013, with the majority anticipating relatively small increases in the one to nine per cent range. Middle market finance executives reported they’re more optimistic than their corporate counterparts with regard to revenue increases: ◉◉ 17 per cent of middle market CFOs anticipated a revenue increase of 10 to 14 per cent, compared with 10 per cent of corporate CFOs ◉◉ 16 per cent of middle market CFOs anticipated a revenue increase of 15 per cent or more, compared with 14 per cent of corporate CFOs

More than twothirds of respondents currently have cash holdings stockpiled, but less than a quarter intend to put the funds to use as part of their business strategy this year. Most companies plan to hold the cash into next year at least.

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CFOs confidence in economy highest since 2006 For the first time since 2006, more CFOs believe the state of the U.S. economy will improve (51 per cent) rather than remain the same or worsen (49 per cent) during the next six months, says the Grant Thornton LLP ‘2014 Spring CFO Survey’. This also marks the highest percentage in the survey’s history, which reflects the insights of more than 1,000 CFOs and other senior financial executives across the U.S. In fall 2013, 40 per cent of respondents said the U.S. economy would improve or significantly improve compared to 45 per cent in the firm’s spring 2013 survey and just 25 per cent in summer 2012. “While optimism slipped a bit in the fall — likely due to gridlock in Washington at the time — the results of our spring survey and recent improvements in key economic indicators seem to signal that the slow increase in confidence in the U.S. economy might be back on track,” said Stephen Chipman, chief executive officer of Grant Thornton. “However, in order for businesses to feel confident in long-term growth, hiring and investment, our country’s leaders must pave a path to progress and a sustained economic recovery by ensuring stability in fiscal, public, and tax policies.”

Increased optimism among CFOs is prevalent throughout the survey results, with 51 per cent of those surveyed predicting that industry financial prospects will improve or significantly improve during the next six months, compared to 44 per cent in the fall. The manufacturing industry’s optimism trended even higher, with 56 per cent of respondents from that sector expecting an improvement in financial prospects during the next six months. This marks an increase from 51 per cent in the fall survey. The number of CFOs who believe the pricing or fees charged by their industry will improve or significantly improve increased to 41 per cent, up from 37 per cent in the fall. For manufacturing executives, this number increased to 44 per cent, up from 39 per cent in the fall. According to the survey findings, 46 per cent say their company’s headcount will increase or significantly increase during the next year, up from 40 per cent in spring 2013. In addition, 68 per cent of CFOs expect the average cost of an employee’s salary to increase during the next 12 months, revealing no change from the fall, but up from 65 per cent one year ago.

Financial planning and employer accommodation crucial for the disabled A financial plan can play a pivotal role in easing financial stress for the 3.8 million Canadians who have a disability and for those caring for them, says a report by the BMO Wealth Institute. The report also notes that, as the population ages, the percentage of Canadians who will become disabled will rise. Currently 42.5 per cent of Canadians over the age of 75 identify themselves as having some form of disability, with hearing loss, mobility issues and memory loss being among the most prevalent. “In our aging society and with the prevalence of disability on the rise as we age, a disability can lead to significant challenges for individuals and their families,” says Chris Buttigieg, senior manager, wealth planning strategy, BMO Financial Group. “Therefore, it’s important that Canadians understand how disability can affect one’s personal and financial situation. Planning for the possibility of a disability should be a consideration in any financial plan to help safeguard individuals and their families from the unexpected.” Having a well-constructed financial plan that properly utilizes a variety of tools – wills; powers of attorney; tax-free savings accounts (TFSA); investment accounts; and registered disability savings plans (RDSP) – can work to provide the most financial benefit. The study also found that Canadians believe employers have an important responsibility to accommodate people with disabilities. Respondents stated the following as the top improvements needed by employers to assist disabled workers – greater accessibility to company premises’ more supportive policies and practices in the workplace, such as people care days and flexible work arrangements; improved accommodations in the workplace; consumer friendly interactive devices, such as self-serve checkouts and direct payment devices; career development and training; and executive sponsorship and support in hiring disabled persons. “The longer an individual is disabled, the more pronounced the impact is on their ability to work and earn an income,” says Buttigieg. “While improvements have already begun in workplaces, it is crucial that employers continue to support employees requiring time, resources and flexible work arrangements to help them or their caregivers get the care and support that they need.”

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Regulatory news

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BANKING AND FINANCIAL SERVICES REPORT Regulatory news

Staying Upright on a Sea of Change Corporate treasurers can leverage tumultuous external environments to enhance their position within their organization. By Diane S. Reyes and Michael Cummins

CFOs and boards of directors are increasingly relying on the treasurer’s insights to help them make the right decisions at the right time. SUMMER 2014

hen the external environment is roiling, the key to successfully navigating the tumult is to not just accept, but in fact leverage, the forces of change. That often holds true for professionals in any career path, but it’s certainly the case for treasury professionals today. Since last decade’s liquidity crisis, the role of the corporate treasurer has been wholly transformed. In this era of heightened counterparty risk, low interest rates, and tight liquidity and credit, effective management of the treasury function has become a determining factor in businesses’ success. As a result, the role of corporate treasurer has become both more visible and more strategic than ever before. These days, CFOs and boards of directors are increasingly relying on the treasurer’s insights to help them make the right decisions at the right time. From ensuring that global capital levels are adequate to support growth and minimize liquidity risk, to engaging in corporate initiatives that require proficiency with increasingly complex accounting, tax, legal, and regulatory rules, the treasurer’s insights have been in high demand over the past decade. Likewise, the value of a strategic treasurer has become more pronounced. Effective treasurers today are measured on their ability to manage initiatives beyond the traditional role. And their ability to successfully support the varied needs of their company may well define the strategic direction of the organization. Of course, treasurers must continue to ensure that their company’s payments mechanisms are effective, that its cash flow forecasting and management are appropriate, and that

relationships with its banks remain productive. At the same time, they must navigate new regulations and technologies, which are having a profound impact on the day-to-day operations of their function, as well as on the banks that support them. And they need to be prepared to advise senior management on the cash-flow implications of expanding into new markets around the world. Managing it all is a challenge — but within the challenge lie unmistakable opportunities.

The regulatory opportunity People usually don’t think of government regulations as a source of great opportunity, but viewing regulations as only a burden is shortsighted. The recent onslaught of regulations, in its abundance, has changed the ways in which both banks and treasury functions operate. And the changes continue to come. Keeping up with these changes often presents challenges, yet smart treasurers are embracing the opportunities. For example, the Single Euro Payments Area (SEPA) presents substantial opportunities for any company that accepts payments or performs cash management functions within the Eurozone. Most organizations will have to alter their accounts receivable (A/R) technology infrastructure in order to comply with SEPA. Treasurers who embrace the potential for improvements that is inherent in this change are revamping processes and automating receivables activities. Some are looking at SEPA as a good reason to standardize and centralize payment processes, not only in the Eurozone but around the world. By going above and beyond, leading treasuries are finding opportunities to lower their company’s operating costs,

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Regulatory BANKING ANDnews FINANCIAL SERVICES REPORT increase integration among their software systems, and achieve big benefits through economies of scale.

Geographic economic power shift On top of the legal and regulatory issues that directly affect their function, treasurers need to stay abreast of the continuously evolving global economic environment. Economic power is clearly shifting to the south and to the east. HSBC expects growth rates of around 1.7 per cent for the developed world, compared with about 4.6 per cent for the emerging world, driven by Asia and Latin America. And while the rise of trade in the southern hemisphere may not appear to be a boon for Western companies, there are opportunities for developed-world businesses to plug into this growth if they know where they can add value in today’s increasingly disaggregated supply chains. Emerging markets are increasingly consumers and investors as well as producers. Latin America is already a net importer of manufactured goods. The astonishing fact is that globally another 2.6 billion people are expected to join the middle class in the next 40 years, most of them in the emerging world. In 2012, emerging economies generated almost one-third of global foreign direct investment outflows, according to the United Nations Conference on Trade and Development (UNCTAD). It is important to note that although China is a major force in emerging-market growth trends, it is not alone. In fact, we have already seen some manufacturers that operate in China shifting toward more sophisticated, less labor-intensive processes as land and wage costs rise there. These global geographic and demographic shifts are impacting companies’ working capital positions, their payables and receivables, their liquidity position, and their trade finance requirements. Due to the interconnectivity of the global economy, coupled with the inherent shift in economic growth, few treasury functions are isolated from these changes, regardless of their organization’s current mix of international and domestic business. Ultimately, we are all affected by the evolution of the macroeconomic global environment, and we will continue

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Corporate banking customers are gaining greater visibility into their money and greater power to direct it where (and when) they see fit. to be affected in the coming years. As corporations expand sales channels or supplier networks around the world, the challenge for treasurers will be extending the financial supply chain so that it always provides optimal support for the organization’s physical supply chain. In many cases, moving into new markets raises clearing-infrastructure or regulatory issues that the company may not have dealt with previously; issues that may well impact other areas, such as liquidity management. In global expansion, knowledge is power. Companies entering a new market need a clear picture of all the ways in which that market’s unique characteristics might impact their cash flow. Thus, treasurers can add real value when their organization is venturing into the unknown, by raising awareness of any laws and regulations in consultation with legal counsel and social conditions that may affect payables, receivables, borrowing, or banking activities in the region. A company’s expansion plans, including the introduction of new products, is not going to get off the ground easily if the treasury team doesn’t manage currency and foreign exchange issues properly, or if they’ve overlooked a necessary component of the infrastructure for making or receiving payments. Identifying, disseminating, and communicating this information requires a treasurer to leverage multiple information streams , including legal counsel, tax experts, consultants, client-facing resources, and banks. At the same time, the treasurer must cultivate an internal network for influencing and driving change within the company. The ability to consolidate knowledge from disparate sources and effectively convey it to corporate management is of paramount importance for global treasurers, especially when they’re entering new markets. Employing a communal approach to discussions about entering new markets – including steering

committee and working group members from each discipline – helps a treasurer, and his or her company, better understand all the relevant decisions. It’s a challenge, to be sure. But like regulatory changes in familiar markets, it’s also an opportunity for treasurers to prove their strategic worth.

Technology rules the day Technology has utterly revolutionized consumer banking over the past 10 years. Now it’s doing the same for commercial banking. Corporate banking customers are gaining greater visibility into their money and greater power to direct it where (and when) they see fit. For example, advanced rule-based end-of-day sweeping allows for a passive, scenario-based concentration of excess liquidity. Layered in on top of this are advanced rule-based investment engines that automate the management of excess liquidity positions to any number of investment end points. Additionally, the regional and global enterprise resource planning (ERP) tools that are now commonplace at many organizations enable treasurers to develop meaningful, objective, and strategic recommendations rapidly using realtime global information. As globalization continues to mature, so will the concepts of virtual and mobile treasury. Not only can new technologies simplify a treasurer’s day-to-day operations, but they can also provide valuable insights. The treasurer has a unique role, sitting across multiple information flows that could, and should, inform the CFO’s decisions. This information goes much deeper into corporate strategy than just cash positions. Internally, treasurers must effectively digest information and incorporate input from financial planning, business development, and sales and marketing to ensure that objectives are clear and that the necessary resources are made available. Externally, feedback from shareholders, ratings agencies, banks,

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BANKING AND FINANCIAL SERVICES REPORT and other credit providers should help shape the appropriate capital structure and deployment strategies. Treasurers who succeed in using technology to collect, marshal, and deploy information by orchestrating meaningful and comprehensive discussions can add significant value to their organization and thereby help solidify their strategic position within the company. Furthermore, corporate treasurers can leverage their relationships with the company’s banks to gain access to data. Ensuring their banking partner has international experience can help them make better-quality, more intelligent decisions about liquidity management and the company’s working capital. International banks are effectively the ambassadors of best practices in liquidity and working capital management across various industries and geographies. The strategic treasurer leverages the knowledge of his or her partner banks to understand the drivers of successes and failures in other organizations. In the future, clients will lean on banks more than ever before, and the ability of a bank to deliver valuable information will ultimately dictate the success of these relationships. In fact, HSBC has found that our conversations with our customers have changed. When considering expansion into a new market, clients now seek our help and guidance in how to structure their operations for success rather than help in just making payments. Aided by new technology and greater insights, banks are able to provide advisory services, as well as implement new technology. It’s a rapidly-evolving model of

‘value added’. These changes open up the possibility of new collaboration between companies and across all banking partners in a way that has not been possible before.

Embracing the trends At the intersection of technology advancements, evolving regulatory regimes, and global economic shifts sits the corporate treasury function. To meet expectations in this environment, a treasurer must bring valuable new insights to the conference room table. Many businesses are finding that the best way to sort out these insights is to standardize and centralize the global treasury organization. Smart treasurers help their company compare the benefits and tradeoffs of different organizational structures, weighing customization and independence of action against companywide strategic partnerships, collaboration, and shared services. According to a 2013 CapGemini payments report, several key industry initiatives under way now are specifically focused on payments, including SEPA migration. While their individual objectives may differ, they are all primarily aimed at standardizing processes for greater transparency and enhanced risk management. At the same time, many markets that have traditionally been restricted are opening up, making it more feasible to run a truly global treasury function. For example, China is working toward internationalization of the Renminbi (RMB), which will make it easier for companies to conduct cross-border business inside and outside of mainland China. In Canada, the industry

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bodies are looking at cheque imaging implementation and ISO 20022 that will change the domestic payment landscape. Clearly, there is no simple recipe for success in this day and age. Standardizing treasury is a good option for many companies, but it’s not right for every business. Ultimately, modern treasurers need to analyze the intelligence needs of their organization as it works to manage the risks and seize the opportunities that the future brings. Then they need to determine how they can generate valuable insights that support those decisions. At the top of the list for most treasurers will be understanding the macroeconomic changes in the world, analyzing the treasury impacts of globalization and the economies of scale that accompany it, grasping the ramifications on cash flow of the unrelenting march of technology, and positioning the treasury function for the increasingly important role companies are expecting it to fill. Those treasurers who embrace these trends – and, of course, their related insights – will be best positioned to thrive in the long-term. ABOUT THE AUTHORS: Diane S. Reyes is global head of payments and cash management for HSBC Holdings plc, managing profit and loss ownership, product, client, risk, and operations management as well as sales and distribution across the globe. Michael Cummins is executive vice-president and North America head of payments and cash management for HSBC, overseeing all sales, client, business, risk, and control management of the function as well as product strategy and innovation in the region. © HSBC Bank Canada 2014. All rights reserved.

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Regulatory BANKING ANDnews FINANCIAL SERVICES REPORT

Seven Federal Policies That Are Changing the Future of Credit Unions Can Ottawa affect the trajectory of 320 credit unions spread across the country? By Dr. Marc-André Pigeon

Introduction Credit unions can be forgiven for thinking that what happens in Ottawa does not really matter. Some of this sentiment may arise from simple geography: for some credit union communities, Ottawa is more than 5,000 kilometres away – out of sight, out of mind. In many more communities, the provincial capital or even the American border is much closer and a more real and present presence. Some of that sentiment is also surely regulatory – after all, credit unions are provincially regulated, as are their provincial/ regional Central organizations. And as local institutions, local matters are what matter. Too, some of it may simply be indifference. What could Ottawa possibly do to affect the trajectory of the 320 credit unions spread across the country, many of which are thousands of kilometers away? The reality is that increasingly, the decisions being made in Ottawa are, and will, reshape the credit union movement, which collectively holds more than $160 billion in assets. Each in their own way, the seven policy changes discussed below will likely compel more credit unions to

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merge, more credit unions to look at the federal option, and more credit unions to ask what the future holds.

1. OSFI disengagement Perhaps the most significant, but unheralded, federal policy change for credit unions is the one that was found on page 133 in Budget 2014. In an innocuous-looking bit of phrasing, the budget text simply noted that “joint supervision of provincial credit union centrals by the Office of the Superintendent of Financial Institutions (OSFI) will cease.” Superficially, this might seem like a good thing – who could be against less credit union regulation? But the consequences of this change could be far-reaching because it compels the provinces to re-examine how they regulate centrals, a role they currently share with OSFI, and ultimately how they regulate credit unions. No one knows what will come of this reexamination but at a minimum, it creates some degree of uncertainty that is amplified by the other federal policy changes discussed below. While provincial/regional centrals discuss these matters with their provincial governments and regulators, the credit union system’s national trade association, Credit Union Central of Canada (Canadian Central), has established a

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BANKING AND FINANCIAL Regulatory SERVICES REPORT news working group that is determined to make sure that whatever transpires federally, leaves credit unions in a better place than they are now.

2. The federal credit union option The federal credit union option is alive and well and getting more interesting by the day. Thanks to new measures in Budget 2014 advocated for by the credit union system, individual credit unions contemplating the move to the federal level will be able to take advantage of a more streamlined merger process, extended deposit insurance support, a more generous timeline to segregate out their insurance business, and the possibility of liquidity support should the move to the federal level lead to any loss of liquidity. While the specifics of these promises have yet to be spelled out, Canadian Central is working with the federal government to make sure they serve the interests of the system. It is also working to ensure that, should a credit union opt for the federal option, it will find a regulator that at least has some understanding of how co-operative financial institutions differ from their joint-stock counterparts.

capital and helped offset some of the tax preferences enjoyed by banks. Figure 1 shows just how dependent credit unions are on retained earnings for their capital relative to the banks. While small credit unions continue to benefit from the small business deduction available to any credit unions with up to $500,000 in taxable income and less than $15 million in taxable capital, larger credit unions have to contend with the phasing out of the Additional Deduction for Credit Unions (ADCU) that provided them with comparable tax benefits and saved Canadian Central-affiliated credit unions an estimated $28 million in federal taxes in 2012. The federal tax increase has also called into question provincial tax savings that were tied to the ADCU. To replace the ADCU, Canadian Central is proposing a Capital Growth Tax Credit (CGTC) that would be set at five per cent of the previous year’s increase in retained earnings. This tax credit, if implemented, could save the credit union system $35 million in taxes a year, helping them increase their capital and support additional lending in their communities. To make the case, Canadian Central is

a survey of affiliated credit unions to gauge the impact of regulatory burden on the system. The survey found that small credit unions – those with fewer than 23 employees – devoted 21 per cent of their staff time to dealing with regulatory matters whereas bigger credit unions – those with more than 100 employees – devoted on average only four per cent of their staff time to regulatory compliance. Since banks are many times bigger than the biggest credit unions, their share of employee-time devoted to regulatory compliance is undoubtedly smaller still, giving them a competitive advantage relative to the credit union sector. The survey also revealed that the most burdensome regulation was federal in origin, namely the anti-money laundering and terrorist financing regulations. Canadian Central has taken action to alleviate this burden. Beyond making representations to federal policymakers, Canadian Central has also set up a liaison group with the Financial Transactions and Reports Analysis Centre (FINTRAC) which has already, despite early going, delivered some promising results. Canadian Central has also asked the federal government to apply its red tape reduction lens to financial sector policy, recognizing that credit unions are the small businesses of the financial services world.

5. Crown competition

3. Tax policy changes By now, most people have probably forgotten most of what they knew about the federal government’s 2013 budget. For credit unions however, Budget 2013 is still a very present document because, unexpectedly, the federal government eliminated a tax incentive that for more than 40 years recognized the limited ability of credit unions to easily raise

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mounting a grassroots and high-level government relations campaign to put this proposal on the Government’s agenda.

4. Regulatory burden Regulatory burden. Red tape. Bureaucratic inertia. Call it what you will, but dealing with government rules can test anyone’s patience. In 2013, Canadian Central conducted

In a 1997 article for the Centre for the Study of Co-operatives on different organizational forms, academic Brett Fairbairn noted that “the function of public enterprise is … lost when it ceases to behave like public enterprises – when it adopts so many of the characteristics of private enterprise as to be functionally indistinguishable (emphasis added by original author).” Somehow, this simple but compelling point has been missed in Ottawa, at least insofar as Farm Credit Canada (FCC) is concerned. FCC has managed to grow its market share – and profitability – over a very long period of time, unhindered by any requirement to complement the activities of the private sector or even a periodic mandate review that might answer the question: what is FCC for anyway? Credit unions know this isn’t an esoteric

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Regulatory BANKING ANDnews FINANCIAL SERVICES REPORT question. They have lived the loss of business to FCC. And for some time now, Canadian Central has been working to fix the problem, setting up a liaison group and organizing regional meetings that by all accounts, have yielded promising results, with FCC taking measures to minimize competition between it and credit unions. Our repeated representations have also started to bear fruit, most recently helping spur a call by the House of Commons Finance Committee for a review of FCC’s mandate, an important first step in getting a complementarity requirement embedded in FCC’s legislation like the one that governs the Business Development Bank of Canada (BDC) and Export Development Canada (EDC), two Crown corporations that have been far more faithful to Fairbairn’s simple but compelling depiction of the role of government-owned enterprises.

Meanwhile, in Canada, the inexorable effects of inflation will reduce the value of $100,000 to closer to $80,000 by 2017 (assuming two per cent annual inflation), when the federal government does its next major review of financial services legislation. In the past this kind of depreciation has helped prompt a reset, as depicted in Figure 2. If the federal government extends its deposit insurance to something closer to the new international norm of $250,000, this could change the competitive balance between federally-regulated banks (and possibly credit unions) and provinciallyregulated credit unions.

7. Competition review It’s not much of a secret. Canada’s banking sector is oligopolistic. Canada’s five largest banks hold about 90 per cent of all banking assets in the country.

TBTF. The budget also promised to set up a ‘bail-in’ regime that could see some forms of debt convert into equity in a crisis, as well as “enhanced supervisory and recovery and resolution plans.” Budget 2013 also announced the federal government’s intention to conduct a competition review that could make it easier for new entrants, credit unions included, to get a federal charter. More recently, OSFI has appointed a senior official to handle matters related to small financial institutions. If these measures are halfway successful, credit unions could see the competitive landscape get more crowded as a new crop of foreign entrants move into the most lucrative markets. Canadian Central has generally been supportive of these pro-competition measures but has urged the federal government, and OSFI in particular, to pay attention to the peculiar features of financial co-operatives along the way.

Conclusion: But there’s more. Much more.

6. Deposit insurance review Budget 2014 contained another surprise, namely a promise to review Canada’s deposit insurance system. With the needle firmly parked at $100,000 of deposit insurance, Canada has become something of an anomaly in the developed world. The Australians had gone from no deposit insurance to unlimited to a million dollars to, finally, AU$250,000. The Americans had, in the midst of the crisis, upped the ante from US$100,000 to US$250,000. The European Union, while not making any formal changes to its deposit insurance, effectively put in an unlimited regime by promising to backstop EU banks come what may.

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Seven. It’s an auspicious number, a lucky roll of the dice. But the seven policy issues discussed represent only the proverbial tip of the iceberg of federal policy measures that will affect credit unions. They are of course vitally important but there are many more, any one of which could easily move to the top of the credit union agenda. The upshot? What happens in Ottawa matters. The ongoing challenge is to make federal policymakers understand that credit unions matter too. Over the years, the federal government has tried to change things, most significantly by opening up the market to foreign firms. These efforts have often had the unintended consequence of entrenching the power of the large banks which, for years, have enjoyed the privilege of being too big to fail (TBTF) and the related cost savings (on funding) that make it seem obvious that bigger is better. The federal government has started to take this concentration seriously. In Budget 2013, it promised that systemically important banks would be required to carry extra capital to compensate for their funding advantages derived from what the government describes as the “mistaken belief” that banks are

Dr. Marc-André Pigeon is the director of financial sector policy at Credit Union Central of Canada (Canadian Central) where he is responsible for monitoring, researching and advocating for credit unions on a range of issues. Prior to joining Canadian Central, Marc-André worked as lead analyst for the Senate Banking Committee and House of Commons Finance Committee, as a project leader at the Department Finance, as an economics researcher with the Levy Economics Institute in New York state, and as a business reporter for Bloomberg Business News in Toronto. Marc-André holds a PhD from Carleton University in Mass Communications, where he teaches as a sessional lecturer, a Master’s Degree in economics from the University of Ottawa, and a journalism degree from Carleton University.

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2014 2014

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2014

GOVERNANCE Regulatory news

Handing Over the Reins CFOs make the impact and the difference in transition and succession planning By Robert D. Katz

t a recent social event, the owner and matriarch of a very well known business that operates in both Quebec and Ontario mentioned she was having some health issues and concerns and wanted to transition the leadership of the business to her children. The owner was relatively financially astute and what she lacked in formal accounting/financial training, she made up through her 34 years in the business. She could quote product costs, selling prices, and overhead allocations in significant detail.

No clear leaders Despite having both a son and daughter in the business, for many years the owner never clearly discussed or articulated any succession plan. Neither of the children has demonstrated the same financial acumen or strong leadership as the founder. Both children are committed and dedicated to the business and enjoy a good financial package – yet neither seems apparently ready to transition to role of executive officer. And while they are committed, the company has both an organized union and a need for additional working capital. It is presently ramping up for its busiest season and needs to re-negotiate its credit agreement. Add to this the fact that, at the present time, neither the son nor the daughter seem to have that certain ‘toughness’ that many CEOs seem to have.

An action plan Now, put yourself in the position of being the company’s chief financial officer or treasurer – one who has been with the company for some

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time. The family is looking for you to assist its next generation of leaders. The transition will undoubtedly have a major impact and be one of the most significant decisions – one that will impact the company well into the future. Without being too melodramatic, it could mean the difference between success and failure and even survival for the coming generations. There are five things to consider: 1. Will the family listen to you?

For the family-owned businesses that I have worked with during the last 20 years, it is one of the toughest questions to answer. Ensure that the owners and participants will listen. The last thing that is needed is a ‘lapdog’ or ‘yes person’ that some businesses are looking for. It is important to understand and be able to influence the dynamics; otherwise the company might just as well save their money. The process, the time, and the money are costly and a true commitment for the future good is needed. 2. Is the next layer of management capable of taking over and leading the organization?

Do they have the drive, experience, work ethic, and respect of their peers? When evaluating and assessing these factors, hopefully their experience within the industry and within the company has positioned them to step in, direct, and lead. Do they and do you have the ability to work, teach, and train the younger family members? This will be critical to the potential longevity of the business for its future. 3. If there are multiple siblings or relatives that work at the company, has one clearly emerged as a leader? As the CFO/Treasurer are you willing to assess and address this?

Stepping up to do this can be unbelievably

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Governance tough. Observe how the employees treat the family members; most likely they will treat them differently, albeit subtly so. Based on my experience of working in distressed and tough situations, I have found that respect is earned and rarely, if ever, automatically given – regardless of whether you have the ‘right’ name or not. Ask other members of the company’s management team as to whether there is a succession plan in place and who is the most likely candidate? Take the time to really listen, assess, and dig deep. Listen not only to what may or may not be said, but also to what they are really trying to tell you. 4. Consider compensation in the broadest sense. Is it commensurate with the contribution?

Compensation encompasses much more than the wages, expenses, perks, cars, memberships, etc. I have recently been involved in a situation where the chairman’s salary is more than the CFO/ COO and EVPs combined, while his contribution to the company is far less. If this sounds like the situation in the company you are involved with and it appears that it could be jeopardizing the cash flow of the company, it needs to be addressed. 5. Succession planning is not just about the CEO but also about the entire executive.

When I think about it, I am reminded of

two situations – one in the past and one I am currently involved with that is evolving in real time. In the former we were interviewing for a chief financial officer to replace me, while I was serving as the interim financial officer. The controller – a family member – asked why he wasn’t being considered as a candidate. I told him that from what I had seen, there were too many inconsistencies in his performance and I was not ready and could not afford to place the livelihood of the company and its 350 families into his hands. In the latter situation, I am working with a business that has been owned by two families for over a century. One of the family members believes he is ready to step in as CEO despite never having been responsible for supervising more than two people or having true overall decisionmaking authority. Currently the only true qualification he has is that a family member is one of the owners. I firmly believe that in the process of succession planning and transitioning to the next generation, choosing the right people will pay off; they will bring the required vision, perspective, and expertise. However, a wrong hire/ appointment can also have dramatic and negative consequences. Look at when Apple fired Steven Jobs or when Dell parted ways with Michael Dell. Consider how, over the ensuing time, these

companies declined until both Jobs and Dell were reinstated in order to return their companies to prominence. Succession planning is really tough and can be traumatic. Essentially it is an executive acknowledging that it is time for him/her to step aside, and that is really hard to do. Few do it voluntarily, but those that do, and who do it proactively, are the most successful in the majority of cases. However, most companies need help in properly determining and/or executing a succession plan. If the CFO’s relationship in the company is longstanding, the owner(s) may be a bit taken back by questions regarding the next generation of leadership. But ultimately, one hopes that the owner understands that the questions and assessments are sincere and the CFO’s concerns are for the longevity of the company, its employees, and the family. Robert D. Katz, CTP, CPA, MBA is part of the succession plan at Executive Sounding Board Associates LLC. He has led numerous operational and financial turnarounds for both publicly traded and private companies, generating substantial cash flow and operating improvements. He has acted as an interim restructuring officer for companies both in and out of bankruptcy. He sits on the CFA’s education foundation, is a former TMA executive committee member and a current board member. He is also an Adjunct Professor of Finance and Strategic Management at Temple University. He can be reached at rdkatz@esba.com.

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Regulatory news NEWS REGULATORY

Lease Receivables Sales Management Given the sophistication of modern leasing businesses, directors will increasingly attract and be held to a higher standard of care By David Chaiton

n the post-Enron environment, lessors are increasingly discovering that their usual forms of agreement for the sale or purchase of lease receivables are attracting an increased level of scrutiny. To a large extent, this is an unfortunate side effect of widely publicized abuses of the accounting rules by a small number of companies. But it is due, in part, to a recognition that certain practices have developed in the leasing industry in connection with the sale of lease receivables that are inconsistent with the notion of a non-recourse, off-balance sheet, true sale of receivables. To further complicate matters, equipment lease receivables often include a software and/ or a service fee component. This can have a profound effect on the way in which a sale

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Regulatory news of receivables is treated under various accounting and true-sale legal rules.

Higher standard of care The issue of how to treat receivables in financial statements is an extremely important one for directors of companies as well, who are obligated to approve the financial statements prior to their submission to the shareholders of the company. The annual financial statements of public companies are also audited and reviewed by the corporation’s audit committee. Shareholders and creditors then rely on these statements when making their investment and credit decisions. Should the financial statements prove misleading, and the directors knew or ought to have known that they were misleading and incorrect and that the plaintiff was within a predictable class of persons who might be expected to rely on the statements, then the offending directors might well find themselves on the unhappy side of a judgment holding them liable to the reliant injured party. Furthermore, given the sophistication of modern leasing businesses, directors will increasingly attract and be held to a higher standard of care by courts in these types of lawsuits. So too, they may be drawn into situations where investors, secured creditors, governmental authorities, and other ‘beautiful losers’ who in the past simply fell from the vine whenever insolvency occurred, now find the courts receptive to allegations of misjudgment, or worse, and the search for deep pockets intensifies. Words like ‘fraud’ are often tossed about with abandon as the investigators complete their task. More often than not, the central issue in the inquiry will be one of accounting and the prodigious efforts that were made to circumvent one potential treatment or another, efforts which in the absence of insolvency or some similar disaster would be hailed as innovative, creative – even ingenious. Ever amorphous, and far from ‘bright’, the line dividing fair presentation from misrepresentation emerges in the clear light of hindsight as one allegedly well known, forever understood, and now crossed with the foul deception of self-serving, manipulative, ill-conceived, deliberate shades of meaning actively

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“Directors and officers of leasing companies need to recognize and internalize the need for knowledgeable, conservative, and welldocumented management …” deployed to lull the innocent into slumber. Or so they say…

Well-documented management The point here is that the directors and officers of leasing companies need to recognize and internalize the need for knowledgeable, conservative, and welldocumented management. To some that would seem an impossible task if for no other reason than the fact that others appear to be engaged in the same type of transactions, assuming risks that carry the just entitlement of reward for those clever enough to exploit them, and dismissal for the rest if inaction results in competitors assuming dominant positions in the marketplace. Here, then, are the basic accounting rules to apply under Generally Accepted Accounting Principles (GAAP)1: As a threshold matter, the lessor and the buyer should ask whether ‘true sale’ treatment is appropriate for the transaction in question. As a general rule, in order to have a true sale: the buyer must not have excessive recourse to the lessor; and the lessor must be willing to give up control over the lease portfolio, including the right to any possible upside in the portfolio. Otherwise, the transaction looks more like a loan and should be treated as such under the applicable accounting rules. For a variety of reasons, a non-recourse true sale may not be feasible in certain situations. The following outlines a few examples. ◉◉ Lessee credit risk The buyer may not be willing to accept the credit risk of the more challenging lessees in the portfolio without recourse to the lessor. With limited exceptions, in order to be a true sale, the sale must be without recourse to the lessor.

◉◉ Control by the seller – recapture of upside The lessor may not be willing to give up the potential upside in the portfolio and may desire an option to buy the portfolio back. With limited exceptions, the lessor must be willing to give up not only control over the portfolio but also the ability to obtain the upside if the lessor wants to have the transaction treated as a true sale. ◉◉ Legal and documentationrisk In some heavily negotiated lease transactions, the underlying lease receivable may not constitute a firm, non-cancelable payment obligation of the lessee. For example, the lease may not contain a strong hell-or-high-water clause or waiver of defenses against assignees. Another example is where a lessor who is also the manufacturer uses a combined form of lease and maintenance service agreement. If the agreement is not properly drafted, a maintenance breach by the lessor can lead to a defense to payment of rent by the lessee. Indeed, in certain types of transactions, such as consumer finance, it may be impossible to separate service/warranty performance from the payment obligation under a lease. In commercial lease transactions it is unlikely that a buyer will be willing to purchase a lease portfolio without recourse to the lessor if the leases can be canceled upon a performance breach by the lessor. ◉◉ Performance risk Sometimes the receivables are ‘future receivables’ that do not exist at the time of transfer and have not been earned by performance of the lessor. Receivables that relate to future service obligations or future deliverables that have not been earned by performance may be difficult to sell on a non-recourse basis. A buyer is

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Regulatory news often willing to accept lessee credit risk but not the risk that the receivable may not exist or be enforceable. In all the foregoing examples, either there are risks inherent in the lease receivables that the buyer is unwilling to assume, or the lessor is not willing to give up the potential upside in the asset for the price that the buyer is willing to pay. Added to these, of course, is the fact that sellers and buyers often have incompatible goals in embarking on the deal, which frequently leads to distortions in the documentation that obscure or confuse the transactional characterization requirements of the parties. As a result, the buyer may not be willing to purchase the lease receivables without recourse to the lessor, or the lessor may not be willing to give up control over the lease receivables. In any of these cases, the parties should acknowledge the situation at the outset and not try to get off-balance sheet and true-sale treatment which would raise issues with respect to the recording of the transactions on the corporation’s books of which the officers and directors must be cognizant.

True-sales For accounting purposes, the existence of a true sale primarily turns on two key questions: ◉◉ Has the risk of loss shifted to the buyer? In order to constitute a true sale, the buyer must assume the risk that the lessee is financially unable to pay on the lease receivables. In other words, the buyer must not have excessive recourse to the lessor. Prohibited recourse can take many forms, including direct recourse, contract damages, put rights, holdbacks from the purchase price, reserves, guaranties, collateral, or subordination of other payment streams owned by lessor. Some forms of limited recourse are, however, permitted but their availability must be scrupulously analyzed. ◉◉ Has the buyer acquired the benefits of ownership of the lease receivable? In order to constitute a true sale, the buyer must be entitled to all the benefits of ownership, including any upside inherent in the lease receivables. For example, if the lessor sells a lease rental stream at a time

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when discount rates are high, the lessor might like the idea of having a repurchase right so that the lessor could repurchase the receivables and refinance them at a lower rate if discount rates should drop. However, this degree of control over the lease receivables and ability to recapture upside is inconsistent with the notion of a true sale.

Although these concepts may appear simple and straightforward, the truesale analysis in a typical lease portfolio sale transaction can become quite complicated. The following list shows that the true-sale characterization of a transaction requires careful consideration of all the facts and circumstances, so in many cases no single factor is determinative: 1. intent of the parties – both words and conduct 2. notice to the lessees of the assignment – notice is indicative of sale 3. representations and warranties – should speak as of date of transaction, not prospectively – none should be made as to collectability or financial inability of lessees to pay 4. covenants – ongoing covenants are dangerous to characterization as truesale transaction – as a general rule, covenant breaches should not give rise to a put or other recourse that may lead to a return of the purchase price 5. security interest in the leased equipment – should ensure that the excess value of the equipment over and above the present value of the remaining rent does not secure other amounts independently owed to the buyer by the seller (‘crosscollateralization’ in loan parlance) 6. prepayment rights for upgrades or early terminations – effectively allow refinancing of lease receivables at lower discount rate and for a higher price if interest rates drop and therefore would appear to be inconsistent with the notion of a true sale 7. maintenance of leased products – breach must not give rise to a right of the buyer to put the purchased lease receivables back to lessor or a right to some other form of recourse – better to

have right to replace service provider if that would help to mitigate future losses 8. collection of lease receivables – if by lessor, may look like a loan – however, may be outweighed by other factors such as direct notification to lessee, retention of right to assume administration upon lessor’s default, for example 9. cost of enforcement of the lease – one of the risks accepted by buyer in a true sale, therefore, lessor must be careful that it does not inadvertently end up bearing the costs of enforcement, for example, where residual interest of lessor and/or service fees are subordinated to buyer’s recovery of costs 10. remarketing of equipment on lessee default – permitted under true-sale analysis so long as for market rate compensation 11. repurchase or put rights – if too broad, transaction looks more like loan 12. indemnities from the lessor – may be acceptable for third party claims such as patent indemnity, but should not go too far

Lease classification under GAAP In accounting for a lease transaction, one must first classify the lease as an operating lease or a direct financing lease. Basically, if the lease is a direct financing lease, the present value of the minimum rent is referred to in accounting parlance as a ‘finance receivable’. Under a direct financing lease, if the lease rents are assigned to a funder, it is possible to record an immediate sale of the finance receivable that is generated by the lease. However, if the lease is an operating lease and the rental payments are assigned to a funder, the transaction cannot be treated as a sale of a receivable. The proceeds from the assignment must be reflected as a debt on the balance sheet of the company. The difference is quite important in both balance sheet disclosure and in income calculation. There are a number of circumstances where GAAP does not permit the recognition of income on a bulk sale of leases, many of which are detailed elsewhere in this presentation. In dealing with revenue recognition it is essential to ensure that recourse losses are both

SUMMER 2014

Regulatory news

“In dealing with revenue recognition it is essential

to ensure that recourse losses are both limited and accurately estimated, and that there are no de facto practices of, for example, repurchasing leases in default whether or not the company has a recourse obligation to do so.” limited and accurately estimated, and that there are no de facto practices of, for example, repurchasing leases in default whether or not the company has a recourse obligation to do so. Also, the recording of a discounted stretch value (DSV) and other residual values on leases may indicate there has been no transfer of the risks and rewards of ownership.

Initial Direct Costs (IDCs) In accounting for leases, it is appropriate for the lessor to record the direct costs incurred in acquiring a lease as an expense of the accounting period. To avoid showing an operating loss merely through the acquisition of leases, it is also appropriate to record sufficient income to exactly offset the initial direct costs. Initial direct costs, defined in the CICA Handbook, s.3065.03(1), are restricted to costs directly associated with negotiating and executing a specific leasing transaction and exclude supervisory and administrative costs, among others.

Allowances for doubtful accounts It is normal in accounting to record a provision for lease losses, or bad debts, as an expense in the income statement and as an increase in the balance sheet valuation account for finance receivables called the ‘allowance for doubtful accounts’. Every entry in accounting has two parts (thus, ‘double-entry accounting’). If you wish to reduce the value of finance receivables, you do so by both an increase in an expense (bad debt expense or provision for doubtful accounts) and a deduction from the finance receivable balance. When a specific lease is identified as a bad debt and the amount of loss is determined, the actual loss is recorded as a reduction of finance receivables balance and a reduction of the allowance for doubtful accounts balance

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(called a ‘bad debt write-off’).

Income on finance leases – sum of the digits versus actuarial basis GAAP requires income on a finance lease to be recorded in a manner similar to interest on a loan. This is referred to as the actuarial basis. This method results in income being recognized over the lease term on a basis that produces a constant rate of return on the investment in the lease. In contrast, the ‘sum of the digits’ (SOD) method to record interest income (which is called finance income) provides a close approximation of the actuarial method for short-term leases that do not have a residual value. The calculation assumes equal periodic payments to totally amortize the unearned income on a lease. This would be similar to the method used by a bank when it receives equal periodic payments on a car loan but where there is no balance of principal left at the end of the loan period. Where a lease portfolio contains leases with quarterly or other non-monthly payment terms, or with high recorded residual values (such as a large portfolio of automobile leases with significant recorded residual value), the use of the SOD method rather than the actuarial method to record finance income on these leases would overstate income in the early years of the lease term. The overstatement is offset by an understatement of income in the later years of the lease term – only the timing of recording the interest income varies.

overhold periods. While it is not unusual at the end of the term of small ticket leases for the termination date to be forgotten by a lessee, it is not appropriate, however, to assume at inception of the lease that the lessee will continue to make lease payments beyond the expiration of the initial lease term (‘post-diem payments’), and to record this estimate in income. This is contrary to s.3400 of the CICA Handbook on revenue recognition as well as to the lease accounting section, s.3065. It would only be proper to record such income in the period in which it is received but not earlier. Accordingly, since GAAP does not permit the recording of contingent gains, this practice distorts financial results by artificially increasing income.

Conclusion As you find yourselves regaled with the delights of lease accounting, it is well worth remembering that the failure to comply with these standards may result in more than mere embarrassment when creditors and investors are left in the lurch in any insolvency, or following a reassessment of tax (under several statutes which depend upon clarity in characterization and consequential reporting). It is a tangled web that has been woven, a slippery slope for those who begin on the wrong foot, and a bad day for all of us when the sheriff arrives at our doorstep carrying bundles of wildly enthusiastic love notes from aspirants of every stripe – the appalled, the crushed, the victims – or just plain enthusiastic plaintiffs who will compete vigorously for their ratable share of your financial estate. ABOUT THE AUTHOR: David Chaiton is widely recognized as an expert in equipment financing, leasing, asset-based lending, corporate finance, and banking matters, has been involved in complex bankruptcy and receivership engagements and represents banks, insurance companies, leasing companies, and other purveyors of financial services. A former director of the Canadian Finance

Residual values – DSVs

& Leasing Association, David was a member of

In preparing their financial statements some leasing companies have adopted the ‘aggressive’ stance with respect to bargain purchase option leases – that some lessees would fail to exercise such options causing the leases in question to fall into stretch or

its legal committee and was recognized for his contribution to the development of the vehicle leasing and equipment finance industry in Canada when he received its member of the year award. 1. Consideration of the new rules under discussion is beyond the scope of this primer.

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Regulatory news

In Conversation With The role of financial executive continues to evolve, with increasing responsibility and a widening of scope

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By Karen Treml

n an interview with Canadian Treasurer (CT), Duane Gomes talks about how his role as vicepresident of finance with Everlink Payment Services is changing and evolving. With increased diversification comes the increased need for such things as investment analysis, risk management, and human resources management.

Gary Tannyan

Duane Gomes and quarterly to our board of directors. I am also responsible for ensuring our financial statements are prepared in accordance with IFRS, and we are subject to an annual audit by a Big-4 firm. While we are fortunate to work on the accounting systems of our majority owner, I do have to ensure we have reporting systems that meet our management needs.

CT: As the head of finance at Everlink, what is your role and that of your team?

CT: What changes have you seen over the last several years and how has that impacted what your position encompasses today?

Gomes: I am vice-president of finance at Everlink Payment Services Inc. My role entails both an accounting team and a banking settlement team. As well, I am the main liaison to a shared services provider for the companyâ€™s human resources function. My team is responsible for financial reporting, treasury, budgeting, forecasting, and maintaining internal controls. We report on a monthly basis to our two shareholder companies,

Gomes: I would say my role has evolved in the last six years such that I have to ensure our reporting and measurement systems keep pace with the additional lines of business that have been added over the years. Furthermore, I have lead my team through the move from GAAP to IFRS and maintained properly documented internal controls to keep compliant with our parent companiesâ€™ SOX requirements in the U.S. From an HR perspective, I have had to ensure

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Regulatory news EXECUTIVE PROFILE opportunities for my staff to learn and grow into their roles and develop as the company changes. I have maintained a very low staff turnover rate. CT: Is there increased responsibility now versus five or 10 years ago?

Gomes: Yes, particularly with regards to looking at the investments we make to grow our business via diversification into new lines of business. As well, there is an increasing need to look at the profitability of each line of business. With increased diversification in both our products and our customer base, I do need to play a greater role with regards to granting credit to new customers and monitoring their receivables. As there have been increased needs with regards to internal control, investment analysis, and human resources management, my responsibility have increased. CT: Is there a change in fiduciary responsibility?

Gomes: I would say so. We have made strategic investments and as a result, we must keep a conscious eye on where our capital is being spent. Being at a technology company that is required to continually innovate, it is critical that innovation is carried out in a transparent way and that we can closely monitor our development dollars. CT: What are the ‘modern day’ challenges you deal with as the vice-president of finance?

Gomes: As vice-president of finance, I need to make sure the staff of a small, but growing, company is fully engaged in driving the business ahead and is motivated to deliver quality

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products and services in a cost effective manner. As well, as a department leader, I need to ensure my staff have opportunity to learn while on the job and make a greater impact to the entire organization as the organization diversifies its product and service offerings. CT: What changes have taken place with respect to performance management/measurement and how have these changes affected overall strategy?

Gomes: While we have always had a keen eye on our EBIT, given the nature of our operations and the underlying contracts, we do have to monitor service availability not only for our core businesses but also for our new business lines such as Card Issuance, Fraud Management, and POS Acquiring Services. We do look at revenue growth by individual line of business and keep a keen eye on the profitability of each line. This allows us to understand the effects of our investments both from a short-term and a long-term perspective. CT: Have your scorecard metrics changed and what impact does that have?

Gomes: Not all performance metrics will map easily into all lines of business, so it is key to be open to using different metrics. Knowing the high cost of turnover to an organization and the lost intellectual capital that can result, we also place greater emphasis on talent retention. We also look at growth in transactions as a key indicator of the overall success of out diversification strategy.

CT: How has risk management changed and what changes has that effected, both from a shortterm and long-term perspective?

Gomes: Risk management has really developed to a point where it is side-by-side with all other key decisions when evaluating a company’s strategic decisions and just the overall day-to-day operations of the business. Disaster planning has taken on a much greater level of formality over the course of the past decade due to events occurring all over the world – politically, weatherwise, and from a security perspective. Risk management also plays a greater role with regards to ensuring a company’s strategic plans are consistent with those of the parent entities and those of our strategic business partners.

CT: What trends do you see emerging in the role of financial executive?

Gomes: I see a trend to greater formality of policy and procedures, as we increasingly realize that they are more than key to a business’s success. While SOX has created a catalyst for this, all companies and departments are learning that it is paramount to success. As well, I am seeing the need to have a strong second tier of management such that the executive level can maintain perspective on the strategic direction of the business at all times. This has led to the need to have highly skilled managers available to monitor and direct day-to-day operations and provide skilled and dedicated support to those within the finance department.

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HR Management

Regulatory news

Skills Gap Widens as Finance Oversight of HR Increases HR is frequently becoming more aligned with the finance areas within organizations Will you have more oversight and responsibility for HR and payroll in the next 5 years?

35%

56%

Already have full oversight and responsibility Yes, my role will expand No

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By The Canadian Financial Executives Research Foundation

anadian senior financial executives are becoming more involved in the oversight of HR functions, but despite their increasing sphere of responsibility, a large proportion of these executives rate their knowledge of HR functions as moderate or average. This admission suggests a widening skills gap among finance executives who are starting to oversee HR managers and payroll functions.

Increasing accountability These are the results of a study released in May by the Canadian Financial Executives Research Foundation (CFERF), the research arm of FEI Canada, and sponsored by Ceridian. An online survey of Canadian financial executives found that 61 per cent of respondents reported that they had taken on more accountability for such functions, including payroll, recruitment, talent management, training, benefits, and bonus management, in the past five years. In addition, more than a third expect to see their involvement in HR and payroll expand in the next five years. Despite the increasing sphere of responsibility, a relatively large proportion of those surveyed described their knowledge of HR functions as moderate or average: three in four ranked their own skills in this field as two or three on a scale of one to five, while only 11

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HR Management per cent described themselves as extremely knowledgeable. Some executives want more information about how to manage personnel costs. “We currently don’t have any true measurements for productivity,” observed an assistant vice-president of a fast-growing financial services firm. “Our resources are growing but do we have the right number of people to do the work, or do we have too many people doing the work?” Traditionally, finance and human resources executives operated in separate spheres within most corporations. But rapid globalization has caused a growing number of companies to focus much more intensively on labour costs and human capital, as well as their role in delivering value to shareholders. “Financial executives manage many moving pieces on the modern business landscape. They need to think strategically about all levels of their business, while managing risk, staying ahead of technology, fostering innovation, and working with fellow executive team members to build enterprise value,” says Michael Conway, president and CEO of FEI Canada. “Human resources is another area where CFOs are being held accountable and we continue to seek insights into helping our executives improve their skills in this area.” “HR is frequently becoming more aligned with the finance areas within an organization,” says Rob Rose, senior vice-president of product management, Ceridian. “Reporting for finance and HR can be extensive since employees are typically a large expense for many organizations. In some cases

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HR reports directly under finance or some type of a parallel relationship exists. Moreover, the relationship between Finance and HR is becoming much stronger than what we’ve seen in the past.”

Organizational overlaps Many senior financial executives are taking an increasingly active role in the oversight of payroll and HR divisions. As the organizational overlap between these two corporate functions expands, finance executives are looking for better ways to measure and benchmark HR/payroll outlays, which means relying on and learning to interpret a wide range of HR metrics. CFERF canvassed senior financial executives for their views, combining the results of an online survey with insights gathered at round tables. The executives were asked for their views on the relative importance of a range of key HR benchmarks and ratios. The goal was to determine what sorts of measures financial executives rely on most heavily and whether there are opportunities for companies to develop other useful metrics. Some key findings: ◉◉ Respondents said they paid most attention to the average cost of employer-paid sick days, personal leaves, with 73 per cent ranking these HR expenses as moderately to most important in their analysis; ◉◉ Almost four in five reported that they rely heavily on a per capita-based formula for evaluating performance management, tracking revenue, cost, profit, EBITDA or return on investment per full time equivalent (FTE).

Yet the survey also found that many finance executives assign relatively less importance to more granular HR/payroll related metrics that focus on areas such as absenteeism, turnover, recruitment, and talent management costs and human capital. For instance, 18 per cent said they did not pay any attention to data on voluntary separation of high performers, while only 10 per cent thought such information was crucial. While some participants indicated that the return on investment in human capital metric needs more development, many were seeking a comprehensive measure such as this, with 53 per cent indicating it was moderately to very important. “If someone came up with a human capital ROI, I think it would bring significant benefit not just to the HR team, but for the whole organization,” said Victoria Davies, CFO of Knightsbridge. If HR actually had a measure that we could all use, it would drive significant value in decision making. It would be nirvana to have a defined and accepted return on investment on human capital measure.”

Clear targets Several round table participants expressed the view that finance executives should track HR metrics, but felt that the measurement function itself was secondary to the importance of setting legible and clear targets for improvement. “We just find that we need more leadership and accountability to what the metrics are providing, rather than just focus 100 per cent on the metrics alone,” said Derek Petridis, CFO and principal

of Shikatani Lacroix Design Inc. “I’d be happy with the metrics being 80 per cent accurate and more time spent on an implementation plan on how exactly to execute what the metrics are telling us.” According to John Forester, CFO at DBG Metal Manufacturing, “executives are all about getting things done as opposed to measuring things. The measurements are expected. If you can’t measure it, you cannot manage it. The question becomes, how do these things help you identify the opportunities and actions that need to be taken? And then, more importantly, have you taken the action, have you made a difference?” One example of a company that has a successful performance management system is Canadian Tire Corp., according to Victor Wells, a corporate director who also serves as the chair of CFERF. “Canadian Tire, in my view, has a true performance management system. In their annual information, they disclose their objectives for the company, and it flows all the way through the senior management. Here’s a company that spells out what they’re going to do and is prepared to be measured against those objectives.” About the Canadian Financial Executives Research Foundation CFERF is the non-profit research institute of FEI Canada. The foundation’s mandate is to advance the profession and practices of financial management through research. CFERF undertakes objective research projects relevant to the needs of Canada’s senior financial executives in working toward the advancement of corporate efficiency in Canada. For more information, please visit feicanada.org

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COMPLIANCE

Regulatory news

Important Changes to Canada’s AML Laws: Here We Go Again Bill C-31 addresses virtual currencies, crossborder money services, and expands the application of these due diligence requirements By Dawn Jetten, Jacqueline Shinfield, and Vladimir Shatiryan

n March 28, 2014, the federal government introduced important proposed amendments to the ‘Proceeds of Crime (Money Laundering) and Terrorist Financing Act’ (PC Act), Canada’s anti-money laundering legislation. The proposed amendments are introduced by Bill C-31, the ‘Economic Action Plan 2014 Act, No. 1,’ which implements certain provisions of the federal budget tabled on February 22, 2014. Among other proposed changes, Bill C-31: ◉◉ extends the application of the PC Act to persons dealing in virtual currencies; ◉◉ extends the application of the PC Act to money services businesses and persons trading in virtual currencies that do not have a place of business in Canada but provide services to residents of Canada; ◉◉ introduces new enhanced due diligence requirements for providing services to individuals that occupy certain prominent public functions within Canada or in international organizations where such individuals (or their prescribed family members or known close associates) are assessed as high risk; ◉◉ introduces a group-wide information

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sharing requirement between regulated financial institutions and their affiliates in Canada and in other jurisdictions that are also regulated financial institutions; ◉◉ requires reporting entities to report to the Canada Revenue Agency international electronic funds transfers of C$10,000 or more.

These proposed amendments are discussed in greater detail below.

Regulation of virtual currencies As outlined in the 2014 federal budget, the government is amending the PC Act to bring persons engaged in the business of dealing in ‘virtual currencies’ within the ambit of the legislation. Under the proposed amendments, persons dealing in virtual currencies will be required to register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) and comply with the PC Act. The terms ‘virtual currency’ and ‘dealing in’ virtual currencies are not defined in Bill C-31 and will be specified by regulations which have not yet been made public. The regulations will also specify what compliance requirements will be imposed on dealers in virtual currencies. Currently, money services businesses registered with FINTRAC are required to

report certain transactions to FINTRAC, verify the identity of customers and keep records in certain threshold transactions, and implement an anti-money laundering and counter-terrorist financing compliance regime. The regulations could adopt these requirements, with necessary changes, for dealers in virtual currencies as well. Under the proposed amendments, the PC Act will apply to both dealers in virtual currencies that have a place of business in Canada and to those that do not have a place of business in Canada but provide services to customers in Canada. Therefore, dealers in virtual currencies that do not maintain a physical presence in Canada but transact with residents of Canada will be captured by the proposed new regime.

Cross-border money services businesses In another important proposed amendment to the PC Act, Bill C-31 extends the application of the PC Act to money services businesses that do not have a place of business in Canada but are providing services to customers in Canada. In the past, in determining whether the PC Act applied to foreign money services businesses (FMSB),

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COMPLIANCE FINTRAC examined factors relating to the FMSB’s connection to Canada. Such factors included whether the FMSB had agents or employees in Canada, bank accounts in Canada, computer servers in Canada, physical premises in Canada, or customers in Canada. The changes to the PC Act appear to reflect a change in FINTRAC’s policy in this regard. Under the proposed legislation, when a FMSB without a place of business in Canada is transacting with Canadian customers, even if they are doing so on a crossborder basis, the FMSB will be subject to compliance with the PC Act and will be required to be registered with FINTRAC. FMSBs are required to provide a name and address for service of an individual who resides in Canada as part of their registration and must provide police clearance certificates for their senior executives, directors, and for individuals who own or control 20 per cent or more of the applicant.

Due diligence requirements for Canadian financial institutions Bill C-31 expressly prohibits Canadian financial institutions from opening or maintaining an account for, or having a correspondent banking relationship with, FMSBs or with foreign dealers in virtual currencies that provide services to residents of Canada and which are not registered with FINTRAC. Because this rule prohibits financial institutions from maintaining an account for such foreign entities (as opposed to only opening an account), financial institutions will be required to do a ‘look back’ on all accounts they have to determine if any such accounts are with FMSBs or foreign virtual currency dealers and determine whether such entities or businesses are properly registered with FINTRAC. By imposing this requirement, the proposed legislation is effectively placing some of the responsibility for monitoring the FSMB FINTRAC registration requirement on the financial institutions that provide banking services to these businesses. It is hoped that there will be some grace period provided to FMSBs and dealers in virtual currencies to register with FINTRAC once the legislation becomes effective so that neither financial institutions banking

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such clients nor the clients themselves will be in breach of the new requirements once the legislation comes into force.

Politically exposed persons Currently, the PC Act and associated regulations set out enhanced customer due diligence requirements for reporting entities that provide services to individuals – and their prescribed family members – who have been entrusted with a prominent public function in a jurisdiction other than Canada. Known as politically exposed foreign persons (foreign PEPs), these individuals are considered inherently high risk because of their position of influence and the potential for abusing that influence for money laundering or terrorist financing purposes. For this reason, foreign PEPs are subject to enhanced due diligence requirements under the PC Act. Bill C-31 expands the application of these due diligence requirements in three significant ways: Foreign PEPs

First, Bill C-31 extends the requirements currently applicable to foreign PEPs and their specified family members to also include persons that the reporting entity “knows or should reasonably know” is closely associated, for personal or business reasons, with a foreign PEP. Bill C-31 does not specify the circumstances in which a reporting entity will reasonably be expected to know that the customer is a close associate, such as a friend or business partner, of a foreign PEP.

government or equivalent rank ◉◉ ambassador, or attaché, or counsellor of an ambassador ◉◉ military officer with a rank of general or above ◉◉ president of a corporation that is wholly owned directly by the Crown in right of Canada or a province ◉◉ head of a federal or provincial government agency ◉◉ judge of an appellate court in a province, the Federal Court of Appeal, or the Supreme Court of Canada ◉◉ leader or president of a political party represented in a legislature ◉◉ mayor ◉◉ holder of other office or position that may be specified in the regulations

When a reporting entity determines that it is dealing with a domestic PEP and riskassesses the domestic PEP as high risk, the reporting entity is then required to apply the same enhanced due diligence measures that currently apply to foreign PEPs. This requirement also applies in respect of family members of a domestic PEP, as well as to persons that the reporting entity “knows or should reasonably know” is closely associated, for personal or business reasons, with the domestic PEP. This casts the net of domestic PEPs remarkably widely and could include a significant segment of the Canadian population. Importantly, however, the requirement to apply enhanced due diligence in respect of domestic PEPs is only triggered when the reporting entity assesses the domestic PEP as high risk. In all other cases, no requirements specific to domestic PEPs apply.

Domestic PEPs

Second, Bill C-31 introduces the concept of a politically exposed domestic person (domestic PEP). Specifically, individuals who hold, or have held within a time period that will be specified in regulations, the following offices on behalf of a government in Canada will be considered domestic PEPs: ◉◉ Governor General, lieutenant-governor or head of federal or provincial government ◉◉ member of the Senate or House of Commons or member of a provincial legislature ◉◉ deputy minister of federal or provincial

Heads of international organizations as PEPs

Third, Bill C-31 provides that heads of international organizations will be subject to the same regime as domestic PEPs, meaning that the enhanced due diligence requirements that currently apply to foreign PEPs will apply in respect of customers that are heads of international organizations, if the reporting entity risk-rates such person as high risk. This requirement also extends to prescribed family members of a head of an international organization, as well as to persons that the reporting entity “knows or should reasonably know” is closely associated, for personal or business

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COMPLIANCE reasons, with the head of an international organization.

Group-wide information sharing Bill C-31 introduces a new requirement for regulated financial institutions such as banks, life insurance companies, provincial and federal trust and loan companies, credit unions, credit union centrals, and securities dealers to develop and apply policies and procedures for exchanging information with their affiliates that are also regulated financial institutions in Canada or in foreign jurisdictions for the purpose of detecting or deterring money laundering and terrorist activity financing offences and for assessing the risk of such offences. This proposed group-wide information sharing requirement follows the publication in January 2014 of new guidance – ‘Sound management of risks related to money laundering and financing of terrorism’ – by the Bank for International Settlements’ Basel Committee on Banking Supervision. The Basel Committee’s 2014 guidance recommends that financial institutions establish robust information sharing with their affiliates to facilitate the implementation of money laundering and terrorist financing risk management processes on a group-wide basis and across international operations. Although Bill C-31 stops short of requiring groupwide integrated management of antimoney laundering and terrorist financing risks, the trend is moving towards global enterprise-wide monitoring of clients.

anti-money laundering and counterterrorist financing measures are deficient or where such deficiency may adversely impact the integrity of the Canadian financial system. Bill C-31 also introduces amendments to the provisions of the PC Act governing information sharing between FINTRAC and other governmental agencies, makes certain changes to Part 2 of the PC Act dealing with reporting of currency and monetary instruments, and extends the application of the PC Act to online casinos. In addition, Bill C-31 introduces a new requirement that certain financial institutions report to the Canada Revenue Agency international electronic funds transfers of C$10,000 or more, as discussed in our previous ‘Blakes Bulletin: Electronic Funds Transfer Reporting: Once is Not Enough.’

including credit card and stored value card issuers and program managers, payment processors, payment networks and others. Contact Jacqueline at 416-863-3290 or email jacqueline.shinfield@ blakes.com Vladimir Shatiryan is an associate. His practice focuses on advising Canadian and foreign banks, trust and loan companies, credit unions, money services businesses, finance companies, and other businesses on compliance with Canada’s financial institution and consumer protection legislation. Vladimir has expertise in regulatory requirements for cross-border lending and other operations, incorporation of federal and provincial financial institutions, ownership, control, investment and business restrictions applicable to regulated financial institutions, Canada’s payment clearing and settlement legislation, regulation of payment products, as well as in Canada’s anti-money laundering and economic sanctions legislation.

Effective dates

Contact Vladimir at 416-863-4154 or

Bill C-31 is currently at the second reading stage in the House of Commons and may be subject to amendments prior to its enactment and royal assent. Many of the proposed changes discussed in this bulletin will come into force on a day to be fixed by the federal government. No such date has been made public.

email vladimir.shatiryan@blakes.com ABOUT BLAKES: As one of Canada’s top business law firms, Blake, Cassels & Graydon LLP (Blakes) provides exceptional legal services to leading businesses in Canada and around the world. We focus on building long-term relationships with clients. Thanks to our clients, Blakes was ranked as having the leading law firm brand in Acritas’

ABOUT THE AUTHORS: Dawn Jetten is a partner

Canadian Law Firm Index 2014, which measures

and co-chair of the financial services regulatory

law firm brands most favoured by top companies

group. She has extensive experience providing

in Canada and internationally. We were also the

advice to numerous Canadian and foreign financial

only Canadian firm to be named “Canada Law Firm

institutions, including banks, trust companies, loan

of the Year” for six consecutive years in the Who’s

companies, insurance companies, commercial and

Who Legal Awards 2014 and “Law Firm of the

consumer finance companies, and a variety of

Year: Canada” for the fourth time in the Chambers

other financial service providers. She also advises

Global Awards 2013. In addition, we consistently

Other proposed amendments

corporate clients who require assistance with

rank as one of the top Canadian firms in terms of

In addition to the foregoing measures, Bill C-31 will also bring into force, with certain amendments, Part 1.1 of the PC Act, which was originally enacted in 2010 but was not promulgated into force. Part 1.1 enables the Minister of Finance to issue written directives requiring reporting entities to take certain measures in respect of financial transactions originating from or bound for a foreign jurisdiction or entity. The Minister of Finance may issue such directives when the Financial Action Task Force or any other similar international body of which Canada is a member has called on its members to take measures in relation to a foreign state or entity whose

financial services or products. Contact Dawn at

transactional value or number of deals for Canadian

416-863-2956 or email dawn.jetten@blakes.com.

announced transactions in the Bloomberg, Thomson

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Reuters and mergermarket M&A league tables. Jacqueline D. Shinfield is a partner. Her practice

Many of our lawyers are also recognized as leaders

focuses on all aspects of regulatory compliance in

in their respective fields, evidenced by the fact that

the retail financial services and payments industry

they are continually recommended in The Canadian

at both the federal and provincial levels. She

Legal Lexpert Directory, Canada’s leading guide to

provides advice to regulated financial institutions,

lawyers, in almost every category of law.

pay day loan companies, money services businesses,

Serving a diverse national and international

foreign exchange dealers and others. She has

client base, our integrated network of 11 offices

extensive experience providing advice in respect of

worldwide provides clients with access to the

Canada’s anti-money laundering and anti-terrorism

Firm’s full spectrum of capabilities in virtually every

financing legislation as well as Canadian sanctions

area of business law. Whether an issue is local

legislation. Jacqueline also has particular expertise

or multi-jurisdictional, practice-area specific or

in the payment industry and provides advice to

interdisciplinary, Blakes handles transactions of all

those involved in all aspects of the card industry,

sizes and levels of complexity.

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your Team

Regulatory news

Do You Need an Internal Auditor? Often misunderstood, the internal auditor is not the bad guy, and can often be the hero

he word ‘audit’ often strikes fear – whether with individual taxpayers or organizations. Despite what one may read in the press, auditors are not just watchdogs who love to get environmental groups in trouble and take away their charitable status. An internal auditor provides a valuable and necessary service for both the employer and the economy. What should you look for in an internal auditor and what can you expect?

In-demand skills According to Robert Half’s ‘7 Attributes of Highly Effective Internal Auditors’, technical attributes are no longer enough in today’s rapidly evolving and highly competitive job market. An internal auditor should also possess the following general and soft skills in order to succeed: 1. Auditors must exhibit integrity so they can fulfill their professional mandate. The facets of integrity include resiliency, objectivity, trust, independence, objectivity, toughness and other similar skills, all of which are necessary when dealing with potentially tense situations. 2. An internal auditor should be good at relationshipbuilding in order to reduce resistance, foster collaboration and gather

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information effectively. 3. Partnering encompasses understanding the needs, projects and risks of the operation, and to share and gain best practices. This skill requires business acumen and being service-oriented. 4. Financial professionals in all roles need strong communication skills, but they’re even more important in auditing jobs. Besides writing concise and compelling reports, an internal auditor has to be able to give engaging presentations and converse with a wide range of company employees. 5. Teamwork is the ability to collaborate on business processes, ensuring the efficient running of the organization. In order to work well on a team, one should be able to lead, influence and empathize. 6. In today’s global business world, diversity is a key attribute. In addition to respecting and understanding various cultures, backgrounds, generations and so forth, a good auditor also needs to know how to work with people of varying perspectives and learning styles. 7. An internal auditor must be naturally curious — a “sponge for knowledge” — and committed to continuous

learning to keep current with technology and business developments, not to mention to developing personally and professionally.

Compensation and credentials An experienced internal auditor is in demand and well compensated. Overall, the salary for internal auditors in Canada has increased between 3.3 per cent and 4.2 per cent from 2013, according to the ‘2014 Salary Guide’2014 Salary Guide from Robert Half. Junior-level auditing jobs typically require a bachelor’s degree in accounting or finance, some experience, proficiency in MS Office, and a thorough understanding of generally accepted accounting principles (GAAP) and riskassessment practices. Moving up into management and senior-level auditing positions usually requires up to eight years of experience in accounting, as well as a master’s degree in business administration or a designation such as CPA (Chartered Professional Accountant) or CIA (Certified Internal Auditor).

collar crime, and of those, 61 per cent report that their own employees were responsible for the wrongdoing. The price they paid wasn’t cheap – one in every 10 of these organizations claimed a loss of more than $5 million. Financial fraud is damaging not only to a company, but also to society as a whole, as repeated contravention of financial and taxation laws can have a detrimental effect on a country’s economy and international standing. Internal auditors help organizations uncover instances of corruption, tax evasion, bank and insurance fraud, money laundering, and other financial violations. They assess and evaluate a company’s procedures, ensure compliance demands are satisfied and recommend riskmanagement strategies. All this helps the organization meet its objectives more effectively while saving money. This article is provided courtesy of Robert Half Canada, parent company of Accountemps, Robert Half Finance & Accounting and Robert Half Management Resources. Robert Half is the world’s first and largest specialized staffing firm placing accounting and finance professionals

Financial crime fighters

on a temporary, full-time and project

More than one-third of Canadian organizations surveyed in a recent report from Pricewaterhouse Coopers have been a victim of white-

basis. Follow Robert Half Management Resources at http://www.twitter.com/ RobertHalf_CAN for workplace news.

SUMMER 2014

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