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Capital Markets Better Served by Transparency and Regulatory Competition than by Excessive Regulation

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Release Date: May 1, 2002

Transparency and regulatory competition are more effective tools than increased regulatory oversight in ensuring the effective functioning of Canadian capital markets, according to a new study Securities Market Regulation in Canada released today by The Fraser Institute.

This paper suggests that authorities seeking to build a better model for regulating Canadian capital markets should examine the individual pieces of the existing regulatory framework and explore to what extent market forces and private incentives can be relied upon to achieve specific public policy objectives. Market solutions should be considered before resorting to new regulations and more supervision.

Historically, Canadian authorities have a long track record of taking a hands-off approach to markets, preferring to rely on self-regulation unless significant problems emerge. However, regulators have been rapidly shifting to the other extreme and have been tightening the regulatory environment even where no discernable problem exists.

"Without a clear problem surfacing that a market solution cannot resolve, there is no rationale for introducing regulation and the burden it imposes," says Neil Mohindra, senior economist at the Institute and author of the paper.

"Increasingly, regulation is becoming the first line of defense for investors when it should be taking a back seat to other strategies such as corporate governance. Canadian securities regulators need to regain confidence in market forces as an effective tool to use in their pursuit of public objectives."

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 business incentives to offer quality self-regulation and safeguard the operational integrity of their trading infrastructure.

"Consequently, regulatory oversight over an exchange isn't needed, and it impairs the ability of the exchange to market itself based on the quality of its self-regulation," says Mohindra.

The existing Canadian securities regulatory regime is a complex web, composed of 13 provincial and territorial securities regulatory authorities (SRAs), along with various self-regulatory organizations (SROs), such as the Investment Dealers Association and Mutual Fund Dealers Association.

There are some signs that the combination of an increasingly tighter regulatory environment and the complicated regulatory framework is proving to be a toxic mix. "For example, compliance costs have doubled over a five-year period for junior companies," notes Mohindra. "The right prescription for Canada's capital market woes is a healthy mix of deregulation and regulatory competition."


Mohindra argues that SRO oversight programs could be replaced by increased transparency. This would consist of periodic external performance reviews that would be publicly disclosed. "Information on how well SROs are executing their self-regulatory functions should be in the hands of investors rather than controlled by regulators," he says.

In addition, the burden associated with multiple organizations exercising oversight can be alleviated if external performance review requirements are consistent across jurisdictions. Easing regulatory barriers that inhibit competition from foreign self-regulatory organizations further strengthens incentives to offer quality regulation.

Encouraging authorities in other countries to sign on to the concept of more transparency and less formal oversight will further increase the global integration of capital markets. "It will be easier for securities exchanges to establish global platforms if they are not subject to different oversight regimes in every country," says Mohindra.

Regulatory Competition

To the extent that regulatory frameworks serve as a barrier to more regulatory competition amongst SROs, they run counter to the interests of Canadian investors and other market participants. Easing regulatory barriers to competition will strengthen the incentives of self-regulating organizations to offer quality regulation in line with investor preferences.

Competition between SRAs (provincial regulatory authorities) would also contribute towards healthier capital markets in Canada. Regulatory competition would not only improve the quality of regulation, but it would also facilitate differentiation, and thus regulatory regimes could be constructed in tune with the needs of different types of public companies.

"While a national regulator might be better positioned to foster regulatory competition with other countries through bilateral and multi-lateral negotiations, it would be risky to move in that direction," says Mohindra.

"Concerns raised over the impact on junior and regional markets are legitimate, and trying to address these concerns within a national regulator would likely result in the internalisation of existing flaws in the regulatory system into one giant bureaucracy," he continues.

Private Enforcement

There is a role for public enforcement of securities legislation against transgressions such as fraudulent behaviour. However, to ensure the integrity of information disclosure of public companies, 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 to be vigilant than regulatory bodies acting in the broader public interest," says Mohindra.

Other Recommendations

· Canadian SRAs should resort to regulatory solutions only when market solutions fail to materialize.

· Canadian SRAs should be prepared to act unilaterally in easing regulatory barriers to foreign entry.

· Canadian SRAs should encourage the International Organization of Securities Commissions to study how regulatory barriers to cross-border activity impede the public objectives of regulators themselves.

· Market participants in Canada should not be burdened by multiple SRA oversight.

· Provincial authorities should consider stronger public accountability measures for SRAs.

About the Author

Prior to The Fraser Institute, Neil Mohindra worked as a policy analyst on financial sector issues at the federal Department of Finance. Before that, he was a research associate with the Task Force on the Future of the Canadian Financial Sector (the "MacKay Task Force").