The federal government has provided its answer to what Canada’s regulatory structure should be. But it may not be responding to the right question.

The federal government’s latest budget, delivered Jan. 27, sets out the feds’ plans for regulatory reform in the financial services industry, largely adopting the recommendations of the Hockin Report. The plan is to develop a national securities regulator with the provinces that are willing to go along.

At this point, however, the federal government is not planning to utilize an idea in the Hockin Report that would allow reporting issuers to opt into the proposed national body. Nor will it seize jurisdiction from the provinces; the feds hope to get the new regulator off the ground on a voluntary basis.

To that end, the government is planning to establish and fund a transition office composed of participants from the willing provinces. That office will have a year to develop a transition plan. Further details of the office are expected to be announced shortly.

The budget also sets aside $154 million for the creation of the new regulator, which will fund the transition team, finance further work on the model and compensate certain provinces for ceding their jurisdiction, if necessary. Past efforts to create a single regulator have crumbled partly over dollars — more specifically, the loss of provincial revenue. Since then, some provincial securities commissions have moved to self-funding status, but in other provinces, regulation remains a source of revenue for governments. Getting the buy-in of the provinces that stand to lose revenue if there is a national regulator will probably require compensation.

The federal government is also pledging to table a common securities act — which would function as the new regulator’s enabling legislation — within the year. The act will cover some of the basic elements set out in the Hockin Report: introducing an independent adjudicative tribunal; giving investors a greater voice in policy-making; adopting a more principles-based model designed to deliver more proportionate regulation; and imposing performance standards on the new regulator.

This new regulator would also have financial market stability as part of its mandate. Indeed, the budget proposes a host of changes designed to ensure financial system stability — such as giving the federal minister of finance the authority to inject capital into banks, if necessary, and introducing powers for Canada Deposit Insurance Corp. that would give it greater latitude to intervene to ensure stability.

Specifically, the budget proposes giving the minister of finance the power to order the CDIC to take action to prevent damage to financial stability. The proposal also would allow the CDIC to own shares in its member institutions and give the CDIC a broader range of options to respond to systemic concerns, including the ability to resolve a financial services institution failure in a way that may not necessarily be the least expensive. The CDIC will also be able to establish a bridge institution to preserve critical functions and maintain stability if one of its members fails.

With the turmoil in global financial markets over the past 18 months, it’s no surprise that our federal government is concerned about financial system stability. In the budget, it insists that the Canadian system remains stable and well capitalized. But, it adds, establishing these proposed powers to ensure future stability is necessary, and that these steps are in line with Canada’s commitments under the plan agreed upon by the G20 countries to shore up financial markets.

But if the feds are truly intent on beefing up regulation of the Canadian financial system so that it will be able to deal with a similar market crisis in the future, are they thinking big enough? Simply establishing a few new powers for existing authorities and developing a voluntary, national securities regulator to join the collection of agencies — including the Department of Finance, the CDIC, the Bank of Canada, the Office of the Superintendent of Financial Institutions and the Financial Consumer Agency of Canada — that already worry about systemic stability seems a modest goal.

Indeed, one of the research papers commissioned by the Hockin panel suggests that Canada should actually be looking at either a single, integrated super-regulator (similar to Britain’s Financial Services Authority, which combines all the oversight responsibility under one roof) or the so-called “twin peaks” model (which has been adopted in Australia), whereby the job is divided into prudential regulation and conduct regulation, with an agency that’s solely responsible for each task.

@page_break@The paper, written for the panel by Eric Pan, associate professor at the Benjamin N. Cardozo School of Law in New York, recommends that financial regulation should be a national responsibility, organized along the lines of prudential supervision, business conduct oversight and market stability. The paper then considers three possible structures — a single regulator, the twin peaks model and a model in which separate agencies are maintained but one is designated the lead regulator and is required to co-ordinate the others.

This third option is the easiest to achieve because, as the paper notes, it demands the least amount of reorganization of the current system. However, the paper also points out, such a system would be “quite complex” and is the least efficient of the three alternatives: “The lead regulator model continues to promote divided regulatory agencies with overlapping competencies and separate overhead. This system seems to have few advantages over those of the single regulator and twin peaks models.”

TWIN PEAKS MODEL
The paper warns against getting hung up on the choice between a single regulator and the twin peaks model: “What is most important is that Canada’s regulators have clear lines of authority, share information freely and continuously, and co-ordinate [their] regulatory actions.

“With that said, the single regulator and twin peaks models are superior to the lead regulator model,” the paper concludes, “because they more effectively eliminate overlap between regulatory agencies and enhance efficiency.”

Thus, the paper recommends that Canada implement either the single regulator or the twin peaks model.

Yet, that’s not where the federal government is heading. Amid an unprecedented global financial crisis, which presents a once-in-a-lifetime opportunity for reform instead of rethinking regulation from first principles, the government is looking merely to consolidate securities regulation and maintain the rest of the complex web of authorities.

In doing so, it appears that the government is settling for a far from ideal structure. That’s assuming that the government even achieves its ambition of developing a single securities regulator, which is far from certain.

The government appears to be content to implement the recommendations of the Hockin Report — which was commissioned before the financial crisis emerged in August 2007 and was mandated to look only at securities regulation.

Heather Zordel, partner with Cassels Brock & Blackwell LLP in Toronto and a member of the Hockin panel, notes: “We were cautious in not recommending specifically that we combine the regulators, because it wasn’t our mandate and we hadn’t studied that specifically. But we heard a lot about it in London — and it’s clearly a global governance issue. We also thought it important to get the securities side sorted out before we try further consolidation.”

Despite the panel’s restricted brief, its report does recommend that once the path to a national securities regulator has been established, the question of reforming financial-sector regulation should be considered. The report points out that many firms operate in the banking, insurance and securities sectors, all of which have separate regulatory regimes. “This has had implications,” the report notes, “for the safety and soundness of the financial system and the general efficiency of regulation.

THE TIME IS RIGHT

“There may be an opportunity, therefore, to reform the structure of financial-sector regulation to reflect better the realities of the modern financial services industry.”

The report adds that the panel was “intrigued” by Pan’s recommendation that Canada should adopt either a single regulator or the twin peaks model.

But there could hardly be a better moment for studying, and working toward, optimal regulation than now. There is a great deal of optimism in the financial services industry that a common securities regulator will be achieved this time around. Yet, the Hockin Report imagines that it will take three years to get to that point. At that juncture, it’s hard to believe that there will be much of an appetite for further major structural reform.

Of course, more ambitious reform will carry even larger risks. The recent combination of the Investment Dealers Association of Canada and Market Regulation Services Inc. to form the Investment Industry Regulatory Organization of Canada shows how complex and tricky a regulatory merger can be — even one in which the functions are highly complementary.

Zordel worries that merging securities and banking regulation before achieving a national securities regulator could create unnecessary problems. She points out that prudential banking regulation is quite different from securities regulation.

That said, she also believes that the question of a more fundamental regulatory restructuring should be examined. “The result of that study may be that we don’t need to merge everything right at this time,” she says. “But we do need to start by establishing clear lines of communication and accountability between the organizations so that emerging issues are dealt with in a co-ordinated fashion, as opposed to the ‘Its not my mandate’ approach we use right now.”

Indeed, the Pan paper also stresses the importance of establishing effective co-ordination and communication: “The exact organization of the regulatory system is less important than the means by which regulatory agencies and internal regulatory divisions are made to work together and act in a co-ordinated fashion.”

But in the often defensive, turf-protecting world of regulation, sometimes the only way to ensure such co-operation is to tear down the walls that divide the many regulators. IE