Industry News

Association president calls for tighter regulation of EMDs

By James Langton |

You don't often hear the securities industry calling for tougher regulation. But that may be part of the answer to reviving the moribund venture markets in Canada, the Investment Industry Association of Canada (IIAC) suggests.

Since the onset of the global financial crisis in 2007, the Canadian venture markets have been in seemingly irreparable decline. And, according to IIAC president and CEO Ian Russell's latest letter to the industry, equity financing activity in the venture market in 2014 was less than half of what it was back in 2007. Further, trading volume is down by one-third, and new listing activity has plunged as well. As a result, Russell warns, "Canada is at serious risk of losing its respected small and mid-cap venture marketplace."

The causes, Russell suggests, are numerous. Along with general economic weakness and resources-sector turmoil in particular, he also points to demographic patterns, which involve aging investors shifting from speculative equities to more balanced portfolios; a shift in institutional investor demand from speculative stocks to foreign assets; heightened regulatory scrutiny of suitability standards; market structure changes that have boosted trading and dealing costs; and the growth of the exempt market and private equity, which allow companies to raise capital without going public.

As a result, Russell says, domestic, institutional boutique brokerages are disappearing from the market, with 21 firms exiting over the past two years. Without this sector, Russell writes, "the underpinnings of the venture markets will collapse."

And, he warns, the overall economy will suffer too. "This loss of liquidity for potential investors in the venture markets hits right at the Achilles' heel of Canada's business sector — the inability of mid-sized Canadian businesses to grow and expand and become global leaders and innovators," Russell says.

To fix the problem, the IIAC has a couple of recommendations for policymakers: "First, regulators need to examine closing the regulatory gap between SRO-regulated dealers and [exempt market dealers (EMDs)], raising the standards of the latter group and strengthening investor protection."

Additionally, Russell says, markets "need to reconsider their listing and trading practices." In particular, he wonders whether listing requirements should be raised; whether quoting spreads should be widened; and whether trading in illiquid small caps needs to be continuous or if intermittent auctions would suffice. Similarly, Russell says, regulators also need to re-think market structure and, in particular, the challenge of market fragmentation for small caps.

Finally, the IIAC reiterates its call for the government to help stimulate venture markets through tax policy, such as a deferred capital gains tax on the shares of small companies, provided the proceeds are reinvested.

"There are several options," Russell concludes, "but one thing is certain: We must tackle the underlying causes of deteriorating liquidity and the financing in venture markets soon, or run the risk of losing the best source of capital to grow small and medium-sized Canadian businesses into globally competitive enterprises that drive job creation, innovation and economic growth."