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TD Bank Financial Group's Submission in Response to Finance Canada's Large Bank Mergers:

TD Bank Financial Group

Comments on Issues raised in the Department of Finance's June 2003 Paper on Large Bank Mergers in Canada

Pursuant to the June 2003 report entitled "Response of the Government to Large Bank Mergers in Canada," the Department of Finance requested input on certain key policy issues. TD Bank Financial Group submits the following comments to questions raised in Part B of the Report:

1. Cross Pillar Mergers

Given the changes that have taken place since the Government established its policy with respect to the large demutualized insurance companies, should the Government consider a policy change to allow these companies to merge with each other and/or with large banks? Should cross pillar mergers and mergers among large insurance companies be subject to a public interest determination by the Minister of Finance in addition to the standard regulatory review process involving the Competition Bureau and OSFI?

• TD Bank Financial Group supports the view that the Government should change its policy prohibiting cross-pillar mergers and should allow these companies to merge with each other and/or with large banks.
• In order to ensure a level playing field, TD Bank Financial Group supports the view that cross pillar mergers or mergers among large insurance companies should be subject to the same public interest considerations that the Government has concluded must apply to mergers among large banks.
• Over the past several years, there has been a significant level of convergence occurring within the financial services sector. Large banks and insurance companies are offering a variety of similar services, and are becoming increasingly competitive. The recently announced merger of Manulife Financial Corp. and John Hancock Financial Services Inc., will result in the creation of a merged entity with a market capitalization greater than all but one Canadian bank. As large insurance companies and large banks are comparable in size and sell some of the same services, it would be fair for them to be subject to the same public interest considerations.
• Where applicable, the public policy issues supporting a public interest review in any bank merger (i.e., access in rural and low-income communities, choice for SME's, etc.) should apply equally when an insurance company proposes a merger with a bank or another insurance company.

2. Structural Characteristics

Are there any market structural characteristics of the financial services sector which should be specified in advance of the Government considering merger proposals and, if so, what objective measures can be used in defining them? In this context, for example, should the Government specify a minimum acceptable number of large institutions and, if so, should "large" be defined in terms of product offerings, geographic range, market capitalization, assets, equity, or in some other way?

• TD Bank Financial Group does not support the introduction of new rules governing the structural characteristics of the financial services sector. While it is important that the merger process be governed by fair and clear rules, clarity does not necessarily mean more rules -- in our view it means less.
• Currently, the Merger Enforcement Guidelines as Applied to Bank Mergers provide a clear view of the analytical framework used by the Competition Bureau in assessing the competitive effect of a merger under the Competition Act. In addition, the Bank Merger Enforcement Guidelines contain natural restrictions that are generally understood by the Government and the financial services industry. (For additional comments on the Bank Merger Guidelines refer to Appendix I).
• Although TD Bank Financial Group does not support the introduction of advance rules concerning market structural characteristics in principle, if the Government has come to any conclusions about market structure, these rules must be made public. There is no point in having a bank propose mergers that do not comply with predetermined structural constraints assumed by the Government.
• The existing characterization of a large financial institution (common shareholder equity) should be maintained. This method of valuation offers clarity, and has been used in previous insurance mergers. As well, the equity characterization of a large financial institution is preferable to market capitalization which, as a function of fluctuations of a bank's stock price, would be more volatile.
• While we do not believe that the Government should specify a minimum number of large institutions, we take this opportunity to propose that the $5 billion amount in the general characterization of large financial institution be revised to reflect the impact of inflation and normal economic growth. Considering that the $5 billion equity threshold was arrived at several years ago, the amount should be increased at this time and should be regularly updated in 2004 and beyond.
• TD Bank Financial Group would not recommend the use of other ways to define large financial institutions, such as product scope or geographic range. These definitions would add complexity and may cause confusion with the Competition Bureau's mandate which already takes into consideration the product and geographic dimensions of any proposed merger.

3. Process For Reviewing Multiple Merger Applications

Should the Government establish a window of time, say 60 days, following receipt of the first merger application, after which all applications received during that time period would be considered together?

• The merger review process should not favour the first merger application received by the Government. It would encourage banks to make merger proposals as early as possible in the hope that their merger proposal would be the first one considered.
• No merger of any of the large banks should be reviewed or approved without the others being given the right to apply. Everyone should have the same options. A merger in one area of the sector affects the other parts, and they must be given the chance to respond as they see fit.
• In practice, when reviewing a merger application, the Competition Bureau considers subsequent proposals together with the first application it has received if it has not yet rendered a decision on the first application. We believe that an ex ante specification of the length of time of such a window would offer greater clarity in the merger review process. We believe that the establishment of a 60-day window of time following the receipt of the first merger application would effectively eliminate any first mover advantage. It would also simplify the Competition Bureau's review process, and provide additional clarity and certainty to consumers who may be affected by the merger of banks. Moreover, a 60-day window would be in the public interest, as it would provide the public with a clearer view of the possible ultimate shape of the industry.

4. Divestitures

How can divestitures in any merger context be used to maintain or enhance competition in the sector and contribute to public interest objectives? Should specific policies be designed to guide the divestiture process?

• TD Bank Financial Group does not support the introduction of additional rules concerning divestitures in a merger context.
• In addition to the public interest test, merger proposals are reviewed on the following basis:
• OSFI examines the safety and soundness of any merger proposal, including divestitures.
• The Competition Bureau has rules that determine whether mergers are anti-competitive or not. The Competition Bureau has a well-established process and skill-set to manage divestitures and enforce remedies to protect Canadians under the current rules.
• The Bank Act includes rules regarding the appropriate notification of customers in the event of a branch closure. These specifically address the question of branch closures in a rural community. Compliance with these rules is supervised by the Financial Consumer Agency of Canada.
• Any new rules governing the sale of assets as a result of a merger could be duplicative and may further complicate the divestiture process.
• Under the current rules, divesting assets as part of a merger is already difficult to execute. During the TD Canada Trust transaction we were required to divest branches that we would have been happy to keep. Our experience also demonstrated that many of our customers affected by the divestiture process were upset to learn that their branch was being sold.
• We believe that the process of divestitures already skews the marketplace, and has resulted in branches being sold at "fire sale" prices due to a lack of interested buyers. For instance, in 2000 we were required to sell 13 branches as a condition of the approval of the TD Canada Trust transaction, including a branch in Paris, Ontario. Recently, when TD acquired 57 branches of the Laurentian Bank, we repurchased the Paris branch for a price reflecting its true market value that was approximately 2.5 times the price we received three years earlier.
• In a review of any merger proposal, the Competition Bureau currently has the power, effectively, to require a bank to sell branches in order to obtain approval of the merger. The Competition Bureau also has the authority, effectively, to give direction as to whom a customer's business cannot be sold. There have been suggestions that there should also be a process of providing direction on whom a customer's business should be sold to. TD Bank Financial Group does not support the view that a government agency should be in a position of selecting who shall buy bank branches. Any additional rules that identify potential purchasers would result in distortions to the natural marketplace and place the selling institution at a significant disadvantage in terms of realizing fair value.

5. Full Functionality

Is the absence of ABM full functionality an important impediment to competition in Canada? Would the introduction of ABM full functionality permit smaller regional banking operations and new entrants to expand their reach and be strong competitive forces in Canada? If full functionality does hold significant promise to add an important new element of competition in the Canadian financial service sector, what steps should the government of Canada take to ensure that it becomes a marketplace reality?

• TD Bank Financial Group opposes the introduction of ABM full functionality.
• Currently there is a significant difference in financial institutions' ABM network size. Some have chosen to invest in a large off premise ABM network to gain a strategic advantage; others have focused on their branch network. The present system encourages competition among banks to provide their customers with the most innovative and convenient functions for their ABMs. Moving to a shared ABM network could lead to a dampening of competition, as banks would have little incentive to invest in new ABM functions if they were required to open their client delivery channels to competitors.
• The ABM delivery channels provided by each of the largest banks have been built on differing architectural platforms and are at various stages of development and maturity with respect to hardware and operating software. These architectural differences act as an impediment to moving to a single shared ABM network. Large banks currently use different service providers for deposit pickup, deposit processing and cheque processing. These different service models act as an impediment to moving to a single shared ABM network.
• Moving to full functionality would provide new opportunities for those seeking to take illegal advantage of the Canadian ABM system. ABM fraud is a large and growing problem in Canada. Moreover, the institution owning each ABM would take an increased operational risk for errors, losses and fraud.
• Upgrading or replacing hardware and software to extend full functionality to the ABM delivery channel would be extremely expensive. Banks would incur significant additional costs in accepting deposits from non-customers. ABM full functionality would increase the cost of servicing each machine. Such an increase would particularly harm the economics of low volume machines such as those located in small businesses and rural areas, where there are fewer transactions over which to defray costs. Since regulatory changes in 1996, there has been a substantial increase in the number of ABM machines in Canada, many of them managed by white label providers. A universal network of ABMs would likely result in higher overall service charges and less customer choice.
• Any mandatory requirement to move to full functionality would be an additional regulatory burden for an already over-regulated industry.
• Other alternatives to full functionality are available to smaller institutions through the Exchange Network.
• The definition of Full Functionality is unclear. The Government's response paper gives it a broad meaning describing full functionality as "deposits, withdrawals, bill payments..." However, testimony given to the House Finance Committee and the Senate Banking Committee referred only to deposits and withdrawals in the context of full functionality. The definition of full functionality must be better defined so that the consequences and costs of any proposal can be accurately evaluated.

6. Foreign Bank Entry

Is the restriction on foreign banks that choose to operate directly through a branch, rather than a Canadian subsidiary, from taking retail deposits a practical constraint and is it necessary on policy grounds? Should removal of such a condition be done unilaterally or should the Government seek to do it on a reciprocal basis only if other countries have similar rules?

• In Canada, deposit-taking banks, federally incorporated trust companies and loan companies are required to be members of the Canadian Deposit Insurance Corporation (CDIC) and to have deposit insurance. Foreign banks that operate directly through branches are not required to be members of the CDIC, are not required to provide deposit insurance, and face somewhat lighter regulatory requirements than Canadian banks or Canadian subsidiaries of foreign banks. In addition, foreign banks operating directly in Canada are generally subject to less onerous examinations by OSFI than their Canadian counterparts.
• As such, the restriction on foreign bank branches from taking retail deposits in Canada serves to protect retail depositors in the event of a failure of a foreign institution.
• This restriction does not deter foreign banks from retail deposit taking in Canada, as foreign banks have the option of establishing Canadian subsidiaries and applying to become CDIC members. Thus, TD Bank Financial Group does not support the elimination of this restriction.

7. General Comments on Bank Mergers and the Public Interest

• Financial Institutions already consider the public interest in formulating their merger plans. When TD acquired Canada Trust, we considered job losses, branch closures and service levels because we know that customer, employee and community satisfaction are crucial to the success of any merger.
• Overall, we believe that TD Canada Trust customers have benefited from an increased level of service. This includes increased hours, a larger branch network which has been of particular benefit to Canada Trust customers, and any branch banking -- which means that they are able to do any transaction at any branch regardless of where their account is. The TD Canada Trust transaction demonstrates that it is possible to have a merger that is customer-centric and takes in consideration the needs of communities served and of employees.
• About 25% of TD Bank Financial Group's revenues come from outside Canada, but 80% of jobs and taxes accrue to Canadians. We believe that there is a strong national interest in having Canadian champions with headquarters in Canada. Achieving scale allows Canadian banks to offer a wide range of products and services to consumers and achieve economies of scale -- the TD Canada Trust merger gave customers the best of both.

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Appendix I

TD Bank Financial Group Comments on Merger Enforcement Guidelines as Applied to a Bank Merger

Revisit market share and concentration thresholds:

• The Bank Merger Guidelines indicate that a high post-merger market share is a necessary condition that must exist to justify a conclusion that a merger is likely to prevent or lessen competition substantially. They also provide that mergers will not be challenged on the basis of concerns relating to the interdependent exercise of market power where:
• "the post-merger share accounted for by the four largest firms in the market would be less than 65 percent; and
• the post-merger market share of the merged entity would be less than 10 percent."
• TD Bank Financial Group submits that the "65 percent" and "10 percent" thresholds should be changed to reflect the realities of the Canadian financial services industry. Although these guidelines are intended to be a means of separating mergers that are unlikely to have anti-competitive consequences from those that require more detailed analysis, we believe that the current levels provide neither a realistic nor an effective threshold. We believe that the first threshold should be eliminated and the second should be raised to "35 percent."

Expand types of Financial Institutions to be considered at the market share and initial screening stages:

• When defining markets and conducting the initial screening process, the Competition Bureau should broaden the array of products and services it takes into consideration to include competitive products offered from financial institutions other than banks.
• The Competition Bureau's practice of bundling products and services is restrictive and does not accurately reflect the behaviour of customers. For example, the Competition Bureau has treated products and services offered by discount brokers and full service brokers as being fairly distinct. Recent experience has demonstrated that there is a high degree of substitutability between the products and services of discount brokers and full service brokers, and our experience shows that when a customer shifts business from a discount broker to a full service broker, it is not uncommon for them to shift to another competitor.

Efficiency vs. competitive losses:

• The Canadian Federal Court of Appeal in the Superior Propane and ICG case has held that efficiency gains can outweigh competitive losses. The Competition Bureau should consider the possibility of examining the overall income gains being brought to Canada, and consider whether consolidations in the Canadian industry would lead to greater success through Canadian-based companies expanding into foreign markets. The wide-ranging income and new jobs, which will flow into Canada as the result of a merger, should also be considered.

20 kilometre radius should be broadened -- and weight should be given to presence of three or more FI's in a "rural" market:

• In a letter to TD and Canada Trust on January 28, 2000, the Competition Bureau indicated that to determine the competitive environment of rural areas^[1], it had examined branches within a 20 kilometre radius of each other. We believe that the 20 kilometre radius should be enlarged as it does not take into consideration the true competitive area in rural areas (i.e., particularly in areas such as rural Saskatchewan). This distance does not reflect the actual distance many consumers travel to visit a bank of their choosing.
• In addition, the presence of three or more financial institutions in a rural market should be deemed to be sufficient evidence of competition.

Only material divestitures should be required:

• TD Bank Financial Group supports the view that divestitures should only be considered when a material number of branches would be affected. A relatively small group of divestitures would not have a material impact on the overall competitiveness of the financial services industry, and should not be required. TD Bank Financial Group's experience demonstrates that the process of divestitures is extremely disruptive to customers, employees and generates a substantial run-off of business as soon the change is announced.
• The 13 branch divestitures required by the TD / Canada Trust transaction created significant disruption and inconvenience for consumers. For the 13 branches sold (12 to BMO and 1 to Laurentian), business volume declined by 16% between the announcement of the divestitures in early 2000 and the conversion dates in July-September 2000. This decline was composed of 9% business volume growth, less 25% customer-requested transfers out. By the time TD purchased back the Laurentian branch in Paris, Ontario in 2003, its business volume had declined by an additional 25%.
• It is difficult for any purchasing bank to maximize customer retention where the number of branches being purchased is small. There is insufficient business volume involved to justify establishing intensive customer retention programs. A purchasing bank would be able to apply more resources to customer satisfaction and retention if purchasing a larger and more cohesive network. Given the disruption of minor divestitures and the nominal market impact (25 branches = 0.3% of the Canadian market), we suggest that if the Bureau's review of a particular deal indicates a divestiture of less than 25 branches, the Bureau should allow the deal to proceed without any divestitures.

Look at a longer period than two years for competitiveness trends:

• In the January 28, 2000 letter, the Competition Bureau also indicated that it considers the level of barriers to entry, and whether entry or expansion on a scale sufficient to offset the substantial lessening or prevention of competition is likely to occur within two years. TD Bank Financial Group believes that two years is not a sufficient time period to assess competitiveness trends.

Remedies should be considered simultaneously with a review:

One interpretation of the Bank Merger Enforcement Guidelines is that a merger proposal must remain unchanged until the Competition Bureau renders a conclusive view, and only then can remedies be considered. The Competition Bureau should commit to reviewing any remedies submitted by large financial institutions proposing to merge simultaneously with reviewing any potential anti-competitive impacts of the merger.

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^1.  Defined as areas outside of the local urban markets identified by Statistics Canada as census agglomerations [return]