December 2001
Stretching Their Mandates:
Signs of a Growing Regulatory Burden for the Canadian Securities Industry
by Neil Mohindra
A recent Fraser Institute Critical Issues Bulletin, Commissions Unbound: the Changing Status of Securities Regulators in Canada, documents the impact on the financial behaviour of the transition by the securities commissions (responsible for regulating securities markets and participants) of Alberta, BC, and Ontario from being funded by government appropriations to self-funding. The study reveals that the transitions lead to increasing salaries, significant expansions of staff levels, and the build-up of excessive levels of reserves.
Commissions Unbound also notes that prior to the conversions, the securities commissions already had "policy independence"—in other words, the ability to operate without the interference of others, including political authorities, in the implementation of securities policy and administration of securities law. The transition to self-funding status merely lifted the funding constraint imposed by the budget discipline of the appropriations process under which budget decisions are centralized.
The study examines the impact of financial independence. This article looks at how the interaction of financial and policy independence is affecting the behaviour of the commissions. In other words, how are the commissions making use of their easy access to resources? Financial constraints compelled the commissions to set policy priorities, i.e. trade-offs between the scope and depth of their activities. With the removal of financial restraints, is there a danger of over-regulation? Are new measures needed to ensure policy accountability?
The transition to self-funding for the commissions of Alberta, BC and Ontario were fairly recent, particularly for Ontario. Yet there are signs that the Canadian Securities Administrators (CSA) are expanding their sphere of influence. While the commissions have had their traditional role in regulating equity and futures markets and their participants, the fixed income markets have generally remained unfettered. This market generally consists of large institutional players, such as banks and pension funds, trading wholesale quantities of government and corporate debt instruments over the counter. However, under the guise1 of introducing a new framework for alternative trading systems (ATS), the CSA is drawing these markets under provincial securities regulation. Dealers in these markets now face new reporting requirements on their order information and will have to enter agreements with regulation service providers who will be responsible for monitoring and enforcing conduct.
Is this expansion of scope an example of how self-funding facilitates what is necessary for the securities commissions to adequately fulfill their mandates, or is it evidence of bureaucratic empire-building in response to inadequate financial discipline? One way to examine this issue is to compare this new initiative directly to the OSC's mandate as outlined on its website. The next three paragraphs set out the mandate (in italics), followed by the comparison of the new regulatory initiative to the mandate.
Protecting investors from unfair, improper, and fraudulent practices.
Existing securities regulation makes a distinction between small retail investors
and those that are more sophisticated. An example of this is that prospectus
and registration exemptions exist for securities that can only be sold
to investors who qualify as sophisticated purchasers. Generally, sophisticated
purchasers, such as large institutional investors, are expected to be able
to understand the risks and assume more responsibility for their actions.
As noted earlier, the unlisted fixed income market is essentially a wholesale market where the buyers and sellers are large institutional players such as banks, pension funds, insurance companies and mutual funds. The absence of small retail investors weakens the argument that regulation is integral to the protection of investors in this market against unfair, improper and fraudulent practices.
Fostering fair and efficient capital markets.
The CSA received comments
on its proposals for order and trade reporting requirements from issuers
(the Bank of Canada and the BC Ministry of Finance and Corporate Relations),
dealers and investors. All the commentators argued that the proposals would
adversely affect the market, primarily by damaging liquidity. Comments
that addressed the price discovery process indicated that the requirements
would either do nothing to improve it or would in fact harm it. In this
case, the CSA's regulatory proposals appear to run counter to their role
in fostering fair and efficient capital markets.
Maintaining public and investor confidence in the integrity of those markets.
To date, trading in the fixed income market has never been regulated by
provincial securities commissions. The Bank of Canada, which monitors trends
in the domestic bond market including trade volumes, indicated in its comments
to the CSA that it is not aware of the compelling reasons for market regulation
to be introduced in the fixed income markets. Market integrity issues have
emerged in the past, most recently in 1998 when indicators revealed that
possible manipulations were occurring in the market for Government of Canada
debt securities. These issues were successfully resolved by government
and industry participants without the intervention of the securities commissions.
The regulatory objectives cited by the CSA for its new ATS rules are to "provide investor choice, improve price discovery, and decrease execution costs" (OSC, 2001, p. 89). For fixed income markets, the proposals do not affect choice, and commentary suggests that the regulations will either do nothing to improve price discovery or will in fact harm it. The new regulatory requirements for fixed income markets will create compliance costs for participants in this market, enforcement costs for the regulation services providers, and oversight costs for the securities commissions. These expenses will ultimately be reflected in execution costs. The CSAs' proposals for fixed income markets do not appear to contribute towards their clearly stated objectives for ATSs, and there does not seem to be any case that the proposals are needed to fulfill the commissions' mandates.
Commissions Unbound concludes that if the securities commissions continue to operate under the crown corporation model, effective financial accountability requires the separation of financial and policy oversight. The commissions' initiative to regulate fixed income markets suggests this approach may also contribute towards improved policy accountability. Indeed, it may prevent a cycle of ever-increasing budgets that will drive a need for ever-increasing regulatory responsibilities, or the converse: increasing regulations that are designed to spend ever-increasing budgets.
Notes
1 In the over-the-counter derivatives market, the OSC made a more direct attempt to establish a regulatory presence. It was thwarted last year when the Ontario Minister of Finance returned the proposed rule for further consideration of the need for it.
References
Bank of Canada (1998). Revised Rules Pertaining to Auctions of Government of Canada Securities and the Bank of Canada's Surveillance of the Auction Process. August 11.
Minister of Finance, Government of Ontario (2000). Notice of Minister of Finance Request for Further Consideration Ontario Securities Commission Rule 91-504 Over-the-Counter Derivatives, Dec. 2. Available electronically at www.osc.gov.on.ca/en/Regulation/Rulemaking/Rules/notice_rule91504_001201.html.
Ontario Securities Commission (OSC) (2001). Alternative Trading System (National Instruments, Companion Policies and Forms–The Regulation of Marketplaces and Trading. August 17. Available electronically at www.osc.gov.on.ca/en/Regulation/Rulemaking/Rules/rules.html.
[Note: Commissions Unbound is available from The Fraser Institute for $12.95, plus shipping, handling and GST. Call 1-800-665-3558, ext. 580 to order your copy.]
Neil Mohindra (neilm@fraserinstitute.ca) is a Senior Economist with The Fraser Institute specializing in financial sector regulation. He has a MBA from McGill University.
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