In a bid to reduce the regulatory burden on smaller firms, the Investment Industry Regulatory Organization of Canada (IIROC) is contemplating the idea of lowering capital requirements for certain introducing brokers on the basis that they pose a lower risk of client loss.

IIROC published a concept paper Tuesday that proposes setting lower minimum capital requirements for certain dealers, in particular so-called type 1&2 introducing brokers. These firms represent a lower risk of client loss in the event of insolvency because they either don’t hold client assets, or if they do, it’s in a limited way, the paper notes.

Therefore, IIROC is considering the idea of lowering capital requirements for these firms, which it says would help level the playing field with other sorts of dealers, such as mutual fund dealers and exempt market dealers, in other sectors of the industry.

“IIROC is putting this proposed concept paper out for comment as we explore opportunities to create a more level playing field for IIROC-regulated firms,” said IIROC president and CEO, Susan Wolburgh Jenah.

In the paper, IIROC benchmarks its existing minimum capital requirements to those imposed by other regulators and concludes, “Based on this comparison, it is clear that lowering the minimum capital required for Type 2 introducing brokers would more closely align IIROC’s minimum capital requirements with those applicable to other securities industry registrants, such as Canadian exempt market dealers, portfolio managers and certain types of mutual fund dealers.”

The current minimum capital requirements for each category of IIROC dealer is $250,000, except for a type 1 introducing brokers, where it is $75,000. However, there currently aren’t any dealers in the Type 1 introducing broker category. So, effectively, the minimum for all firms is $250,000. So, the paper considers reducing the minimum capital requirement for Type 2 introducing brokers to either $50,000 or $100,000.

It calculates that cutting the capital requirement to between $50,000 and $100,000 would increase the risk-adjusted capital (RAC) available to between 11 and 15 dealers to more than $500,000; and, increase RAC for another one or two dealers to more than $1 million.

Reducing capital requirements to these levels would also reduce the number of firms failing IIROC”s early warning tests that are based on liquidity and/or profitability. So, the paper suggests that “In order to address the investor protection concerns” IIROC compliance staff would use their discretionary authority to closely monitor the capital of those dealers.

While existing type 2 brokers would be the obvious beneficiary of these proposed changes, IIROC also notes that other firms could also alter their business models and choose to operate as type 2 dealers to take advantage of the lower requirements.

The paper notes that IIROC also considered possibly lowering minimum insurance coverage requirements for Type 1 and 2 introducing brokers, but it decided not to pursue this option as dealers generally maintain much more insurance coverage than the required minimums — so cutting the minimum may not create that much benefit for firms.

The paper is out for comment until July 9.