Could a systemic-risk regulator succeed?

In fact, the SCC has indicated that there could be some federal jurisdiction in areas of truly national concern, such as systemic risk. In turn, federal Finance Minister Jim Flaherty has suggested that he intends to explore whether a national regulator can still be created, with the provinces’ co-operation, to address systemic risk.

Given the time, energy and political capital that have been invested in the effort to create a national regulator over the past couple of years, it’s not surprising the feds don’t want to walk away from the project empty-handed. But apart from the political value in creating some sort of national authority, it’s not clear that there’s much sense in building a systemic-risk regulator just for the securities sector.

For one thing, with the SCC having clearly declared the day-to-day business of securities regulation a provincial responsibility, the existing regulators appear to be here to stay, which means any new federal initiative would represent yet another player on the field. Far from consolidating securities regulation, as the national regulator initiative had intended, this proposal is likely to fragment regulation in Canada further.

Moreover, creating a new federal authority not only risks added fragmentation and duplication, it also creates the likelihood of more, unproductive turf wars in an area that has long been rife with them.

Imagine a scenario in which a federal risk regulator spots a weakness in disclosure practices that it concludes represents a systemic risk. Indeed, a paper from the Bank of Canada points out that the collapse of the non-bank-sponsored asset-backed commercial paper market in 2007 “is a clear example of how insufficient disclosure undermined investor protection [and] contributed to systemic risk.”

The logical way to head off that risk would be by changing the rules to require better disclosure. But with the provincial regulators still on the field, the systemic regulator would need to have the authority to force that change. Without that authority, the systemic regulator effectively would be impotent and pointless; with it, the provincial regulators would be usurped.

In addition, it’s not clear how systemic-risk regulation can be separated from securities regulation — or if it should be. Ensuring market transparency and setting and enforcing business-conduct rules are inextricably bound to the challenge of identifying and dealing with systemic risk. And securities regulators are in only the early stages of figuring out their role in mitigating systemic risk; thus, it’s not a task that’s well settled or easily hived off.

Historically, securities regulators haven’t paid much attention to systemic risk. Prior to the 2007-08 financial crisis, this risk was largely seen as a job for central bankers and prudential regulators — the BoC and the Office of the Superintendent of Financial Institutions. The crisis has changed some of that thinking, however, and securities regulators have started to add systemic-risk regulation to their repertoire in the past couple of years.

At the International Organ-ization of Securities Commissions’ annual conference in Montreal in the summer of 2010, IOSCO (the international umbrella group for securities regulators) had pledged to start paying more attention to systemic risk. IOSCO then adopted two new principles devoted to systemic risk at that meeting, in recognition that market regulation has a role to play in identifying — and addressing — systemic risk.

Individually, securities regulators have been trying to work out just what that role is. And, interestingly, Canada’s provincial regulators have been on the leading edge of that quest.

Even before IOSCO embraced the notion, Canada’s provincial securities regulators were trying to get their heads around systemic risk, metaphorically speaking. In 2009, the Ca-nadian Securities Ad-ministrators formed a committee to examine the issue, which produced a report on possible systemic risks in the Canadian markets. Highlighted in that report were hedge funds, electronic trading, and clearing and settlement systems, among others, along with recommendations about how securities regulators can sniff out and tackle those sorts of risks.

In addition, IOSCO’s first working group to deal with systemic risk was co-chaired by Quebec’s Autorité des marchés financiers and the Ontario Securities Commission. That group also produced a report, published in January 2011, that details how securities regulators can start to incorporate systemic-risk considerations into their existing mandates.

Finally, systemic risk isn’t something that’s confined to an industry silo. In the wake of the financial crisis, policy-makers around the world have been seeking ways to improve their monitoring of systemic risk; the consensus approach has been to bring regulators from various sectors together to take on that task rather than divvy up their oversight efforts by industry sector.

In Canada, that approach would entail somehow bringing together the BoC, OSFI and the securities sector. And if the federal government truly believes that a national authority is necessary on the securities side, there already is one — the Investment Industry Regulatory Organization of Canada, which could be drafted to the cause without adding to the regulatory population.  IE