david dodge : income trusts remarks by mr david dodge, governor of the bank of canada, to the house of commons standing committee on finance, ottawa, 1 february 2007. * * * good morning, mr. chairman, and members of the committee. i'm happy to be here and to assist the committee, insofar as i am able, in your study on income trusts. i should start by making clear where the bank of canada's main interest in the income trust sector lies. our interest in income trusts relates to the efficient functioning and health of canada's financial system. a safe and efficient financial system is essential to canada's economic well - being. the bank of canada works with other government agencies, as well as market participants, to promote the safe and efficient functioning of the financial system. capital markets are a key component of that system. and so we are naturally interested in developments in financial markets – such as the evolution of the income trust market – that have the potential to affect financial system efficiency. with that introduction, let me quickly summarize the highlights of the bank's analysis of this topic. i'd refer committee members to the june 2006 edition of our financial system review. in that publication, we noted that limited evidence suggests that income trusts can enhance market completeness in a couple of ways. first, income trusts can provide diversification benefits to investors, because trusts can have different risk - return characteristics than either equities or bonds. second, the income trust structure appears to allow some firms improved access to market financing. so, insofar as income trusts allow investors to achieve risk - return benefits that they could not otherwise achieve, and serve as a source of financing to firms that might not otherwise have had access to markets, it can be said that income trusts enhance market completeness, and therefore support financial system efficiency. that same article also noted two areas where the standards for trusts are not the same as those for corporations, and where improvement is clearly needed – standards related to accounting, and those related to governance. these are the aspects of income trusts that we at the bank have looked at and on which we are best able to comment. of course, there are very important public policy questions related to income trusts that fall outside the bank's mandate. the bank has done no specific research on how the income trust structure affects economic performance, or would affect the future productivity of the canadian economy. but, based on general economic principles and my

market failures and a suboptimal allocation of funds. most often, these failures arise when there are significant differences in the quantity or quality of relevant information available to market participants. regulation should be designed so that investors are able to adequately gauge the risks and potential returns of an investment. to be clear, i'm not saying that the goal of regulation should be full disclosure of all information. rather, the aim should be to reduce information asymmetries to the point that the benefits of disclosure still outweigh the costs of compliance. in that way, regulation can lead to a more efficient financial system. the third way that financial system regulation can support efficiency is to promote overall financial stability, which essentially means limiting systemic risk. the idea that regulation can support efficiency at the same time as it promotes stability may strike some as counterintuitive. but these objectives are not mutually exclusive. if the regulation is carried out in the right way, enhancing stability can lead to increased efficiency through the saving of resources that would otherwise be dedicated to guarding against systemic risk. let me elaborate. i noted earlier that the bank's monetary policy supports efficiency by increasing certainty about the future value of money. this reduces the need for canadians to spend resources on activities intended to protect them from inflation. similarly, enhancing the safety of the financial system reduces the need for canadians to unnecessarily spend resources to guard against the risk of a financial crisis. policy - makers are more likely to successfully promote both stability and efficiency if they bring market players into the picture when addressing a particular issue. canada's large value transfer system ( lvts ) provides a good example of how systemic risk can be mitigated in the most efficient way. the lvts processes canada's large - value or time - critical payments. it gives participants the certainty that once a payment has been processed, the transaction will settle on the same day, regardless of what might later happen to any of the participants. this certainty enhances efficiency on its own. but, in addition, the design of the lvts minimizes the amount of collateral that each institution needs to pledge to the system, compared with the gross settlement systems used in other countries. this reduction in collateral frees up resources that can then be put to more efficient uses elsewhere. 2 / 5 building an effective framework that's a look at three ways in which a sound regulatory framework can improve the efficiency of the financial system — by promoting competition, by