The investment industry has long complained about a fragmented approach to regulation in Canada, which often adds needless compliance costs for firms. Industry lobbyists now propose that regulators bear the costs of the disarray.
The latest source of frustration for firms is the effort to improve market surveillance by adopting unique client identifiers. In June, the regulatory division of the Bourse de Montréal Inc. (MX) published a consultation paper outlining a proposal to require client IDs to accompany each trading order, with the aim of enhancing the data available to regulators. The IDs would make supervising trading activity and rooting out misconduct such as market manipulation or illegal insider trading easier.
While the project’s goal may be noble, the proposed execution attracted a scathing response from the Investment Industry Association of Canada (IIAC). The industry lobby group suggested the exchange pick up the tab for the systems changes that industry firms would have to make in order to adopt client ID requirements in the derivatives market.
The chief source of the industry’s frustration is the lack of co-ordination between regulators at the MX and the Investment Industry Regulatory Organization of Canada (IIROC), which recently finished its own project to adopt client IDs in the securities markets. IIROC revised its rules to require client IDs — typically, account numbers for retail clients and legal entity identifiers (LEIs) for institutional accounts — to improve its ability to oversee trading in debt and equities markets.
Now, the industry has been asked to consider the same kind of changes for derivatives markets, causing consternation among firms that just finished implementing IIROC’s changes.
According to the IIAC’s submission to the MX’s consultation, which closed at the end of August, the industry trade group recommended to both IIROC and regulators at the MX that a client ID effort be carried out jointly for the securities and derivatives markets when IIROC first broached the idea in 2017.
“The industry requested that the [MX’s] regulatory division participate actively in the IIROC group, which included dealers, vendors and marketplaces, to create an identifier and marker framework that could be used in a changing regulatory environment, and for years to come, for derivatives and for their underlying products,” the IIAC’s submission stated.
That didn’t happen. Instead, IIROC proceeded with its project, and the final requirements took effect on July 26. Now that the MX is considering its own initiative, industry firms are facing a potential second wave of changes.
“Asking industry members to revisit client identifiers and order markers for derivatives — when the IIROC project has been completed and the software development has been executed — creates disruption and increased costs for our members. This is unacceptable,” the IIAC’s submission stated.
The association added that the costs of introducing client IDs for derivatives markets will be compounded by required updates to know-your-client documents, systems changes and outreach to clients to explain the project.
The IIAC said the MX should pay for any resulting technological changes to firms’ systems. Furthermore, the industry group argued, “it is unacceptable for IIAC members to pay for the [MX] regulatory division’s complacency, considering the regulatory division was aware of the IIROC working group well in advance of the first meeting and invited to participate.”
The process to develop client IDs on the securities side involved extensive consultation, including two rounds of public comment and a three-phase implementation effort that ran for almost two years.
While investment industry firms routinely resist regulatory reforms, firms do not usually call on the regulators to bear these types of costs.
The MX acknowledged that its proposal would result in added costs for firms, but suggested the adoption of client IDs would also reduce post-trade data requests to firms, thereby reducing firms’ costs over the long term.
No investor advocates commented on the MX proposal.
The IIAC had other complaints with the proposal, including that the use of LEIs for derivatives creates other complications; that, even now, the project doesn’t contemplate IIROC’s involvement; and that the MX’s proposed timeline for adopting these changes by the end of 2022 is unrealistic.
If the proposal goes ahead, the IIAC’s submission suggested the end of 2023 would be a more realistic deadline. Furthermore, firms believe the project should be the task of a joint working group involving both the MX and IIROC, with a view to facilitating surveillance across both securities and derivatives markets rather than having the MX develop its new requirements separately.
“The IIAC and its members understand the benefits of increased regulatory data for market integrity and investor protection. However, the industry fails to understand how the [MX] regulatory division can assess derivatives identifiers and markers without the formal input of IIROC, which supervises market activities on the underlying products of these derivatives,” the IIAC’s submission stated.
To ensure adequate oversight, the group stated, regulators should have access to data on both derivatives and their underlying securities.
“Patterns of market manipulation may emerge when reviewing both types of data collectively. Such manipulative patterns may not be identified if multiple regulators review trading data in silos,” the IIAC’s submission stated.