Identifying and managing systemic risk across the financial system will be a major area of focus for the Investment Industry Regulatory Organization of Canada as the industry emerges from the financial crisis, IIROC president and CEO Susan Wolburgh Jenah said on Tuesday.

Speaking in Toronto, Wolburgh Jenah said many lessons have emerged from the financial crisis for regulators and industry participants alike.

“Policymakers and regulators around the world are considering how to address gaps that create an unlevel playing field, and which expose markets and investors to systemic risk,” Wolburgh Jenah said. Identifying and managing such systemic risk will become a key area of focus for IIROC going forward, she added, as the organization works to improve the efficiency of the regulatory system in Canada.

One of the biggest challenges, she said, will be for regulators and industry to work together to realign incentives that encourage desired behaviour through compensation structures, risk management strategies and a longer-term focus on sound business practices.

So far, international discussions of regulatory reform have focused on three main areas, Wolburgh Jenah noted. One area involves defining and overseeing a “shadow banking system” that has developed largely unchecked in recent decades, including hedge fund and short selling activity. Another area considers products that are either unregulated or underregulated, such as asset-backed commercial paper and credit default swaps. Third, discussions of regulatory reform must consider the extent to which regulations are necessary.

“If regulation is necessary, to what end?” she asked. “If we do not respond thoughtfully to this question, we risk unleashing new regulations that fail to address the underlying root causes of the recent crisis, offer little hope of addressing tomorrow’s issues, and may result in unintended consequences.”

A key issue that regulatory reform must address is the extent of the role that self-policing can play in the regulation of the industry, Wolburgh Jenah added.

“Historically, too much trust was placed in ability of markets and industry participants to police themselves,” she said. “Every institution has a duty to monitor its own operations and capital allocation, risk-taking and risk management functions, but self-policing is not a substitute for sound regulation.”

Wolburgh Jenah warned that regulators are not the only ones who must work to improve the state of the industry going forward. Even effective regulatory reform could not single-handedly fix the problems that have emerged throughout the financial crisis, she said. She calls on the industry and its leaders to make efforts to rebuild the public trust that has been lost through the crisis.

“The right tone at the top has never been more important,” she said. “Regulation cannot rebuild and maintain investor confidence and trust in the financial system without it.”

Wolburgh Jenah commended TD Bank Financial Group president and CEO Ed Clark for acknowledging the importance of the industry’s role, when testifying at a recent U.S. Senate committee.

“It is unlikely that a regulatory system on its own can solve all the problems,” said Clark. “A mix of sound regulation and sound business practices from financial institutions is required.”

IE