Regulation: Reality bites

However, the reality of the draft rules and legislation that have been produced by policy-makers so far is provoking some serious doubts. The industry appears to be increasingly concerned that the proposed regime will fundamentally change numerous aspects of securities regulation and grant the authorities sweeping new powers, all without adequate debate or oversight. (See story at right.)

Just how committed the new federal government is to the CCMR initiative, which was launched under the previous administration, also is not clear. A spokesman for Bill Morneau, the new federal minister of finance, says: “This government’s first priority is ensuring long-term growth for our economy, and we believe that effective regulation of the Canadian securities market is important for a healthy and well-functioning market that will help attract investment, protect investors and contain risk. For these reasons, we are committed to working with interested provinces on a collaborative model for securities regulation.”

Although both the federal government and the industry appear to endorse the premise of the CCMR, the practical reality of creating a new, unified regulatory regime out of a collection of somewhat different systems is proving tougher to love.

Both a revised version of proposed provincial securities legislation and the first draft of the accompanying rules were published last autumn for a prolonged, 120-day comment period. Those proposals are generating fundamental concerns about the real-world impact of the regime that is being crafted by policy-makers.

The clash of political and market realities underlying the CCMR regime represents one of the basic concerns. Historically, Ontario was the only province that explicitly supported a national regulator, yet the CCMR took off only after British Columbia was persuaded to get on board. However, the cost of B.C.’s participation now is looking excessive, as the industry faces the prospect of losing well-established regulations in Ontario, Canada’s biggest securities jurisdiction, in favour of B.C.’s policies.

For example, the Canadian Bankers Association’s (CBA) comment warns that Ontario’s long-standing exemption for financial services institutions is slated to disappear under the new regime, which, the comment states, will be very disruptive to banks and their clients and ultimately may harm liquidity in Canada’s bond markets.

The CBA’s comment also notes that the proposed regime would adopt B.C.’s approach regarding the regulation of securities sales to buyers located outside Canada, an approach that is fundamentally different from that employed in Ontario and the rest of Canada. The CBA’s comment adds that adopting B.C.’s approach will hamper the banks’ global issuance programs and impede bank’s ability to raise capital outside Canada.

The CBA’s comment also complains that the proposals use B.C.’s approach to insider trading, which is broader than Ontario’s; and that proposed provisions dealing with over-the-counter derivatives markets also deviate from Ontario’s existing regime.

The comment from Toronto-based law firm Borden Ladner Gervais LLP calls the decision to use B.C.’s laws and rules as the starting point for the CCMR regime “undesirable,” if only because using the regulations that the “vast majority of market participants” are accustomed to following would make more sense: “In a sense, we consider that the approach taken with the new legislation and regulation results in ‘throwing the baby out with the bathwater’ – the ‘bathwater’ being the Ontario legislation and rules and the ‘baby’ being the high degree of understanding and compliance with that legislation and rules, coupled with years of experience with the administration of that legislation and rules.”

In addition to these concerns about the impact of sacrificing familiar regulation, several comments also express worries that the proposals stray far from the vision that the CCMR simply would merge the existing regulators and keep the rules basically unchanged to minimize the disruption caused by implementing a new regime. In fact, critics argue, the proposals threaten to expand the regulators’ powers and influence in some fundamental ways.

For example, some comments complain that the proposals would give the CCMR much greater power to make regulations, to investigate possible wrongdoing and to collect evidence. As well, the breadth of certain proposed investigative powers raises concerns about privacy rights and whether some of these provisions could withstand a challenge under the Charter of Rights and Freedoms. And the new regime appears to open the door to capturing financial instruments, such as segregated funds and derivatives, under securities law.

A commonly expressed concern is that these fundamental reforms and expansions of regulatory authority are being introduced with a lack of explanation or justification from CCMR policy-makers. Several comments argue that changes of this magnitude should be subject to the normal policy-making process, which often involves extensive public comment and engagement between the industry and regulators.

Many comments also express concerns that the CCMR vision is still far from complete. There are elements of the new regime that have not yet been published, including the exempt-market rules, revised federal legislation, proposed federal rules, the fee model and the mechanism that the CCMR will employ to interface with the provinces that aren’t joining the initiative. Thus, evaluate the overall impact of the proposed CCMR when there are still so many aspects of the regime that remain unknown is difficult.

In early December, CCMR policy-makers published their planned approach to moving to the proposed regime, which spells out how previous regulatory decisions will be treated under the new authority. Certain comments have concerns with those plans too, worrying that they will prove costly for firms as well.

A STALKING HORSE FOR FIDUCIARY DUTY?

Two major policy issues for the retail investment business – the prospect of a fiduciary duty for financial advisors and the availability of personal corporations for investment dealer representatives – are front and centre in the ongoing debate concerning the creation of a new co-operative capital markets regulator (CCMR).

The comment period for the initial set of proposed regulations, and a revised version of proposed provincial legislation to create the CCMR, came to a close at the end of 2015. The consultation attracted a wide range of feedback on a slew of subjects, including some of the most significant policy issues facing the retail investment industry.

For the Investment Industry Association of Canada (IIAC) and the Independent Financial Brokers of Canada (IFB), a central concern is that the proposals appear to lay the groundwork for raising conduct standards for advisors.

As the IIAC’s comment notes, the section in the proposed legislation dealing with these standards has been expanded from the traditional obligation to deal with clients “fairly and honestly” to one that requires advisors meet any future standards that may be imposed.

Creates uncertainty

The IIAC’s comment notes that association is concerned that “the addition of such a broad, sweeping and vague provision creates uncertainty” about these standards.

In particular, the IIAC comment states, the new provision might open the door to the future imposition of a fiduciary duty, or a best interest standard, on advisors: “We are concerned that a new provision with such significant implications has been included in the legislation simply as a placeholder for future rule-making.”

Furthermore, the IIAC’s comment states, this provision should not be part of the proposed legislation.

The investment industry is concerned that this addition to the draft law suggests that tougher conduct standards are a foregone conclusion under the new authority, even though the issue remains hotly debated.

The IFB’s comment stresses that there are “valid reasons” for maintaining the existing standards. In contrast, comments from investor advocates, such as the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) and the Ontario Securities Commission’s Investor Advisory Panel (IAP), argue that the move to a best interest standard is essential.

According to the IAP’s comment: “A best interest standard would immediately require advisors to be the true agents of their clients, putting clients’ interests first. As such, [this standard] should be embedded in the new regime.”

FAIR Canada’s comment also states that the new regulatory framework should include a statutory best interest standard. Failing that, FAIR Canada’s comment suggests that the implementation of such a standard should be one of the CCMR’s top policy priorities, “as this would be a key reform, which would significantly improve investor protection and confidence of investors in our capital markets.”

The strong views on both sides of the issue are well known to the existing regulators, which have been considering a possible best interest standard for several years. In fact, in the wake of recent research into mutual fund fee structures, the Canadian Securities Administrators (CSA) has indicated that it intends to make a policy decision on the issues of fee structures and conduct standards in the first half of 2016. Whether the regulators are prepared to pursue a best interest standard is not yet clear, but the proposed legislation for the CCMR appears to lay the legislative groundwork for creating such a standard under the new authority.

Advisor incorporation

The draft law offers much the same on the issue of advisor incorporation. The proposals do not include provisions that would allow investment dealer reps to operate through personal corporations, but, in a change from the initial draft released in 2014, the current iteration would provide the new regulator with the rule-making authority to allow incorporation.

Although the investment industry is concerned that incorporation would open the door to new conduct standards, investor advocates are worried that the proposal makes personal corporations for advisors a very real possibility. FAIR Canada opposes the concept of advisor incorporation: its comment states that the measure would weaken investor protection and intensify the mismatch between client expectations and investment industry conduct.

FAIR Canada’s comment also argues that there are many more important priorities for regulators, which should not be concerned with facilitating the use of personal corporations: “Reforms should focus on improving investor protection rather than changing business structures so as to reduce tax liability for registrants.”

On the flip side, the investment industry in general favours personal corporations for investment dealer reps. For example, the comment from Toronto-based brokerage firm Raymond James Ltd. states that the firm “strongly supports” allowing reps to incorporate. This would allow advisors to flow their revenue through a personal corporation in order to get favourable tax treatment, among other potential benefits.

The prospect of incorporation is up for debate. The Investment Industry Regulatory Organization of Canada published a white paper in 2015 that proposes allowing reps to incorporate as part of broader move that would allow dealer firms to employ reps who are limited to dealing in investment funds.

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