Judy Wasylycia- Leis, the finance critic for the opposition, New Democratic Party, has proposed that Canada tighten accounting rules for income trusts because many provide “misleading’’ information for investors. At the same time, the Bank of Canada has released a study that notes income trusts can provide a source of financing companies that might not otherwise find access to financial markets.

Reports and statements show that at a press conference in Ottawa, Ms. Wasylcia-Leis has said that “There is a tension between the interest of financial product promotion and the public interest. This is a serious issue that needs to be addressed. But it’s still very invisible at the policy-making levels of this country.’’

She refered to a study by Standard & Poors in March 2006 and characterized income trust managers as not following generally accepted accounting principles, indicating that, “a majority” overstate the amount of cash they have available for distributions.

As we reported here at the time, that S&P study reported on an assessment of 40 of the 200 plus trusts in the market.  Of the study group, roughly half excluded capital spending from their measurement of distributable cash. The study authors proposed that, as a result, such trusts really operate with less cash being available for distribution to shareholders because capital spending is required to maintain their business.

According to Wasylycia-Leis, the NDP intends to propose changes in September that could force income trusts to adhere to righter requirements to maintain their tax-privileged status. A bill being developed by the party would need support from other parties in order to pass in parliament. 

On the day this statement was made, the updated version of its semi-annual Financial System Review was also released by the Bank of Canada. In the Important Financial System Development area, recent developments in the trust market were highlighted (p. 28).

The report generally describes the recent growth in the income trust market, noting that the number of new issues of trusts have exceeded traditional equity issues on the Toronto Stock Exchange. It also suggests that business trusts may be characterized as mid-cap or small-cap equities.

Bank of Canada author on the income trust feature, Stacey Anderson, says that income trust securities can provide financing to companies. Anderson also noted that “there are still some areas where standards for trusts are not equivalent to those for corporations. In particular, two areas related to accounting and corporate governance.’’

Other useful references are made including a note on findings in research by Cleary and MacKinnon (2006) that considers returns on an equally weighted portfolio of 59 trusts between 1995 and 2004.  They “decompose” trust returns into independent stock and bond return factors to reveal that “trusts are more like stocks” than bonds. However, trusts have risk-return characteristics that are sufficiently different from those of traditional public equities or bonds that trusts can provide investors opportunity for portfolio diversification.

The report noted that researchers speak for themselves and don’t necessarily represent the views of the central bank.