A central argument for a national securities regulator is the need to improve foreign investors’ perception of the safety of Canadian markets and thereby bolster their participation. A new study suggests, however, the convoluted Canadian securities system rates rather highly, and it is our rules for courts and banks that could use some fixing.

Research by the Organization for Economic Co-operation and Development attempts to quantify the financial regulatory systems of its 30 members to gain some insight into the impact of regulation on the health of the financial services industry and economic growth. It looks at two major aspects of the countries’ supervisory systems: banking and securities regulation.

On the securities side, critics of the unusually complex and fragmented Canadian system will be surprised to find that the OECD ranks it second overall, just behind New Zealand and ahead of the world’s major capital markets in the U.S., Britain and Japan.

The ranking is an average score based on four criteria: investor protection, contract enforceability, access to credit and the efficiency of bankruptcy procedures. Country scores in each area are based on data compiled by the OECD and the World Bank, and is largely derived from surveys conducted by the latter.

The scores in each area assess systemic factors. For example, the investor protection score reflects the transparency of financial transactions, the extent of liability that corporate directors face and the ease with which shareholders can bring lawsuits.

In the category of investor protection, Canada ranks second overall, again just behind the Kiwis and ahead of the Americans, British and Japanese. It also ranks second in access to credit, behind Britain, and fourth overall for the efficiency of bankruptcy rules.

Timely redress

The one area in which Canada fares poorly is contract enforcement; it ranks a miserable 18th. The weak score reflects poorly on the court system rather than the regulatory system. Scores in the category are based on the timeliness of dispute resolution, the procedural efficiency of the judicial system and the cost-effectiveness of that system.

If nothing else, the score appears to validate the common complaints that investors level at the Canadian system — that there are few efficient, cost-effective options for getting redress when disputes arise, and the courts are slow and expensive. Investors at last year’s Ontario Securities Commission Investor Town Hall and the 2004 public hearings of the standing committee on finance and economic affairs complained about poor experiences with redress alternatives, such as arbitration and the ombuds service.

Putting the category aside, however, the survey says Canadian securities regulation is doing rather well compared with the rest of the developed world. That, in turn, contributes to the financial services sector’s growth. The OECD assumption is that tougher regulation is more conducive to financial development: “In securities market regulation, scores are designed to increase according to the enforceability of claims; hence, higher scores mean more investor certainty, which is better for market efficiency.”

The other aspect that the OECD looks at is banking regulation, primarily the extent to which regulation erects barriers to competition. Areas include barriers to new entrants, obstacles for foreign entrants, the level of government ownership and the breadth of financial services that banks can provide. In contrast to securities regulation, restrictive banking regulation is believed to impede economic growth.

Overall, Canada is just a middling performer in these metrics, ranking ninth. But Canada rates as the most restrictive country in the OECD when it comes to allowing foreign competition in the banking business. It is much less restrictive to domestic competition, ranking 18th. The country is also permissive toward the activities in which banks can engage, and government ownership is essentially non-existent.

Although Canadian policy-makers can take heart in the fact that the domestic banking industry is considered quite permissive, they may want to rethink some of the barriers to foreign competition, particularly as previous reforms were designed to open our banking industry to more foreign entrants.

Barriers hinder growth

The OECD notes: “Regulatory barriers to competition are found to be negatively associated with the volume of bank assets (relative to GDP), which could be taken to suggest that stricter anti-competitive barriers hinder the development of the banking sector.”

By most standards, Canada has a very well-developed banking industry, but it could always be better. The OECD study ranks Canada’s financial services industry in the middle of the pack, as measured by the ratio of the size of the industry to GDP. For Canada, the total value of loans, equity and bond market capitalization is more than double GDP, the study reveals, up from 1.5 times in the early 1990s. The U.S. industry, by comparison, is more than four times the size of GDP, up from about 2.5 times. The size of a country’s financial services industry is important for overall economic growth, the OECD notes, because a large, healthy financial services system finances business investment and more efficiently allocates scarce capital resources.

@page_break@Regulation has an impact on the growth of the financial services industry, both as a constraint and a catalyst. “The degree of investor protection is positively correlated with stock market capitalization and private bond market capitalization, suggesting that more demanding regulation in this area is beneficial to securities market development.”

The message that is less restrictive banking rules and tougher securities regulations can make for a healthy financial services industry. “This analysis suggests that the impact of reducing competition-restraining banking regulations and strengthening investor protection on economic growth would be significant,” the study concludes.

It estimates that if the countries with the most restrictive banking regulations undertook reforms to move toward the OECD average, such action would lead to an increase in annual GDP growth of “one-quarter and one-half of a percentage point for a significant period of time.”

The challenge for Canadian policy-makers is to improve redress on the securities side and let foreign firms in on the banking side. IE