In 2001, the british columbia Securities Commission launched an initiative to streamline and simplify its rulebook. The determination was to reduce the burden of regulation on the capital markets while maintaining strong protection of investors and market integrity. We thought then, just as we think now, that regulators should focus on delivering value to investors, who ultimately pay the costs of regulation. We owe them to make sure that the value of regulatory protection exceeds the costs it imposes.

As we studied ways to streamline the rules, we strongly came to the view that we could make regulation more effective and less burdensome by basing our rules on principles and limiting detailed requirements. Regulation usually works best when we set out clearly what outcome a market participant must meet and leave it to the market participant to find the best way to achieve it. That way, people have to think about what is right and wrong, not what they can or cannot get away with under the rules.

The new legislation and rules we developed have been set aside while we work on harmonizing Canadian requirements and implementing a passport system for securities regulation. But the project changed the way we at the BCSC think about regulation and how we respond to failures in the market. Today, we have a better opportunity than ever to change the way we regulate Canada’s securities markets and to deliver greater value to investors and Canadians in general.

When we started, we faced significant obstacles. Many market participants thought we were right, but naïve, to promote principles-based regulation. “The trend to ever more detailed and voluminous rules was unfortunate, but it’s now irreversible,” they said. Others thought we were wrong: “You cannot enforce principles. You need very specific and detailed rules, both to help the honest in complying and to keep the unscrupulous from cheating investors.”

Just as our project got going, Enron Corp. collapsed, causing shock and uncertainty. A string of further corporate failures and scandals led to the rapid passage of the Sarbanes-Oxley Act by Congress in the U.S. Immediately, we heard claims that Canada was falling behind and needed our own version of SOX. Our call for more principles-based regulation seemed to be running against the tide of history.

But five years later, the tide has turned. Almost everyone now favours more principles-based regulation, even though some aren’t sure what it means. Commentators and blue-ribbon committees speak admiringly of how Britain’s Financial Services Authority regulates. Even the U.S, Securities and Exchange Commission, long considered the bastion of detailed, prescriptive regulation, says it aims for more principles-based rules. A call for more principles-based rules is now part of almost every proposal for improving Canadian securities regulation.

So, why is this happening now?

In retrospect, the darkest hour for principles-based regulation came just before the dawn. The imposition on U.S. public companies of extremely costly and burdensome new requirements for evaluating internal controls persuaded most observers that things had gone too far, that the costs of regulation were far exceeding any benefits.

The backlash against the notorious SOX 404 has shifted the debate, and the time is now ripe for moving forward with a better way to regulate.

Still, there are challenges to a more principles-based approach. Regulators have to develop new ways of thinking, while market participants have to learn to operate in a principles-based environment. Despite the general call for principles, some companies still demand detailed rules because they either do not have to exercise judgment, or they think costly and inflexible rules will keep out new competition.

For Canada to make a successful transition to a new and better regulatory approach, we have to move beyond talking about principles-based regulation and start doing it.

In September 2006, the BCSC hosted a dialogue for Canadian and foreign regulators, market professionals and business leaders on how to implement principles-based securities regulation. (Visit www.bcsc.bc.ca to see what people had to say.)

The discussion made clear that everyone is still learning how to make a principles-based approach work. There is no single right way to do it. We have to be prepared to adapt and try new ideas. At the end of the session, we all agreed that we need to move toward principles, although there was some debate as to how quickly we can do it.

@page_break@It’s critical that we get going, to capitalize on the current momentum. We have to build confidence in this new approach, so we don’t abandon it and revert to our bad old rule-making habits when we hit the next rough patch in the markets. The opportunity is here to give Canada a leading-edge system of regulation that will make our markets fair, efficient and competitive for the future. Let’s seize that opportunity for the benefit of investors and all Canadians. IE



Doug Hyndman is chairman of the British Columbia Securities Commission.