Lofty markets drive regulators’ ratings

Investment Executive’s (IE) 2014 Regulators’ Report Card reveals that firms generally are feeling better about their regulators than they did a year ago. The ratings that compliance officers (COs) and company executives gave their regulators are, for the most part, up from a year ago. This is particularly the case for the two major self-regulatory organizations (SROs) – the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) – and the largest provincial regulator, the Ontario Securities Commission (OSC).

Whether this rosier view of the regulators is attributable simply to buoyant markets is, of course, hard to say. The state of the markets may be only part of the story; but there’s no question that stronger equities markets have given firms fewer reasons to gripe about their regulators.

For one thing, clients are enjoying strong portfolio returns, which means they have less cause to complain. There also is less pressure to seek out alpha in complex, exotic products, products that may raise added regulatory concerns, when the overall market tide is rising. Then, there’s the basic fact that higher markets boost revenue and simply stoke a sense of optimism within the sector, which may cause firms to look more favourably on regulation, an aspect of the business that frequently is regarded as an irritant at best and a needless obstacle at worst.

Of course, there probably are other factors at play, too. For example, ratings are not up across the board, so it’s not simply the rising tide of optimism that is lifting survey participants’ opinions of regulators indiscriminately. In fact, some ratings have dropped and others remain persistently low.

So, although the overall trend appears to be higher marks year-over-year for the regulators from the sector, there’s more to it than market performance. That’s because the efforts of individual regulators also matter a great deal to the COs and company executives surveyed.

Getting better

Indeed, believe it or not, despite the ceaseless criticism that regulators attract from some segments of the financial services sector, they are striving constantly to get better at their jobs. From the perspective of the sector’s various industries, this may mean improving communication with registrant firms, streamlining audit procedures and responding to dealers’ concerns in the regulators’ policy work.

These efforts aren’t always successful, and some regulators are doing a better job than others. But, in general, the staff of the regulators are trying to enhance their stakeholders’ satisfaction. So, some of the changes in their ratings will reflect the efforts of individual regulators.

At the same time, it’s also important to remember that the regulators serve many masters, and don’t exist simply to serve their industries. Although the investment industry is one of the major constituencies, the regulators also have to balance the sometimes competing and conflicting interests of issuers and investors.

And there are also the differing interests within the sector itself, such as the buy side and the sell side, small firms that compete with larger ones, and SRO-regulated firms vs non-SRO-regulated firms.

In addition, the SROs have to answer to the provincial securities commissions; and the provincial regulators, in turn, have their local governments and legislatures to placate.

So, because an industry represents only one aspect of a regulator’s mandate, it’s important to remember that higher scores in the Regulators’ Report Card aren’t unquestionably a good thing – nor are they necessarily the regulators’ objective.

With that caveat in mind, there’s no question that the financial services sector appears to think that the regulators are doing a better job this year than they have in the past.

For starters, both SROs saw their overall average ratings tick higher again this year. IIROC’s overall score jumped by 0.4 of a point, to 6.7 from 6.3 in 2013, which reflects the fact that dealers rated it higher in 16 of the 20 categories in which they were asked to provide a rating.

Next: IIROC improves
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IIIROC improves

In particular, IIROC received a notably stronger mark in “the regulator’s approach when taking disciplinary action against registrants” category, for which its rating jumped by almost a full point.

IIROC also saw its ratings rise by half a point or more in “the regulator’s effectiveness in keeping up its policies with evolving international regulatory developments” and in “the regulator’s effectiveness in balancing evolving international regulatory developments with the regulatory needs of the Canadian marketplace” categories.

IIROC also saw its ratings rise by a similar margin in several categories that reflect the quality of communication between the regulator and its registrants – such as “the regulator’s ability to communicate its priorities in a timely and effective manner”; “timeliness of the regulator’s response to questions and concerns expressed by registrants”; and “how useful is the regulator’s response to questions and concerns expressed by registrants.”

As for the MFDA, the COs and executives with the dealers that the regulator oversees also appear to be happier in general – albeit for different reasons. The MFDA’s overall rating rose by 0.3 of a point this year to 6.8 from 6.5 in 2013. Although this gain is slightly smaller than the improvement that IIROC enjoyed, it’s still enough to allow the MFDA to hold onto its modest edge over IIROC, and the MFDA’s overall rating is the highest among the regulators in the Report Card.

The increase in the MFDA’s overall rating was driven by higher marks in most categories. Indeed, the SRO garnered higher scores in 15 of the 20 categories in the survey.

Yet, the categories in which the MFDA made its biggest gains are completely different from the categories that generated higher ratings for IIROC, which highlights the fact that it’s not simply a question of stronger markets buoying survey participants’ views of their regulators.

A different path

For example, the MFDA saw its rating in “the extent to which registrants and approved persons are involved in the regulator’s audit” category rise by more than a full point – to 7.7 from 6.6 in 2013; in contrast, this was one of the few categories in which IIROC’s ratings slumped.

The MFDA also saw its ratings rise by half a point or more in the following categories: “the regulator’s awareness of dealers’ regulatory burden and concern about keeping it to a minimum”; “the regulator’s sensitivity to the concerns and issues of small firms”; and “the regulator’s effectiveness in balancing fairness and safety without restricting business.”

Among the provincial securities commissions, the trends are somewhat different. Although the ratings for the biggest provincial regulator, the OSC, were up compared with the previous year, ratings for the B.C. Securities Commission (BCSC) dropped notably.

Indeed, the overall rating for the BCSC dropped to 6.1, down by 0.7 of a point compared with 6.8 last year. This puts the BCSC into a dead heat with the OSC, which saw its overall rating tick upward to that 6.1 from 5.9 in 2013.

This drop in the BCSC’s overall rating is interesting for a couple of reasons. For one, although it flies in the face of the hypothesis that stronger equities markets are boosting firms’ opinions of regulators in general, the lower rating echoes the struggle that has taken place in the venture markets recently. If you regard the firms that are directly rating the BCSC to be a proxy for the venture markets in Canada, it makes sense that their mood appears much gloomier.

BCSC sees drops

The depth of that gloom is evident in the fact that the scores for the BCSC dropped in almost every category. In fact, in several categories, the drops were quite significant.

The major caveat to this is that the sample size for the smaller provincial regulators (the Alberta Securities Commission [ASC] and the BCSC) are lower than for the other regulators, so these ratings should be taken with a grain of salt. Nevertheless, what’s clear is that despite the smaller sample, the BCSC’s ratings are off notably from the previous year.

The overall marks for the ASC are even lower than the BCSC’s – the ASC received an overall average rating of 5.7 – but the year-over-year trend isn’t evident because there hasn’t been a big enough sample in previous years to break out the ASC’s marks until this year. As with the BCSC, the sample size for the ASC still is relatively smaller than for the other regulators, so its ratings also should be viewed with some caution.

The other notable observation about the relative trends in the ratings for the OSC and the BCSC – and the convergence in their overall ratings – is that this convergence comes against the background of the potential regulatory merger between the two provinces, which is being pursued by their respective governments as part of the three-way deal with the federal government to create a co-operative national regulator. If that project goes ahead as planned, the target date for its launch is mid-2015.

In previous years, when the BCSC was rated higher than the OSC by a wide margin, there may have been some concerns among COs and executives with firms in Western Canada that what they liked about the BCSC would be diminished by combining with the OSC. Now, however, it appears that a regulatory merger should be less of a worry.

Although the BCSC still holds a significant lead over the OSC in some categories – such as “the fairness of the regulator’s policy decisions” and its sensitivity to the concerns of small firms – the gap between the two regulators in the latter category has diminished notably.

OSC steps up

Moreover, the OSC surpasses the BCSC in other key categories, such as “the fairness of the regulator’s fee structure for registrants,” its efforts to minimize the regulatory burden and its effectiveness in balancing fairness and safety without restricting business.

So, if the planned merger of the OSC and BCSC does come off as the politicians envision, registrant companies’ COs and executives may not have to worry that this will result in dramatic changes for them.

Nevertheless, the financial services sector’s view of such a dramatic reshaping of the regulatory landscape may well be largely driven by what the markets are doing at the time.

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