The drive to create a single securities regulator is in high gear once again. And the risk for the handful of provinces that aren’t keen on the idea is that they will be left behind; the risk for those that are on board is that much needed improvements to their own regimes, such as efforts to regulate derivatives, will languish while the development process plays out.

In the corporate world, any major merger, acquisition or restructuring invites significant execution risk. That sort of risk is compounded in the regulatory realm, in which the players are charged with protecting the public interest and not simply making a profit. A corporation that is distracted by a pending merger may lose a bit of ground to competitors in the process, whereas a regulator being preoccupied with such machinations could have far broader implications. And, in the case of the Canadian regulatory system, that risk is multiplied further by the complexity of bringing together the numerous bodies that currently oversee the capital markets.

The latest push for a single regulator hasn’t reached the execution stage yet, but preliminary talks are underway. In the meantime, major reforms among the new regime’s prospective participants are probably on hold.

In Ontario, where the government has long favoured the creation of a single regulator, all the province’s policy eggs are now in that basket. That’s not to suggest that new rules won’t be introduced or existing ones amended. But fundamental legislative oversight initiatives — such as the effort to reform derivatives regulation in the province or the comprehensive review of securities regulation to occur every five years — are effectively on hold, pending the outcome of the current attempt to create a national regulator.

The final report from Ontario’s initial five-year review committee was delivered back in 2003, and the standing committee on finance and economic affairs, which reviewed that report’s recommendations, made its own recommendations back in October 2004. Now, more than five years later, very few of the major reforms the review committee’s report proposed — including a requested review of self-regulation, the creation of a new mechanism for investor restitution and the proposed hiving off of the Ontario Securities Commission’s adjudicative function into a separate body — have been acted upon.

Even the basic recommendation that the government appoint the next review committee sooner rather than later has not been adopted. If that recommendation had been enacted, then yet another report reviewing the regulatory regime would have been due earlier this year. However, at this point, the next committee has not even been appointed, and isn’t likely to be any time soon.

Rather, Scott Blodgett, spokesman for the Ontario Ministry of Finance, indicates that the provincial government is concentrating on the proposed transition to a national regulator and that it expects draft legislation for the new regime will be ready by next spring.

“Ontario has long advocated for a strong, national securities regulator to improve the efficiency of the capital markets and better co-ordinate enforcement and investor protection,” Blodgett says. “To that end, the government is engaging actively in the [Canadian Securities Transition Office’s] transition process. Working with the federal government and other interested provinces and territories, we aim to produce meaningful results that will lead us toward a strong national securities regulator in keeping with Ontario’s interests.”

If a national regulator does emerge this time, it may not matter a great deal that the Ontario government isn’t pursuing the required legislative review of the provincial system, particularly because it didn’t act upon many of the most significant recommendations in the previous review. However, there’s no assurance that this national regulator effort will succeed. Other efforts to create a single regulator have been close to realization in the past, only to fail at the last minute.

Moreover, the five-year review isn’t the only casualty of national regulator aspirations in Ontario. A planned modernization of derivatives regulation has seemingly since fallen into the same void. A couple of years ago, Ontario and Quebec were both on track with parallel overhauls of their regulatory regimes for derivatives. Quebec has since implemented its new regime, but Ontario’s reform has been relegated to the back burner.

In February of this year, Quebec — which remains determinedly opposed to a national regulator — implemented new derivatives related legislation, which created a modern, comprehensive regulatory regime for both exchange-traded and over the-counter derivatives.

@page_break@Meanwhile, Ontario is no closer to making any of the changes that were recommended by a committee that was formed back in 2005 (the Commodity Futures Act advisory committee) to study modernizing Ontario’s derivatives legislation.

That committee handed in its final report in January 2007, and that report was referred to the SCFEA (the same body that studies the results of the five-year review), which has yet to move forward with it.

Carol Pennycook, partner with law firm Davies Ward Phillips & Vineberg LLP in Toronto, who chaired the CFA committee, says it is unlikely that the Ontario government will act on the recommendations for the time being. It won’t act, she says, until after it sees what other jurisdictions decide to do in response to the global financial crisis; derivatives markets, particularly the largely unregulated OTC markets, have been identified as one of the global financial system’s vulnerable spots.

Blodgett confirms that Ontario won’t be moving on its own to reform derivatives regulation in the foreseeable future: “Unilateral action by Ontario at this time on the matters addressed in the committee’s report would run a real risk of being out of step with still-evolving best practices and ongoing developments, both nationally and internationally.”

Consistency with the approach of other major capital markets around the world, he adds, is important.

Indeed, in the wake of the financial crisis, authorities in the U.S. and Europe have begun looking at reforms.

In the U.S., the House financial services committee has proposed new legislation, which is now moving through Congress. That legislation would, among other things, establish regulatory oversight of all OTC derivatives transactions, push for greater standardization and more exchange-trading of such contracts, and impose new transparency requirements. It would also introduce tougher regulation of derivatives dealers and other participants in that market, including registration, capital and margin requirements.

The European Commission has introduced reform plans of its own, as well.

In addition, back in March, the International Organization of Securities Commissions’ Task Force on Commodity Futures Markets, which was led by the U.S. Commodities and Futures Trading Commission and Britain’s Financial Services Authority, delivered recommendations intended to improve the supervision of commodity futures markets. Those proposals included increasing oversight and transparency, bolstering regulators’ supervisory and enforcement powers, and enhancing global co-operation among regulators.

Meanwhile, in Canada — apart from Quebec — any effort to modernize derivatives regulation appears to be tied to the fortunes of the proposed national regulator, which will probably aim to bring derivatives regulation under its purview.

The Canadian expert panel that had recommended the latest model for a single regulator had highlighted derivatives regulation as one of the areas that would be improved under a national authority: “Regulation in this area has suffered from a lack of attention and co-ordinated effort.”

In particular, that panel’s report had pointed out that various provinces have gone in their own directions when it comes to supervising exchange-traded derivatives, and that much of their efforts are outdated. Moreover, the report concluded that allowing market participants in the OTC market to regulate themselves “has proven to be unsatisfactory”; it added that the lack of infrastructure in the OTC market “is a potential source of weakness for Canada’s financial system.”

The panel had recommended that a single securities regulator have jurisdiction over exchange-traded derivatives and the ability to regulate OTC derivatives, if that is deemed necessary. Doug Hyndman, chairman of the Canadian Securities Transition Office, confirms that this is likely to be the CSTO’s approach.

In the meantime however, setting aside the expert panel’s concerns with the oversight of derivatives markets in Canada and the vulnerabilities revealed by the financial crisis, derivatives is an area of frequent innovation that regulators cannot afford to ignore, a point highlighted by the recent publication of an OSC staff notice tackling the question of how “contracts for difference” (a.k.a. CFDs) should be treated by the regulator.

Following a review of certain novel derivative products by staff from the OSC and the Investment Industry Regulatory Organization of Canada, those regulators concluded that CFDs constitute “securities.” That means CFDs are subject to securities law and other regulatory requirements, including registration and prospectus requirements.

However, the OSC and IIROC note that this conclusion is intended as merely interim guidance, pending a more permanent solution. And that would come through either the creation of a nationally harmonized regime for these sorts of products, the adoption of new derivatives legislation in Ontario or a new national regulatory regime for derivatives under the auspices of a single securities regulator.

With that in mind, the Canadian Securities Administrators has established a committee to develop recommendations for a harmonized approach to derivatives. The OSC reports that the CSA committee is reviewing recent developments in other jurisdictions, but “is not yet in a position to publish its analysis or recommendations.”

That, in turn, suggests that a harmonized CSA position is some way off. New legislation in Ontario doesn’t appear to be imminent. And that leaves the proposed national regulator as the most likely source of a modern regulatory regime for derivatives markets in Canada — at least, outside Quebec, which, as Pennycook notes, “has definitely taken the lead in this area.”

Ontario maintains that it hasn’t forgotten this subject. For now, Blodgett says, that government “is closely monitoring” the policy recommendations that are being considered in other jurisdictions (such as by IOSCO and at the G20 forum). And he points to the OSC’s participation in the CSA committee and the likelihood that a national regulator, of which Ontario plans to be a part, will seek to regulate derivatives.

There was always a lot riding on the securities industry’s hopes for a national regulator and, as major reform work is deferred in anticipation of that event, the cost of failure continues to rise. In the end, if a single regulator is finally adopted this time around, it may not make much difference. But if the effort falters — as all previous attempts have done — regulators, markets and investors may end up paying the price. IE