Canada's capital markets seem to be the subject of continuous scrutiny and proposed reform. This reflects the dynamic nature of our capital markets which demands a regulatory approach that is both responsive and adaptive. Broadened mandates for regulators, recognition of the need for inter-jurisdictional collaboration and co-operation and burden reduction initiatives are all illustrative of this trend. The Ontario Government's Capital Markets Modernization Taskforce is yet another example of the ongoing assessment of the adequacy of current regulatory tools – we have written about the public consultation efforts of the Taskforce here.
On June 25, 2020, the CSA released the "CSA Consultation Paper 25-402 Consultation on the Self-Regulatory Organization Framework," [PDF] reviewing the current regulatory framework for the Investment Industry Regulatory Organization of Canada ("IIROC") and the Mutual Fund Dealers Association of Canada ("MFDA"). The consultation paper has been eagerly anticipated since it was first announced in a news release on December 12, 2019. The news release prompted IIROC and MFDA to each release their own proposals on the best way to remake the SRO-regime.
In contrast to the IIROC and MFDA proposals, the CSA paper does not offer specific solutions. Rather, it focuses on more precisely defining the potential problems that exist within the current SRO framework. The CSA paper raises numerous questions for public comment about the framework to assess what does and does not work. The questions are thoughtful as they were informed by a preliminary consultation with a variety of stakeholders, including SROs, investor protection funds, groups representing various registrant categories, industry associations and investor advocacy groups.
Below we have summarized some of the benefits and issues identified by stakeholders during the CSA's preliminary consultation. The CSA notes that "the views expressed by stakeholders may not necessarily represent the views of the CSA."
The identified benefits of the current SRO system
The CSA noted that stakeholders highlighted the following key benefits of the current SRO framework, which has been in place now for over two decades:
- SROs are national in scope, which is advantageous in Canada where securities regulation is managed at the provincial and territorial levels. Stakeholders expressed views that national SROs "provide for a more uniform level of regulation and supervision across the country with one set of rules applicable to all SRO members."
- The specialized industry expertise of the SROs has allowed for sensible and responsive rule making, delivering appropriate oversight of the industry as it evolves.
- Each of IIROC and MFDA is "fit-for-purpose" for certain financial products or investment activities, which may result in better regulatory oversight and rulemaking and also allows for the maintenance of two SRO protection funds.
The identified issues for consultation
The CSA's consultation questions are organized into seven key issues, which arose from its initial discussions with stakeholders. The CSA proposes a targeted outcome for each issue.
- Issue 1: Duplicative operating costs for dual platform dealers: Dual platform dealers with entities registered with each of IIROC and MFDA experience higher operating costs arising from the maintenance of separate compliance staff, information technology and back office systems, multiple membership fees and other duplicative administrative costs. Some of these added costs are indirectly borne by investors. In addition, these costs reduce resources which could be available to SRO members to engage in innovation activities. The targeted outcome is a regulatory framework that minimizes redundancies that do not provide corresponding regulatory value.
- Issue 2: Product-based regulation: Registrants in different categories are increasingly offering similar products and services to similar clients, such as mutual funds, exempt market securities and portfolio management services. However, know-your-client, or KYC, requirements and suitability obligations, individual proficiency and other compliance requirements applicable to the offering of such products and services differ depending on whether the registrant is regulated by IIROC, MFDA or directly by the CSA. This system may create opportunities for regulatory arbitrage and unequal access for investors. The targeted outcome is a regulatory framework that minimizes opportunities for regulatory arbitrage, including the consistent development and application of rules.
- Issue 3: Regulatory inefficiencies: The two-SRO regime creates barriers to efficient product access by investors. For example, mutual fund dealers are not able to easily distribute ETFs because they lack the back-office and clearing systems used by IIROC firms. Clients of mutual fund dealers often bear the cost of complex work-arounds developed to facilitate investments in ETFs. The targeted outcome is a regulatory framework that provides consistent access to similar products and services for registrants and investors.
- Issue 4: Structural inflexibility: The rigidity of the two-SRO regime has created a barrier to entry for evolving business models. New models have arisen in response to changing investor preferences, including the preference for "one-stop shopping". The two-SRO regime creates challenges for these new models, which have a downstream negative impact on investors in terms of access to advice and the latest technological advancements. The targeted outcome is a flexible regulatory framework that accommodates innovation and adapts to change while protecting investors.
- Issue 5: Investor confusion: Generally, Investors do not understand the two-SRO system and why they may not have access to certain products. Investors are also confused by the distinct complaint processes and investor protection fund coverage for each SRO, as well as the multiple registration categories and titles that currently apply. The targeted outcome is a regulatory framework that is easily understood by investors and provides appropriate investor protection.
- Issue 6: Public confidence in the regulatory framework: There is a possible lack of public confidence in the quality and consistency of SRO governance, compliance and enforcement practices and the ability for SROs to achieve their public interest mandate. Some stakeholders perceived the SROs as being dominated by the industries they are supposed to regulate. The targeted outcome is a regulatory framework that promotes a clear, transparent public interest mandate with an effective governance structure and robust enforcement and compliance processes.
- Issue 7: Separation of market surveillance from statutory regulators: The current framework for market surveillance, in which IIROC conducts the surveillance and provides the information it has gathered to the CSA, may give rise to conflicts of interest, information gaps and fragmented market visibility, which may increase market vulnerability to systemic risk. Some stakeholders suggested this risk would be minimized if the market surveillance function was absorbed by the CSA. The targeted outcome is an integrated regulatory framework that fosters timely, efficient access to market data and effective market surveillance to ensure appropriate policy development, enforcement and management of systemic risk.
The CSA has posed a series of specific consultation questions relating to each of the above issues. The CSA has also invited comment on the proposed targeted outcomes, asking whether the outcomes are described appropriately, how the outcomes may be best achieved, if an outcome is unachievable, what other outcome would be more appropriate and which outcome is most important? Finally, the CSA made a general request for commenters to provide quantitative data to support their position, if available.
The CSA notes that its initial round of consultation did not result in "consensus or overall theme noted for solutions, largely due to different perspectives of the stakeholders". The hope is that the broader public consultation will clarify the best path forward to ensure simpler, more robust and efficient regulation.
The consultation period ends on October 23, 2020. Affected market participants and investors should provide input to assist the CSA in this important initiative.
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