Regulators adapt to crisis

Karen McGuinness, senior vice president, member regulation, compliance, at the Mutual Fund Dealers Association of Canada (MFDA), reports that the most common questions the self-regulatory organization (SRO) is receiving from dealers involve attempts to maintain compliance while adopting remote working arrangements and serving clients remotely.

“While members are still required to meet their regulatory obligations, we will be reasonable and flexible on how compliance is achieved,” she says.

For example, some dealers have informed the MFDA that they are carrying out their branch reviews remotely rather than on-site. “We think that is a reasonable alternative in the circumstances,” McGuinness says.

Regulators are taking similar steps in their own operations — pulling back from activities that historically have been carried out face to face, either cancelling them or implementing work-arounds that don’t involve direct physical contact. For the most part, regulators are continuing their compliance work, but they are conducting exams remotely and holding meetings by phone or teleconference only.

Certain enforcement activity is on hold too. The Ontario Securities Commission (OSC) has suspended live hearings until April 30. In the meantime, some proceedings may continue in writing and by using video or teleconferencing, but live appearances before the regulator’s tribunal are off for now.

Regulators also are accommodating dealers regarding compliance procedures that are tough to replicate in a home office, such as voice recording.

On that matter, both the Investment Industry Regulatory Organization of Canada (IIROC) and the regulatory division of the Bourse de Montréal Inc. provided guidance to firms on meeting their audit trail obligations during the pandemic.

While these deviations from normal procedures are understandable — and perhaps unavoidable, given the scale and scope of the pandemic — they do represent relaxed compliance standards that ordinarily exist for a reason.

Whether looser supervisory arrangements will result in additional misconduct probably won’t be evident for some time, but that’s a risk that’s tough to avoid under the circumstances.

There are opportunists trying to take advantage of the unusual market conditions. Several securities regulators have warned about an increase in frauds sparked by the Covid-19 outbreak, ranging from pump-and-dump schemes involving companies touting fake treatments to false promises of help for frightened investors eager to protect their battered portfolios.

Over the longer term, there also is likely to be fallout from the current turmoil on the regulatory policy front. Consultations that are already underway at the provincial regulators — such as the OSC’s proposals for limiting trades in deferred sales charge (DSC) mutual funds — are being extended for 45 days to provide more time for meaningful feedback. These sorts of extensions are likely to spell delay overall.

Sources indicate that other regulatory initiatives — such as the Canadian Securities Administrators’ planned review of the SRO structure, the SROs’ implementation of the client- focused reforms scheduled to take place over the next couple of years and the MFDA’s continuing education initiative — are likely to be delayed too.

The financial markets have been sent reeling by the unprecedented economic fallout from the Covid-19 outbreak. Yet, despite the sharp spike in volatility and the shift toward emergency footing for both firms and regulators, market operations have proven remarkably resilient.

Apart from an outage experienced by the TMX Group Ltd.’s trading venues on Feb. 27, Canadian markets have weathered the effects of the Covid-19 pandemic without interruption. And the TMX’s disruption, which was caused by a surge in message volume, was cushioned by the fact that other markets remained operational during the disruption.

In the weeks since, the spike in volatility has triggered Canada’s marketwide circuit breakers on several occasions. Those temporary trading halts, which are generated by the markets hitting downside thresholds, are intended to prevent trading from failing altogether. And despite the fact that heavy selling may have gutted some investors’ portfolios, the markets have remained functional and relatively orderly.

So far, there haven’t been significant spillovers from the extreme volatility in equities markets into other sectors. During past crises, wild market swings often led to difficulties, such as funds struggling to value assets accurately, surging redemptions and liquidity shortages. Given the exceptional market conditions, these risks naturally are concerns, but as Investment Executive went to press, they have yet to materialize in any major way.

In addition, so far there are not worries about excessive short-selling in Canada’s markets. In Europe, several regulators have imposed restrictions on shorting particularly hard-hit stocks. So far, these kinds of curbs have been limited to a handful of countries.

As bad as the global financial crisis was in 2008-09, at least no one was banned from going to the office back then. During that crisis, short-selling limits on certain financial-sector stocks were adopted in the U.S. and Europe, with Canadian regulators taking action on interlisted securities as well.

At the time, the decision to ban short-selling was controversial, and some followup research concluded that the ban affected market quality negatively — exacerbating volatility and widening spreads. The fact that more pervasive short- selling restrictions haven’t been imposed this time is an encouraging improvement over the 2008-09 crisis.

Current operational stability is even more impressive, given that much of the investment industry and regulatory authorities are operating in emergency mode — public health authorities have steadily ramped up demands for social distancing and organizations have shifted substantially to remote working arrangements.

All these things are now taking a deserved back seat to the growing global pandemic. Putting aside these kinds of minor casualties, investor confidence in market infrastructure and oversight should be bolstered by the resilience shown so far.