Gavel and legal books

As the year comes to a close, it’s more important than ever that securities regulators consider the direction and priorities for securities regulation for the coming year and beyond. Although we have seen considerable progress in protecting investors, we have not seen the same focus on market efficiency. This is despite structural changes in capital markets stemming from demographics and technology, a shifting confluence of investor and market risks, and a pressing need for capital formation and economic growth in Canada.

Securities regulation has always been about balancing the need for investor protection with the need for efficient markets. However, investor protection typically has dominated the mandate because of its more straightforward agenda related to transparency and disclosure of the investing process as well as the government’s strong reinforcement of this theme.

During the past five years, we have witnessed broadly based extensive reforms in the regulation of investment advice and securities execution. Standards of transparency have improved significantly through point-of-sale disclosure for mutual funds and the second phase of the client relationship model (CRM2) reforms. Similarly, the “targeted reforms” to strengthen advisor obligations in know your client, know your product, suitability and managing conflicts are now well underway, as is an imminent decision to prohibit embedded commissions in mutual funds.

Meanwhile, the profound shift to discretionary managed accounts and index-based products, combined with the corresponding move away from brokerage accounts and individual stock-picking, has mitigated risks in the investment business as it has reduced investing costs. We have reached the point at which the biggest investor risks come from cybersecurity breaches or systemic meltdown in capital markets, not investment suitability or advisor malfeasance.

Now, the priority for securities regulators is not another round of new rules; rather, it’s to review and renovate the existing securities rulebook comprehensively. The investment industry must help regulators identify rules that are obsolete and outdated, inefficient and duplicative, rules with unexpected negative consequences and rules that interfere with capital formation without clear offsetting benefits. The review process should also seek innovative approaches to securities regulation, such as eliminating prospectuses and relying on continuous disclosure documents, and rule proportionality for specialized small dealers.

Regulators should also be pressing stock exchanges for strategic improvements to advance efficiencies of trade execution and capital-raising, especially the damaged public venture marketplaces in need of significant repair and restructuring.

This renovation of the securities rulebook has potential to yield major efficiency gains in the domestic markets. For example, many of the detailed reforms — notably within the CRM1 and CRM2 framework — have been undertaken at a rapid pace and often without sufficient evidence-based analysis and without rigorous cost-benefit assessment of regulatory alternatives. This suggests that there’s considerable scope for improved efficiencies that achieve similar outcomes with lower costs and a lighter regulatory burden. The Canadian Securtities Administrators’ (CSA) commitment to post-implementation review of CRM2 is an important first step.

The outcome of the rule review would address the alarming fall-off in small business financings and initial public offerings as well as evident truncation of small business growth as companies stay private longer and often sell out instead of expanding through transactions to “go public.” Specific measures to tackle include: rule proportionality; the elimination of the order protection rules, given the consolation of marketplaces and growth of managed fund products; streamlining of the disclosure regime for small issuers and expanded prospectus exemptions for cost-effective financings; and strengthened enforcement and oversight of all registrants. Regulators should also press public venture markets to develop strategic plans to build cross-border listings and investor participation.

The review would also contribute to stemming the loss of many small retail and institutional boutique dealers that dominate the financing and market-making of small business shares in public venture markets. Some 50 dealers have succumbed to the layering of the regulatory burden with insufficient business scale to spread costs. Although other factors have contributed to the difficulties these firms have faced, easing the burden would be a significant step.

A thorough review of the rulebook to improve market efficiencies for securities trading and financing, promote greater harmony in the rules and enable more cost-effective investor protection will lower transaction costs and stimulate investor participation in markets, boost liquidity and capital formation. These efficiencies will also attract foreign capital to the Canadian markets and foreign businesses to seek capital and joint ventures in Canada.

This systematic rulebook review should be a priority for individual provincial securities commissions, collaborating through the CSA and holding extensive consultations with all market participants. However, this should also be the overriding priority for the new co-operative national regulator as it needs to set a vision for national markets and inculcate a unique culture. This new body could do this by designing a rulebook that can link securities regulation strategically with the needs of the Canadian capital markets and the Canadian economy’s welfare.