Global Challenges, Global Growth

An address by Richard E. Waugh
President and Chief Executive Officer
Scotiabank

Presentation to
New Brunswick Chamber of Commerce
2008 Annual Meeting
Fredericton, New Brunswick

April 29, 2008

Check Against Delivery

Thank you, Peter (Lindfield, President of the Fredericton Chamber of Commerce), and good afternoon, ladies and gentlemen. It’s a great pleasure to be here in Fredericton and to have the chance to speak at the New Brunswick Chamber Of Commerce Annual Meeting.

Scotiabank is proud of the part we’ve played in the lives of Canadians and Canadian businesses in Atlantic Canada for more than 175 years – and here in New Brunswick. We’re proud of our employees and the work they do, not only serving our customers, but in supporting their communities.

And we’re committed to continuing to grow and support growth in the province – working with all of you to play a part in strengthening the economic prosperity of New Brunswick.

Certainly, continued prosperity is on everyone’s minds – especially with the ongoing challenges of today’s economic environment. The slowing U.S. economy; rising oil prices; the U.S. sub-prime crisis; the unprecedented turbulence in financial markets; all together creating a high level of uncertainty around the world and, increasingly, here in Canada. Since August of last year, we’ve experienced severe shocks in the global financial sector and parts of Canada, producing significant volatility.

Notwithstanding these challenges, I remain confident about the future of Canadian business and Canada and our ability to withstand these shocks, albeit with some pain – and confident about the future of Scotiabank.

But there is a powerful need for all of us – Canadian leaders in both the private and public sectors – not to be complacent about our current good fortune – but to be thinking about the future of Canada and the ability of business to compete and grow globally.

What I want to talk about today is what we need to do to continue to succeed. First, I want to talk about the steps underway to address the current financial market crisis – as that is critical for continued confidence in markets going forward; and then, I also want to talk about the steps that the private sector and government here in Canada need to take to support the competitiveness and global growth of Canadian businesses.

Starting with the financial market turmoil, I believe that we will overcome the serious challenges in financial markets that arose this past summer and have continued into this year. As bad as this is, one thing I know after more than 35 years in banking – crises do come to an end.

Let me take a moment to provide a brief summary of what happened. The problems began with the meltdown in the U.S. sub-prime mortgage market. Many financial institutions used securitization and other structures to support their lending and fee generating activities – passing on the risk to investors searching for a better yield in a low-rate environment.

Many investors relied on third parties – primarily rating agencies – to make risk assessments. When interest rates started to rise in the U.S. and house prices started to fall, the faltering housing market led to increasing defaults. Suddenly, everyone became aware of the aggressive lending and selling practices of the past few years in the U.S. – and investors questioned, finally, the value of the investments they held. With the complexity of new, highly structured products, investors were unable to fully determine the quality and value of the assets backing their securities. With the global distribution of these products, the effects were widespread but unevenly distributed, with some investors and financial institutions hurt more than others.

Overall, the result has been a needed repricing of risk, albeit painful and prolonged. The impact in the U.S. and globally has been significant, especially in the financial sector. And consequently, there has been a significant tightening of credit, and a number of financial institutions have struggled to meet capital requirements and liquidity needs. All this, of course, has further undermined an already wobbly U.S. economy, now in recession territory.

In Canada, we have fared much, much better – but we have not gone completely unscathed. And we cannot assume we are immune to these global effects.

The collapse of the non-bank Asset Backed Commercial Paper market here is an example. That situation led to the creation of the Pan-Canadian Investors Committee for Third-Party Structured ABCP. That committee, with the help of banks and other financial institutions, has been focused on finding a way to restructure about $32 billion of non-bank commercial paper to create new long-term notes. On Friday, there was a vote to accept the plan that was supported by 96% of investors – a very positive outcome to a very trying and difficult situation.

In considering all that went wrong – and, as usual, in crises there are always several factors – it seems to me that one of the key root causes was a lack of attention to basic, proven principles of good risk management. Financial institutions with good risk and investment cultures that stuck close to these fundamental principles have been largely protected from the crisis.

Clearly, this is a global issue, and one that is being addressed through the participation of many groups on a global scale.

Public sector responses, initially slow in coming, are now numerous and are an important source for possible solutions. The response from the private sector is the Washington, D.C.-based Institute of International Finance – the IIF – which includes the top 375 financial institutions in the world. I’m privileged to be on the Board, and the institute struck a committee, called the Committee on Market Best Practices, which I co-chair – to address the weaknesses of the market.

A few weeks ago, we announced our interim proposal – which called on the global financial services industry to increase transparency and disclosure, and to significantly improve their risk management, liquidity management and underwriting approaches. Firms will also need to ensure incentives and compensation structures promote the correct behaviours, aligning compensation to both shareholder and customer goals – in particular – over the long term.

An important public sector source for solutions is the Financial Stability Forum initiative, comprised of leading regulators, including Canada’s own Superintendent of Financial Institutions, Julie Dickson, and which our IIF committee is collaborating with.

A key point in the Financial Stability Forum recommendations is that while regulatory oversight and improvements must and will be made, authorities should not pre-empt or hinder market-driven private sector adjustments, but should monitor them and add discipline where needed – a recommendation I completely agree with.

And I think it’s worth stating that whatever final solutions are determined to be needed going forward, they should not be founded in rules-based regulations. They should not be found in Sarbanes-Oxley type legislation, which did little to stop this current crisis.

My sense is – especially for Canada, where there were few underlying systemic issues – solutions should be based upon rediscovering the fundamental principles of risk and liquidity management, and ensuring the necessary transparency and accountability by all market participants.

It’s worth noting that this crisis has helped to highlight the tremendous strength of the Canadian banking system. Our banks are well capitalized and generally in a strong position. In fact, this situation is creating opportunities for us. At the same time, our expertise in risk management is highly regarded – and that’s why Scotiabank, as a representative of our Canadian industry, was invited to help find solutions to this global challenge.

What this crisis should also make clear to all Canadians – in business and government – is that markets are truly global and completely interconnected. We are not an island immune to tidal waves. That takes me to the second area I’d like to discuss. I am convinced that our future economic prosperity is not to be insular and defensive and to try to protect ourselves from the global world. Our future prosperity depends on a more aggressive approach by both business and government to build on our strengths and to succeed in global markets.

Too many Canadian companies are too focused on our home market and too hesitant to participate in global consolidation or looking for protection. Canadian business must aggressively pursue growth opportunities abroad and not rest on past laurels.

I point with pride to the experience of Scotiabank in doing just that – as one of Canada’s largest companies, with international activities in some 50 countries around the globe. Our goal is to grow beyond Canada. That’s as true today as it was more than 100 years ago, when Scotiabankers from the Maritimes opened a Scotiabank branch in Kingston, Jamaica – even before going west to open our first branch in Toronto.

In addition to more globally focused companies, Canada will also be in a better position to win in global markets if our governments gear our public policies towards supporting the international competitiveness of Canadian businesses. In a global economy – and, as I said, there is no denying that is what the world has become today – you can’t build walls, subsidize weakness and hope to be protected.

It was with this thinking that our Bank made our recommendations to the Canadian Government’s Competition Policy Review Panel. The panel was established to discuss globalization and the implications for Canada – as well as the issue of the hollowing out of corporate Canada.

From Scotiabank’s perspective, the recent foreign acquisition binge involving some of Canada’s biggest and best companies is a clear signal that Canadian businesses must become more aggressive international acquirers.

It’s not surprising that some major Canadian businesses are being bought by big foreign firms. We have some great companies. We have some incredibly dynamic industries here in Atlantic Canada. Not only are there the family success stories everyone is aware of – the Irvings, the McCains, the Sobeys – but also there are other stories, such as Altius, Blue Line and Major Drilling. And across the country, we have other success stories in transportation and telecommunications, financial services, manufacturing and more.

Large international firms look at Canada, as they do throughout the world, and recognize the value of our firms – and, in a free and open global world, are attracted to invest and acquire.

Our inward investment policies cannot act as a barrier to foreign takeovers but, at the same time, these policies must not disadvantage Canadian firms and their opportunities to develop into global corporations.

In our experience, there are significant policy disparities between what is practiced in Canada and what applies in other jurisdictions.

Consider the “the poison pill,” which has emerged as the most popular defense against hostile takeover in recent years. Several foreign jurisdictions give directors of companies the right to adopt indefinite poison pills, which function as a strategic defense option that essentially makes the company more immune to an ill-advised takeover. By comparison, Canada’s investor-friendly regime implies that boards can only use poison pills in a tactical short-term manner – in other words, to buy time while the company remains “in play,” solely to get the best prices at the expense of other relevant considerations. Unlike the U.S., our laws severely restrict a board’s ability to just say no.

Also, the review periods for takeovers are shorter in Canada than in other key jurisdictions. This disadvantages Canadian firms in their quest to become global competitors – in particular if foreign governments use the review period (and extend it) in an active/interventionist effort to find domestic alternatives to a foreign takeover bid. I personally experienced this as a former board member of Inco.

While the principle behind some of Canada’s practices – the shareholders’ interests – is absolutely sound, it is not clear that the national interest is always being served effectively. A global – yet practical – perspective is essential to compete and win. One that takes into account long-term shareholders’ interests, as well as the interests of other stakeholders.

At the same time, Canadian companies should work to be much more than the building blocks for the global aspirations of other countries’ firms. To do this, it is imperative that Canadian corporations should identify global markets and opportunities and, as much as possible, gain scale through mergers and well thought out acquisitions. Canadian businesses cannot ignore the competitive advantage that scale provides – stronger ability to acquire in foreign markets, greater diversification, spreading your risks and costs, and the ability to afford the best technology and to attract the best talent to succeed globally.

Truly global scale cannot be achieved unless Canadian firms participate in the global consolidation taking place across sectors. And there’s a clear benefit in doing this. The head offices of large, internationally oriented corporations will remain and grow here in Canada.

Why is this important? Because it brings considerable economic and social benefits, not the least of which are high-paying and rewarding careers and indirect employment for various supporting services. This, of course, adds to Canada’s personal and corporate tax base and provides our communities with people who can – and do – contribute significantly socially and culturally.

We also must remember it is far harder to grow mid-sized companies into the top tier than it is to support the success of the ones already there.

Other countries get this. Considering how volatile annual merger and acquisition activity is, our Bank is struck by the remarkable consistency in the fact that foreigners acquire larger companies in Canada than Canadian companies acquire abroad. While it is true new Canadian companies will emerge, it costs us every time we lose a large successful company with its head offices and people.

There must be a far greater recognition of consolidation and the benefits of global commerce and markets in our domestic policy. As a smaller economy, we have to play to our strengths and build on strategic sectors – like the financial services sector – like the energy and mining and telecommunications sectors – and to think globally.

We must take a long-term approach by moving our policies towards full and open competition, with appropriate transition periods for adjustment, including consolidation by Canadian firms. If you’re going to play in the big league, you’ve got to prepare your team first.

Similarly, to prepare, our trade agenda must be driven by a strategic approach to building on Canada’s strengths. We should ensure Canadian corporations are on as strong a footing as possible when expanding into international markets.

Priority markets should be ones in which Canada has a comparative advantage – advantage related to geography, history, socio-economic policy expertise and industrial capabilities. We can’t afford to do everything, everywhere.

The recent trade and investment focus of the federal government on the Western Hemisphere is the right one – but it should become a sustained and long-term strategy. That means being committed to creating more integrated relationships in North America, Central and South America, and the Caribbean.

I applaud Prime Minister Harper who, last week, reaffirmed the benefits of NAFTA and the need to expand free trade to Colombia and other markets.

Ladies and gentlemen, we are dealing today with tougher economic circumstances and financial market turmoil. But, as I said at the outset, I have confidence in the future.

I believe the crisis in financial markets, like all crises, will end. Going forward, there must be a continuous emphasis on the fundamentals of risk and liquidity management. There is a need for greater transparency and in achieving the right balance of risk and reward to achieve sustainable long-term growth – by all market players – and to ensure compensation incentives support this objective.

I also have confidence in Canada, and Canadian business, and I am not afraid of more competition here in Canada or abroad. We need to orient a range of policies – market structure, competition, investment, trade – toward strategic sectors and the ability of firms to succeed as truly global competitors in international markets. At the same time, Canadian businesses must be more aggressive in their pursuit of growth opportunities and markets abroad.

From Scotiabank’s experience, we know the opportunities the world offers and we’ve demonstrated this. We’ll continue to focus on meeting the needs of our customers here in Canada and around the world. And we will continue to focus on achieving our goal to be the best Canadian-based international bank.

Thank you.