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Securities Market Regulation in Canada

Type: Research Studies
Date Published: May 1, 2002
Research Topics:
The existing Canadian securities regulatory system is composed of 13 provincial and territorial securities regulatory authorities (SRAs) as well as various self-regulatory organizations (SROs). The SRAs generally have similar objectives, but there are differences in powers and responsibilities, particularly in the exercise of oversight over SROs.

Increasingly, Canadian SRAs have been tightening the regulatory environment. The traditional philosophy of Canadian SRAs of resorting to regulation only when there is a problem that market participants cannot resolve themselves has been replaced by a new approach - resorting to regulation first even before a clear problem becomes evident.

While the tighter regulatory environment reflects growth in regulation to a large extent, it is also an outcome of a shift to more micro oversight of SROs and supervision of market participants. Regulatory oversight of stock exchanges, for example, used to consist mainly of reviews to changes in rules or bylaws. Now, the TSE/CDNX's self-regulatory arm is subject to more comprehensive examinations that cover not only rule enforcement, but operational and financial integrity. The shift towards more micro-supervision is readily apparent in the continuous disclosure review programs established by some of the SRAs. Public companies are facing increasing regulatory scrutiny of their continuous disclosures (ie. quarterly financial statements, press releases).

There are some signs that the combination of a tighter regulatory environment and the existing regulatory framework composed of 13 SRAs is proving to be a very toxic mix. For example, compliance costs have doubled over a five-year period for junior companies. Frustrations with the existing regulatory system have lead to calls by both market participants and SRAs for fundamental change. For example, the OSC is calling for a single "pan Canadian" regulator while the BSCS has launched a deregulation initiative.

There has been a tendency, not just with Canadian SRAs, but others as well to respond to new developments in capital markets through introducing new regulations. However, this paper argues that some significant developments such as increasing global integration, advances in information technology and demutualization of exchanges have contributed to the obsolescence of some regulatory functions. For example, a for-profit exchange facing significant domestic or foreign competition has strong incentives to offer quality self-regulation and safeguard the operational integrity of their trading infrastructure, thus the need for rigorous regulatory oversight is highly questionable.

Authorities seeking to build a better model for regulating Canadian capital markets should break out the various pieces of the existing regulatory framework and analyze each piece to explore to what extent market forces and private incentives can be relied upon to achieve the public policy objectives of each piece.

This paper proposes that for SROs, this would mean substituting transparency in place of rigorous regulatory oversight. For the TSE (and its subsidiary, the CDNX), oversight programs and regulatory approvals of rules and by-laws could be replaced by disclosure of its rules and a periodic external performance review that would also be disclosed.

By taking this approach, the TSE would be better able to differentiate itself from its competitors, and be able to market itself on the quality of its self-regulation. The current oversight regime constrains the ability of the TSE to innovate and adopt to changing circumstances as any change of rule or by-law requires the approval of the five SRAs that formally recognize it.

An external performance review that is publicly disclosed is superior to SRA oversight programs not just for the TSE, but other SROs such as the Investment Dealers Association, because the people who would really value the information this would provide (market participants) would have access to it. In the current system, only the SRAs know how well the SRO is performing its regulatory function. Easing regulatory barriers that inhibit competition from foreign SROs complements the transparency approach by strengthening incentives to offer quality regulation.

The transparency approach can also help alleviate the burden associated with multiple SRAs exercising oversight over SROs if external performance review requirements are consistent across jurisdictions. By encouraging authorities in other countries sign on to the concept of more transparency and less formal oversight, it will further global integration of capital markets. For example, it would better enable exchanges to establish global platforms if they are not subject to different oversight regimes in every country.

To the extent that regulatory frameworks serve as a barrier to more competition, they run counter to the interests of Canadian investors and other market participants. Because the existing regulatory framework facilitates monopolist power for Canadian SROs, their incentives to provide quality self-regulation are weaker. Easing regulatory barriers to competition would strengthen the incentives of SROs to offer quality regulation in line with investor preferences.

The regulation of public companies can also be improved through regulatory competition. One way of facilitating this is for SRAs to rely to a greater extent on exchanges for components of regulation such as setting disclosure standards, a role that exchanges played before public regulation emerged. As proposed by various commentators, competition between Canadian SRAs would also contribute towards healthier capital markets in Canada. Regulatory competition would not only improve the quality of regulation, but it would also facilitate differention, and thus regimes could be constructed in tune with the needs of different types of public companies such as junior issuers.

While there is a role for public enforcement of securities legislation against transgressions such as fraudulent behavior, Canadian investors would be better served by a system that places more reliance on private enforcement mechanisms for redress over actions such as deliberately misleading disclosure. In these cases, investors acting in their own interests have stronger incentives than SRAs acting in the public interest to be vigilant. Consequently, SRAs should proceed with a civil liability regime for continuous disclosure, and refrain from the resource intense chore of directly scrutinizing the minutiae of every piece of information disclosure.
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