OSFI warns of a “plain language gap” in financial reporting

A “plain language gap” is becoming evident in the financial services industry and it is a growing cause of concern, Canada’s Superintendent of Financial institutions Julie Dickson told the American Bar Association in a speech made in Vancouver, B.C.
“Indeed, these gaps are likely responsible for much of the unraveling we have seen in the financial sector worldwide,” Dickson said.
In particular, she cited a lack of information and understanding surrounding new complex financial products. Examples include Collateralized Debt Obligations (CDOs), a type of credit derivative appearing at the core of the U.S. mortgage meltdown.
Dickson quoted from an international regulatory report on credit risk transfer that says: “it is questionable whether all investors have the necessary skills, infrastructure and resources to understand and use all the information provided…on complex credit risk transfer transactions.”
The report also says: “the complexity of some credit risk transfer products and activities challenges the ability of boards of directors and senior management to understand and evaluate the risks of these products.”
Dickson supplemented these remarks with an observation made by Warren Buffet, chairman of Berkshire Hathaway: “I read a few prospectuses for residential-mortgage-backed securities —  mortgages, thousands of mortgages backing them, and then those all tranched into maybe 30 slices,” Buffet said. “You create a Collateralized Debt Obligation (CDO) by taking one of the lower tranches of that one and 50 others like it.
“Now if you’re going to understand that CDO, you’ve got 50 times 300 pages to read. [That’s] 15,000 [pages].
“If you take one of the lower tranches of the CDO and take 50 of those and create a CDO squared, you’re now up to 750,000 pages to read to understand one security. I mean, it can’t be done.”
Dickson acknowledged the concern, saying: “You can have a thousand pages of rules, and the best of intentions, but it will all mean nothing if regulators, or risk managers in an institution, are unable to clearly communicate their concerns about the risks in a product or a practice…
“More plain talkers might do more for system stability than many other initiatives,” she said.
She said the challenge is the same for regulators and financial institutions alike. “We all need to be mindful of the risks brought on by the lack of clear communication and understanding around what is actually going on in an industry.”