Federal government publishes long-awaited “fintech regulations”

The Canadian financial sector has evolved rapidly in recent years as financial services move online and regulated financial institutions increasingly compete with businesses outside the federal regulatory framework. In response to concerns from stakeholders that current statutory limitations prevent or complicate investments by federally regulated financial institutions (FRFIs) in fintech firms, and restrict their ability to leverage technology and other commercial activities in-house (each of which may hamper their ability to innovate and serve the needs of Canadian consumers), legislative amendments (the NFA Amendments) were made to the Bank Act, Trust and Loan Companies Act and Insurance Companies Act (the FRFI Statutes) as part of Budget Implementation Act, 2018, No. 1. These amendments were meant to provide greater flexibility for FRFIs to undertake certain non-financial activities and to invest in financial technology companies that offer services beyond traditional financial services. However, almost a decade later, the NFA Amendments have not been brought into force, awaiting the adoption of regulations necessary to establish the terms and conditions required to implement those new provisions.

On October 17, the long-awaited Non-Financial Activities (Banks and Bank Holding Companies) Regulations, together with substantively similar regulations governing foreign banks, trust and loan companies, and insurance companies (collectively, the Proposed Regulations), were published in the Canada Gazette for comment, paving the way for operationalization of the NFA Amendments—hopefully in early 2027.

The Proposed Regulations were drafted to ensure that the NFA Amendments are used in a measured and incremental way, potential risks are understood and mitigated over time, and key principles of the financial sector legislative framework, such as ensuring that FRFIs remain primarily oriented towards financial services, are maintained.

What you need to know

• The proposed regulations would operationalize the 2018 amendments, allowing FRFIs to undertake broader non-financial activities and make certain fintech investments without prior ministerial approval.
• FRFIs could invest in entities that engage in non-permitted activities where at least 60% of the annual revenue, operating expenses or assets of the entity are attributable to financial service activities.
• Non-financial activities would be subject to revenue and capital limits: generally, 10% for large FRFIs, while FRFIs with less than $12 billion in equity would have a 15% revenue limit and 10% regulatory capital limit.
• Large FRFIs would face transaction and annual reporting requirements and should begin assessing existing technology activities and investments, developing calculation methodologies and preparing compliance functions ahead of the proposed regime.

Background: 2018 Budget Implementation Act legislative amendments

The federal government has long imposed restrictions on commercial activities, dating back to the first Bank Act in 1871. While the FRFI Statutes have been amended over time to permit specific non-financial technology or information processing activities in limited circumstances and with Minister of Finance approval, FRFIs generally remain restricted from engaging in, or investing in entities that engage in, activities other than the business of providing financial services.

The federal government introduced several significant amendments in the 2018 Budget Implementation Act to provide greater flexibility for FRFIs to undertake non-financial activities, as defined below in the Proposed Regulations (NFAs). Specific amendments included:

• expanding the scope of permitted NFAs by removing restrictions on the types of information that FRFIs may use when undertaking information processing and information technology activities, modernizing language that specified the types of information technology activities that are permitted, and creating a new permission to undertake any activity that relates to the provision of financial services by the FRFI;
• removing requirements to seek prior approval from the Minister of Finance before engaging in, or investing in, an entity that undertakes permitted NFAs;
• creating a new category of permitted investment to enable FRFIs to acquire a controlling or substantial investment in an entity that engages in non-permitted NFAs, but only where a majority of the entity’s overall business consists of financial service activities (a majority financial services entity, or MFSE); and
• enhancing FRFIs’ abilities to make referrals by expanding the referral power from permitting FRFIs to refer “any person to a financial service provider” to allowing them to refer “any person to any person”.

See our earlier bulletins, Budget 2018’s Impact on the Canadian Financial Sector and Significant Change Ahead for Financial Institution Statutes, for further discussion on the NFA Amendments.

Rather than introducing narrow powers that could be used without limit, the federal government has opted for the broader powers described above paired with quantitative limits, along with a regulatory line of sight into the new activities. Accordingly, the Proposed Regulations establish (i) limits and conditions on a FRFI’s use of the expanded business and investment powers to ensure FRFIs remain primarily oriented towards financial services; and (ii) reporting requirements that ensure the Department of Finance has sufficient information to evaluate the policy outcomes and effectiveness of the business power expansion over time.

Engaging in non-financial activities (directly or indirectly)

Once the NFA Amendments are brought into force, there would be three avenues through which FRFIs may engage in NFAs without prior ministerial approval: (1) directly through business powers contemplated in the FRFI Statutes; (2) through investments in an MFSE; and (3) through an investment in another FRFI or other permitted investment entity that engages in at least one permitted NFA (an entity engaging in non-financial activities, or EENFA).

The Proposed Regulations create a definition of NFA by reference to the updated business powers in the FRFI Statutes related to information processing, dealing in information technology, and activities related to providing financial services, and define “majority” for purposes of the newly created MFSE as at least 60% of annual revenue, operating expenses or assets of the entity attributable to financial service activities¹. This metric would be measured on a quarterly basis against the four most recent quarterly financial statements, or if quarterly financial statements are not prepared, the most recent annual financial statement. From a practical standpoint, these calculations may prove challenging, as many early-stage fintechs generate little revenue and hold mainly intangible assets.

Conditions and limits

The Proposed Regulations impose two main conditions that FRFIs must meet in order to engage directly in NFAs or invest in an EENFA or MFSE, which will vary depending on the size of the FRFI.

The first condition would limit the extent to which an FRFI’s business may be oriented toward NFAs by ensuring that the aggregate annual revenues attributable to NFAs (either directly or through a EENFA or MFSE subsidiary) do not exceed a specified percentage of its total annual revenues.

The second condition is designed to limit the aggregate exposure of an FRFI to MFSEs and EENFAs. Under this requirement, the aggregate value of ownership interests, loans, and guarantees relating to MFSEs and NFAs that the FRFI controls or has a substantial investment in could not exceed a specified percentage of the FRFI’s total regulatory capital.  

In general, large FRFIs (with equity of $12 billion or more) would be subject to a 10% limit under both the revenue-based and regulatory capital-based tests. FRFIs with equity less than $12 billion would also be subject to a 10% regulatory capital limit, but with a higher revenue limit of 15%².

If an FRFI breaches either the revenue-based or regulatory capital-based limit while holding control of, or a substantial investment in, an EENFA or MFSE, all of the FRFI’s investments in such entities would be automatically deemed as “temporary investments”, and the FRFI would have two years to satisfy the conditions of the Proposed Regulations or move the investments into a permitted investment category.

Prior to engaging in NFA business, the FRFI would be required to develop a methodology for categorizing and attributing NFA business revenue and capital exposure. Large FRFIs would be required to provide the Department of Finance with a description of this methodology on an annual basis.

In addition, large FRFIs would be subject to ongoing reporting obligations, but small and medium-sized FRFIs would be exempt (which is welcome news for them, as this could have been a significant burden for smaller institutions that may not have the resources available to dedicate to such reporting). In practice, we are also unsure how these reporting requirements will play out with the larger FRFIs, as the burdensome obligations may encourage fintechs to avoid relationships with banks to protect confidential information. Specifically, for the larger FRFIs, a transaction report would also be required no later than 30 days following the completion of any controlling or non-controlling substantial investment in a EENFA or a MFSE (the reporting requirements will be more onerous in respect of controlling investments) and an annual report would be required no later than six months after any financial year in which the FRFI engages in NFAs or invests in an EENFA or a MFSE.

Notwithstanding the reporting obligations above in respect of NFA activity and investments in MFSEs and EENFAs, we were pleased to note that the Proposed Regulations did not impose any further requirements or expectations on the expanded networking powers that will be adopted as part of the NFA Amendments. In our view, there are already mitigants in place (e.g., reputational, privacy, consumer protection) to ensure that FRFIs do not inappropriately use this power and therefore we were pleased to note that additional constraints were not imposed under the Proposed Regulations.

Exemptions and clarifying amendments

The FRFI Statutes currently permit FRFIs to undertake a limited set of information technology and processing activities with approval from the Minister of Finance. Therefore the Proposed Regulations would not apply to activities for which the Minister of Finance has previously granted approval (the rationale being that the Department of Finance would already have a line of sight into the business as part of the original approval). However, if that business were to change or evolve outside of what was previously approved, the FRFI would be required to apply the conditions of the Proposed Regulations to the unapproved portion of the business, including tracking, measuring, and reporting on it against the proportional limits.

We note that the Proposed Regulations refer to the current sections of the FRFI Statutes that permit these activities, but not to any predecessor sections from earlier versions of the FRFI Statutes under which a Minister of Finance approval may have been obtained. It would be helpful if the Proposed Regulations were more explicit, but we believe that the Regulatory Impact Analysis Statement makes it clear that if a Minister of Finance approval has previously been granted in respect of an activity or investment, the Proposed Regulations would not apply.

The Proposed Regulations also carry forward exemptions from the Information Processing Activities (Banks and Authorized Foreign Banks) Regulations, which include, among other things, classifying and reporting payments, and preparing an employer’s payroll. These activities would not be subject to the conditions and limits in the Proposed Regulations as they are not considered by the Department of Finance to be the type of non-financial commercial technology or activity that merits additional regulatory scrutiny.

Transitional provisions

The Proposed Regulations also include transitional provisions for certain information technology and processing activities or investments that do not currently require approval from the Minister of Finance. These include collecting, processing, and transmitting information outside of Canada, as well as investments in entities whose business is limited to developing, designing, holding, managing, manufacturing, selling, or otherwise dealing with any data transmission system, information site, communication device or information platform or portal that is used to provide information services (as prescribed in the Information Technology Activities Regulations under each FRFI Statute).

Since these activities that are carried out today would become NFA business, they would be subject to the conditions and limits included in the Proposed Regulations; however, the Department of Finance acknowledges the challenge with complying with the Proposed Regulations on Day 1 and therefore a two-year transition period was included.

Next steps

The Proposed Regulations are open for comment until November 16. While they would provide a transition period of two years for certain existing permitted NFA activities, large FRFIs subject to the reporting obligations should begin assessing their existing technology activities and investments, developing limit-calculation methodologies, and preparing compliance functions for the proposed requirements.