Kurt Schacht, managing director of the CFA Institute’s Centre for Financial Market Integrity, discussed the findings of the Canadian Financial Market Integrity (FMI) report. This report provided a backdrop by addressing some of the industry’s attitudes that currently exist regarding Canadian securities regulation.

The Honourable Thomas Hockin, P.C., chair of the Expert Panel on Securities Regulation, discussed the findings of the panel’s final report, which recommends the establishment of a federal securities regulator and a single securities act for Canada.

These presentations highlighted the perceptions that currently exist about our investment marketplace and provided some insight into how a single securities regulator could assist in alleviating many of the current regulatory concerns.

Assessing the soundness and honesty of the markets–Kurt Schacht

Capital markets are built on trust and thus investors must have confidence in:

• Brokers and analysts
• Investment managers
• Financial reporting
• Regulators
• Corporate leaders

The CFA Institute Centre for Financial Market Integrity developed the Financial Market Integrity (FMI) Index as a tool to measure market perceptions and to identify improvements. The FMI Index is intended to gauge the perceptions investment professionals have about the state of ethics and integrity in six major financial services markets. The survey targets all categories of investment professionals and poses questions addressing:

• Accounting standards
• Corporate governance
• Financial transparency
• Legal protections
• Regulatory protections
• Shareholder rights

In the most recently published FMI survey for Canada (performed in the spring of 2008), the results highlighted that financial professionals were rated higher than the impact of market regulation as safeguarding the interests of investors and the industry. The current Canadian regulatory system earned one of the lowest ratings from Canadians among the six market systems reviewed in the survey, and the regulatory system got the lowest score overall. In terms of participants’ comments, the biggest concerns cited were focused on conflicts of interest and the regulatory system. In connection with the regulatory framework, some of the concerns focused on the perceived inefficiencies of having a regulator in every province, which in turn also encompasses the inefficiencies of policy implementation and enforcement. The lack of enforcement is demonstrated by a lack of criminal convictions, and issues in Canada are often instead pursued in the United States where better recourse is expected.

When soliciting views about the overall ethical behaviour of various groups of professionals, hedge fund managers were rated the lowest while pension fund managers were ranked the highest. However, in overall public opinion, investment professionals (stockbrokers) are now seen as one of the least honest and ethical among a wide group of professions (only exceeding the score for lobbyists). Nurses were by far ranked the highest, with accountants, bankers, and lawyers also achieving a better rank than stockbrokers.

The above results indicate that regulation and professional behaviour have room for improvement.

The debate surrounding a single securities regulator–Thomas Hockin

As a result of many of the issues (identified below) produced by having a multiple regulatory system in Canada, recent initiatives were underway to reconsider the current framework and to address the changes needed to give Canada a competitive advantage and to reduce barriers. Many officials from the Department of Finance and multiple industries were enlisted. Research papers were reviewed and solicited, and consultations took place with experts from the United States, the United Kingdom, and the International Monetary Fund (IMF).

Stocks in particular have migrated over the decades from being primarily the domain of Bay Street to “Main Street,” so today many public investors rely on these investments through their mutual funds, making regulation an even more important issue.

Some may suggest that the U.S. Securities & Exchange Commission (SEC) does not work well as a single regulator, but it might be even more questionable to have regulation spread out over multiple jurisdictions. Market participants in Canada are frustrated by the different provincial rules, the different interpretations, the multiple registrations required by adhering to the requirements of the 13 jurisdictions, the varying degrees of enforcement, and even the multitude of fees.

The Canadian system is simply not doing its job. In a recent meeting with the IMF, several of the negative remarks included pointing out that the speed of doing things in Canada is too slow and one does not know who to talk to for representing Canada. Policy development in one province is too long and any policies or solutions implemented do not hold in another province. In addition, some perplexity was expressed as to why several Canadian violators never ended up in prison.

With a single regulator, Canada would have a number of advantages that include reduced compliance requirements, simplified access, a regulator that can speak with one voice, better international alignment, and greater ease in responding to innovations. We thus could have better administration and criminal enforcement, with access to the best judges and prosecutors as a combined pool of resources rather than using the current segmented approach. Currently, for victims of ill advice and fraud, the recourse varies by the province one resides in, but with a single system, we can have a similar adjudicator and also establish an investor protection fund. We should also note that in a financial crisis, people still look to Ottawa or the Federal Minister of Finance for assistance, rather than the local jurisdictions.

Some of the areas that are lacking under the current regulatory environment include the development of rules for new products. There needs to be a heightened focus or awareness expressed on the checks and balances for many products, on a product’s liquidity, on the size of (not just the possibility) of defaults, including the attempts by the regulators to place confidence in the products. For example, there is still no consistent set of rules for commodities, options, futures and other derivatives, yet these products are increasingly entering the retail investor space.

The desire was also expressed across the country towards a more principles-based system (as exists in many other parts of the world) rather than one largely focused on explicit regulation that the Canadian system primarily supports. Such a principles-based system can promote greater accountability for market participants and to the public. In addition, it is believed Canada should also incorporate regulation proportionate to the company, as smaller companies may not have the capacity to comply with all of the regulations, and therefore have too much of an impediment for initiation and growth.

We cannot criticize the current multiple jurisdiction approach as being entirely less effective, since many jurisdictions have exhibited strengths that we do not want to forfeit. Some regulatory jurisdictions have performed an impressive job in encouraging small companies to be successful and to access capital, e.g. Alberta and British Columbia. The big discoveries (e.g. in the mining industry) were made by small companies, not by large ones. Fears have to be alleviated that a single regulator would negate the smaller successful initiatives in pursuit of a wider and bigger regulatory agenda.

How would the new system look?

One notable element of the current regulatory process in Canada is that provincial jurisdictions do not truly report to anyone except to the Minister of Finance in Ottawa— but such a structure likely results in very little true oversight. Under a single regulatory system, we can provide a framework that may include a Board of Governors that presides over the newly formed regulatory commission and that determines how money is spent. The new system would be decentralized with its head potentially being located in any province. Most regulatory offices would be kept in place and most of the regulatory positions would be retained, except that they would be operated under a new name. The “builders and framers” of this new system are currently in the Department of Finance and they have the budget allocated to fulfill this mandate.

In terms of implementing this new structure, Hockin quoted Samuel Johnson who said, “Nothing will ever be attempted if all possible objections must first be overcome.” We therefore have to move forward with a single regulatory system even though there still may be some criticism regarding the potential success or differences of opinion on what some of its goals should be. To arrive at such a system, we must remember that each provincial regulator has its own pride. Therefore if a province does not join initially, there will still be an opt-in provision in place whereby the jurisdiction can join indirectly later (and thus such a decision will rest with the regulator itself). A provincial jurisdiction may feel it is taking a bet if it joins such an initiative upon inception, so some may feel that they cannot support such an initiative publicly until they see it being successful. Once they see it as being a necessity to promote liquidity and that it can enhance the reach of a company, the regulator can encourage their respective provincial premiers to facilitate the means with which the regional regulators can join.

It is anticipated that this new regulatory system should take approximately 18 months to implement, and for us to come under this new regime fully, it could take a total of two years.

Conclusion

It is anticipated that the new regulatory system will become fully implemented unless something currently unforeseen affects its momentum.

We cannot afford to have continued negativity towards our ability to regulate our markets and questions about our integrity when performing our advisory duties. There are efficiencies that can be realized when we all work together under a single regulatory regime, while not sacrificing individual strengths that can put any particular system at a relative advantage.