Canadian Regulation of Capital Flows

1
Canadian Regulation of Capital Flows

• David Butler
• McMillan Binch LLP
• Toronto, Canada
• Saturday, October 2, 2004

Materials prepared with the assistance of Jeff
Scanlon, McMillan Binch LLP
2
Outline

• Capital Flows in Canada
• New Regulations
• Traditional Regulations
• Conclusion

Members of the State Capital Global Law Firm
Group practice independently and not in a
relationship for the joint practice of law, and
are located in capital cities, business markets
and financial centers around the world.
3
Capital Flows in Canada
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion
4
Canada Preferred Capital Destination
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Modern and efficient banking system
• Excellent and reliable financial infrastructure
• Mature business environment
• Extensive regulation

5
Greater Toronto Area
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• 3rd largest financial centre and 4th largest
  economic basin in North America after New York
  and Chicago
• 200,000 people work in financial and investment
  services sector
• 65 of Canada pension fund managers are
  headquartered in Toronto, representing 50 of the
  pension assets under management
• Canadas largest five banks and 80 of foreign
  banks operating in Canada have their headquarters
  in Toronto
• 60 of Canadas top insurers, responsible for 90
  of the industrys total assets, have their head
  offices in Toronto

6
Canadian Capital Markets
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• TSX Group
• Toronto Stock Exchange (TSX)
• serves the senior equity market
• TSX Venture Exchange (TSX-V)
• serves the public venture equity market
• The TSX Group ranks as North Americas third
  largest by market capital (7th globally)
• US1.06 trillion market cap (TSX-V consists of
  US18 billion of this total)

7
Canadas International Liabilities
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion
8
Clearing and Settlement Systems
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Legislation
• Canadian Payments Act
• Payment Clearing and Settlement Act
• Canadian Payments Association (CPA)
• Three clearing and settlement systems
• Automated Clearing Settlement System (ACSS)
• Large Value Transfer System (LVTS)
• U.S. Dollar Bulk Exchange (USBE)

9
Clearing and Settlement Systems
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Automated Clearing Settlement System (ACSS)
• system through which vast majority of payment
  items in Canada are cleared
• information system used to track volume and value
  of payment items exchanged between participants
  and determine balances due to and from
  participants
• used for clearing both paper-based payment items,
  such as cheques, and electronic items, including
  Automated Funds Transfer debits (e.g.
  pre-authorized debits) and credits (e.g direct
  deposits)
• 99 of the daily transaction volume cleared
  through ACSS but represent only about 15 of
  total Canadian capital flows cleared

10
Clearing and Settlement Systems
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Large Value Transfer System (LVTS)
• electronic wire system introduced in February
  1999 to facilitate transfer of irrevocable
  payments in Canadian dollars across country in
  real time
• first model of its kind combining benefits of two
  main models for current payment systems
  real-time payment finality of a Real Time Gross
  Settlement (RTGS) system, with lower collateral
  costs of netting system
• Approximately 88 of total Canadian capital flows
  cleared via the LVTS

11
Clearing and Settlement Systems
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• U.S. Dollar Bulk Exchange (USBE)
• parallel system to ACSS used for payment items in
  U.S. dollars, drawn on and payable to accounts at
  financial institutions in Canada
• although not a clearing and settlement system
  like ACSS, it provides similar mechanism to track
  exchange of U.S. dollar payment items and
  resulting balances due to and from participants
• Settlement is effected through correspondent
  banks in New York and is accomplished through a
  series of wire payments the Bank of Canada is
  not involved in process

12
Clearing and Settlement Systems
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• On average, 13 million payment items,
  representing more than US110 billion in
  transactions, are cleared and settled through the
  CPAs systems each business day
• The ACSS and LVTS cleared and settled over US27
  trillion in 2003
• CPA governing rules at http//www.cdnpay.ca/rules/
  acss_rules.asp

13
New Regulations
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion
14
Impetus for Canada
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Alignment with US
• Acknowledgement that terrorism and organized
  crime affecting both domestic and US interests
  can operate out of base in Canada

15
Money Laundering Regulation (MLR)

• Problem
• Global Response
• Legislation
• Scope
• Reporting Requirements
• Record Retention
• Client Identification
• Money Services Businesses
• Third Party Determinations
• Compliance Regime
• Penalties

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MLR Problem

• US730 billion US1.81 trillion
• (2-5 of global GDP)

Sources IMF Government of Canada Website World
Bank
17
MLR Problem
Conclusion
Capital Flows in Canada
New Regulations
Traditional Regulations

• Antimoney laundering did not historically
  represent a high priority for either
  governments/banking industry and was in past
  perceived as a local issue
• The International Monetary Fund estimates that
  globally, money laundering accounts for 2-5 of
  worlds gross domestic product, totalling US0.73
  - 1.81 trillion (10th-4th largest economy
  globally)
• Low Mexicos economy (10th)
• High U.K.s economy (4th)
• A 1998 study estimated that between US4 billion
  and US14 billion is laundered in Canada every
  year

Sources KPMG, (Global Anti-Money Laundering
Survey 2004), September 20, 2004 Government of
Canada Website World Bank Website
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MLR Global Response
Conclusion
Capital Flows in Canada
New Regulations
Traditional Regulations

• Driven by a growing political determination to
  strike against drug traffickers, organized crime,
  and terrorists, there have been a series of
  concerted national and international initiatives
• Financial Action Task Force on Money Laundering
• Inter-governmental organization created by G7
  (mandate extended to 2012) and closely cooperates
  with OECD
• http//www1.oecd.org/fatf/index.htm
• International Monetary Fund
• World Bank
• Basel Committee on Banking Supervision
• European Union
• Ongoing reforms in many countries

19
MLR Canadian Legislation
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Proceeds of Crime (Money Laundering) and
  Terrorist Financing Act (PCTFA)
• Federal legislation that was introduced in 2000
  but significantly bolstered in the aftermath of
  9/11
• Online http//laws.justice.gc.ca/en/P-24.501/inde
  x.html

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MLR Scope of PCTFA
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• PCTFA applies to financial entities
• Financial entity means
• Bank to which Bank Act applies
• Cooperative credit society, credit union, or
  caisse populaire regulated by provincial
  legislation
• Association that is regulated by the Cooperative
  Credit Associations Act
• Company to which the Trust and Loans Companies
  Act applies
• Trust company or loan company regulated by
  provincial legislation
• Authorized foreign bank within the meaning of
  s.2 of the Bank Act in respect of its business in
  Canada
• Departments/agents of the federal and provincial
  governments which accept deposits or process
  money orders

21
MLR Reporting Requirements
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Where reasonable grounds to suspect financial
  transaction related to terrorist/money laundering
  activity, financial entity must report suspicious
  transaction to Financial Transactions and Reports
  Analysis Centre of Canada (FINTRAC)
• Financial entities must also make a report to
  FINTRAC if they know that they are in possession
  or control of property owned or controlled by a
  terrorist or a terrorist group, or if they have
  knowledge of proposed transaction involving
  terrorist assets

22
MLR Reporting Requirements
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Financial entities must make a report to FINTRAC
  if they receive from a client US7,850 or more
  in cash (i.e. hard currency, such as bank notes
  or coins) in single transaction, unless cash
  received from a financial entity or a public body
• Financial entities must report sending out of
  Canada or receipt from outside Canada, at the
  request of client, of electronic funds transfer
  of US7,850 or more in course of single
  transaction

23
MLR Record Retention
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Financial entities required to keep certain
  records, including records of transactions
  involving US7,850 or more in cash, account
  opening records, copies of client statements, and
  normal records created in course of business,
  such as deposit slips, account operating
  agreements, debit and credit memos, and client
  credit files
• A financial entity must retain the account
  opening record that shows signature of the
  individual who is authorized to give instructions
  for account, unless account is in name of
  financial entity or another financial entity

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MLR Record Retention
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• If a financial entity opens an account in respect
  of a corporation, the financial entity must
  retain a copy of the official corporate records
  that relate to the power to bind the corporation
  regarding the account held with the financial
  entity
• Trust companies have additional record keeping
  requirements concerning trusts for which they act
  as trustee

25
MLR Client Identification
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• financial entities must take steps to identify
  every person who is authorized to give
  instructions for an account
• identity of a client must be verified before any
  transaction other than the initial deposit is
  carried out on an account
• financial entities must identify every person who
  requests an electronic funds transfer of
  US7,850 or more or who conducts a foreign
  currency exchange transaction of US2,350 or
  more with the financial entity, unless the person
  has signed a signature card or is otherwise
  authorized to act with respect to an account with
  the financial entity
• Where the client is a corporation or other
  entity, the financial entity must confirm the
  existence of the corporation or entity

26
MLR Money Services Businesses
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Financial entities also have similar reporting,
  record retention and client identification
  obligations when acting as a money services
  business with persons or entities that are not
  account holders
• A money services business means a person or
  entity who is engaged in the business of (i)
  remitting or transmitting funds by any means or
  through any person, entity or electronic funds
  transfer network, or (ii) issuing or redeeming
  money orders, travellers cheques or other
  similar negotiable instruments

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MLR Third Party Determinations
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Whenever a financial entity is required to keep
  record in connection with large cash transaction
  or the opening of new account, it will also be
  required to determine whether a third party is
  beneficial owner of the account
• Financial entity must record certain information
  in circumstances where they suspect individual is
  acting on behalf of third party

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MLR Compliance Regime
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Reporting persons and entities such as financial
  entities must implement a compliance regime,
  which consists of organizational policies,
  procedures, and employee training
• FINTRAC has the power to examine compliance
  regimes and records

29
MLR Penalties
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Failure to comply with the new legislative
  requirements could lead to criminal charges
• The penalties for failure to comply vary
  depending on the offence, with a maximum penalty
  of up to five years imprisonment and/or a fine of
  US1.5 million for a conviction for failing to
  report a suspicious transaction or failing to
  make a terrorist property report

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Traditional Regulations
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion
31
Investment Canada Act (ICA)
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• What is the ICAs purpose?
• to encourage investment in Canada by Canadians
  and non-Canadians that contributes to economic
  growth and employment opportunities and to
  provide for the review of significant investments
  in Canada by non-Canadians in order to ensure
  such benefit to Canada
• Sets out notification/application for review
  requirements
• 390 acquisitions and 105 new businesses in
  past year

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Investment Canada Act
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• When is a Notification required?
• If you are non-Canadian, then every time you
  commence a new business in Canada or acquire
  control of a Canadian business where
  establishment /acquisition is not a reviewable
  transaction, unless an applicable exemption
  applies
• Must occur no later than 30 days after
  implementation of investment

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Investment Canada Act
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• When is an investment reviewable?
• Investment subject to review if asset value of
  Canadian business being acquired exceeds the
  following thresholds
• If the investor is both non-Canadian and not a
  WTO member, the thresholds are US3.9 million
  for a direct acquisition and US39.8 million for
  an indirect acquisition
• the lower threshold will apply in cases of
  indirect acquisition if the asset value of the
  Canadian business being acquired exceeds 50 of
  the asset value of the global transaction
• If the investor or vendor is a WTO member, any
  direct investment in excess of US185 million
  (in 2004) is reviewable indirect acquisitions
  are not reviewable

34
Investment Canada Act
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Review period can take up to 75 days further
  extensions permitted only if investor and
  Minister mutually agree
• Generally, reviewable investments may not be
  implemented prior to investor having received
  decision from Minister however, there are
  exceptions
• Undue hardship
• Acquisition of non-Canadian corporation
• When investment not normally reviewable

35
Industries with Ownership Regulations (Incl.
Foreign)
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Uranium mining
• Financial services (banks, trust/loan companies)
• Transportation companies (air, rail, etc)
• Books, magazines, and newspapers
• Film/video products

• Broadcasting
• Telecommunications
• Insurance
• Oil and gas
• Alcohol sales
• Security Dealers
• Audio/video music recordings
• Others

36
Taxes on Flows of Capital
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Federal (Income Tax Act) as well as provincial
  and municipal governments impose taxes
• Withholding taxes of 25 (less under treaty) on
  non-residents who receive dividends, interest,
  rents, royalties or management fees from Canadian
  sources (Canadian payor responsible)
• Can be reduced by treaty e.g. Canada-United
  States Income Tax Convention, 1980

37
Canadian Economic Sanctions
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• United Nations Act
• When UN Security Council imposes sanctions,
  Canada must introduce into domestic law
• E.g. Afghanistan, Iraq, Liberia, Sierra Leone
• Special Economic Measures Act
• Federal cabinet may impose sanction separately
• E.g. Federal Republic of Yugoslavia and Serbia
• Export and Import Permits Act
• Used mainly for imposition of trade sanctions
• E.g. Myanmar (Burma)

38
Conclusion
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion
39
Conclusion
Capital Flows in Canada
New Regulations
Traditional Regulations
Conclusion

• Canada remains a popular destination for capital
  flows
• Strengths
• Reliable, safe and secure capital flow
  institutions
• Mature business environment
• Modern infrastructure
• Traditional Regulation
• Centered on foreign ownership regulation and
  other tools
• New Regulation
• Money laundering legislation
• Going forward?

40
Canadian Regulation of Capital Flows

• David Butler
• McMillan Binch LLP
• Toronto, Canada
• Saturday, October 2, 2004

Materials prepared with the assistance of Jeff
Scanlon, McMillan Binch LLP