Domestic capital markets face a serious challenge. Investor participation is down, dampening receptivity for newly offered shares and traded equities, and damaging the capital-raising process. Regulators blame shaken confidence in the integrity of the marketplace and are responding with a number of reforms, with particular focus on the implementation of the client relationship model (CRM).

But recent independent client surveys conclude that the majority of investors who use financial advisors registered with the Investment Industry Regulatory Organization of Canada (IIROC) have a high degree of confidence in their advisors. So, the existing regulatory framework is doing the job intended.

But many other causes of investor skittishness need to be addressed. For example, many investors are still risk-averse following the 2008 financial crisis, concerned about a recurrence. Investors also lack confidence, not in whether to invest their savings but in how and where to invest.

Another disincentive to investor participation is higher transaction costs due to the rising cost of doing business, including technology for investment dealers’ front and back offices and much higher compliance costs. Meanwhile, the rising share of high-frequency trading (HFT) and related volatility turns off investors who perceive that they are at a competitive disadvantage.

Regulators should continue to move forward carefully with their investor-protection agenda while bearing in mind the need to implement only necessary rules to fix well-identified problems, especially with the CRM agenda nearing completion. There are several steps regulators could take to improve market efficiency and enhance market participation.

First, regulators should introduce new rules and regulations, and implement compliance-oversight mechanisms, in a manner sufficient to ensure investors and their advisors properly take risk into account in investment decisions but avoiding the unintended effect of actually discouraging risk investment. For example, the prospect of frequent questioning or second-guessing of investment decisions through compliance audits -second-guessing based on simplified criteria such as age, without taking proper account of experience, portfolio size, risk tolerance and other relevant factors – can discourage appropriate recommendations of risk-oriented investments.

Regulators should also ensure that regulations don’t add unnecessarily to compliance costs, thus increasing transaction costs that can discourage investment.

Second, regulators should review and address the activity of HFT in equities markets, distinguishing between those providing real benefit to the marketplace and those engaging simply in price rebate arbitrage and leveraging off their latent advantage in trading. Decisive action will alter the negative perception of an uneven playing field between retail and institutional investors. IIROC has, in fact, embarked on a comprehensive study of HFT activity in our markets. The industry eagerly awaits the results of the HFT impact study, which will be released sometime next year, as well as the remedial reforms that will flow from the recommendations.

Third, regulators could encourage investor participation in small- and mid-cap markets, thus promoting trading and financing activity and, in turn, reinforcing investor participation. The Ontario Securities Commission has taken positive steps to examine reform of the prospectus exemption rules.

These reforms should recognize the proficiency and professional standards of IIROC registrants, and permit prospectus-exempt distributions for investors advised by IIROC advisors – even in the absence of “accredited investor” standards or security purchase thresholds.

Another suggestion is to exempt a defined investment level, or a percentage share of the individual portfolio, from suitability requirements. Investors could then place a defined amount of high-risk securities in their portfolios – still consulting with their advisors but without the advisor being held responsible for the investment decision. This would be an improvement, in terms of investor protection, over the “crowdfunding” proposal, which would leave investors vulnerable to speculative investments on the Internet.

Finally, amend certain rules and practices to assist smaller dealers in improving their financial strength when it comes to a difficult market environment. These smaller dealers cater to a wide cross-section of investors.

Such amendments could include: allowing IIROC-registered dealers to bring advisors registered by the Mutual Fund Dealers’ Association of Canada into the IIROC firm on a permanent basis to assist in building needed business scale; and eliminating unjustified fees and charges – such as fees imposed when an individual’s holdings of dealer shares exceed 10% of total shareholdings.

A balanced regulatory strategy that focuses on the integrity of the investing process while contributing to market efficiency is the best way to encourage investor participation in the capital markets and enhance capital formation and growth of the Canadian economy.

Ian Russell is president and CEO of the Investment Industry Association of Canada.

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