There are a couple of ways a merger can pay off. Sticking two firms together can allow the combined entity to gain scale, eliminate duplication and cut costs. Or two complementary groups can meld together in a way that stimulates creative synergy, generating a firm that’s greater than the sum of its parts.

It’s the latter, the trickier option, that’s driving the merger of the Investment Dealers Association of Canada and Market Regulation Services Inc.

On the surface, the logic of merging the two self-regulators is fairly obvious. They police many of the same firms, albeit mostly in different areas of operations. A merger would allow them to eliminate overlap, thereby reducing regulatory costs.

In an environment in which regulatory costs seem to rise inexorably, the opportunity to consolidate the self-regulators and wring out some savings in the bargain has an appeal that can not be ignored. However, things are moving somewhat slower than expected, suggesting SRO consolidation may look like a no-brainer in theory, but it’s proving harder to pull off in practice.

The idea of merging the regulators has been kicked around for several years, and has been championed most forcefully by IDA president and CEO Joe Oliver.

At the IDA’s annual meeting in 2005, Oliver made the case for a single, national SRO, calling the arguments for consolidation “as obvious as they are compelling.” Namely, he listed “synergy, operational efficiency, avoidance of overlaps and gaps, less public confusion, increased investor confidence, a more secure role for self-regulation” as benefits.

Soon after that, the push to merge kicked into high gear, and last spring the boards of the IDA and RS agreed in principle to come together to create a new SRO. Since then, various joint working groups have been set up, and negotiations on just how to put these two organizations together are ongoing.

Initially, the hope was that the two could hammer out a model and come up with an information circular by the fall that could be circulated to IDA members for their approval. That has not happened.

There are no indications that the two sides have run into anything serious enough to scuttle a deal. But at the same time, there are plenty of issues to work through, from policy and operations to governance. And the scale of the task is apparently engendering some sense of “deal fatigue” — a not uncommon phenomenon that has merger partners wondering whether the effort is going to be worth it.

Increasingly, it is looking as if that question is going to be answered by the quality of regulation the new organization delivers, not the cost savings it permits. Several of the deal’s key players hinted at this “quality vs cost” benchmark at a conference hosted by the Ontario Securities Commission in early November. At that event, Tom Atkinson, president and CEO of RS; Paul Bourque, senior vice president of member regulation at the IDA; and Ed Waitzer, senior partner at Stikeman Elliott LLP, who’s serving as an advisor on the deal, talked about their vision for a merged SRO.

They suggest that it’s not likely the merger will lead to lower direct costs for dealers — at least, in the short term. There may be some implicit savings for the firms in that they would no longer have to deal with two regulators. But the expense of putting the two organizations together will probably generate some incremental costs. The return is going to be in the form of better regulation, not cheaper regulation, the three explained.

Mergers based on cost savings are the easy ones to pull off — you pool the firms’ assets, eliminate duplication, lay off surplus workers, scrap redundant systems and close unnecessary offices.

Deals based on synergy are harder to implement.

Plus, while it’s hard enough to make a corporate merger work, it becomes infinitely trickier when the parties involved aren’t profit-driven, with only shareholders to please. Instead, they are regulatory authorities with multiple masters to serve (their members, the securities commissions and the investing public, not to mention their own staffs). With all of these constituencies to accommodate, SRO consolidation becomes an even bigger challenge. And it doesn’t carry nearly the sense of urgency that a corporate deal would.

So, it’s not surprising that things are taking longer than expected. Although it’s good that a deal isn’t being pushed through under duress, the lack of urgency allows more time for fatigue to set in.

@page_break@It’s apparent that the information circular won’t make it out before the snow hits the ground. Waitzer says it’s now more likely to happen in January, with a vote to follow soon afterward. The goal is to have the new group up and running by the end of March 2007.

In the meantime, there’s the issue of who will lead the new organization. That search has been underway for some time, and word on the Street suggests that the short list includes a couple of top candidates from the existing SROs, along with one current and two former regulators.

Whomever gets the job, they will be faced with the tricky task of meshing two corporate cultures that bring two approaches to enforcement, neither of which wants to be seen as being taken over by the other. This challenge is on top of the basic organizational challenges that come with any merger, not to mention the peculiar challenges that SROs face.

The new CEO will not only need to negotiate the internal, political minefield, but will also face some high expectations. The success or failure of the IDA/RS merger could go a long way toward defining the future of self-regulation in Canada.

The good news is that the players are optimistic that they are creating something that will be greater than the sum of its parts. At the OSC conference, Waitzer revealed that the merger discussions took months to bring both sides to the conclusion they could build something better than simply a consolidated version of what exists today. Atkinson pointed out that if the goal was just to build a bigger regulator, that could be done easily, but the aim is to create something better.

Indeed, there are any number of ways that the current system could be improved. For example, Bourque suggested to the conference that self-regulation could become notably more effective if the provincial commissions could be persuaded to give SROs the power to certify their own rules.

This is one of the areas in which the self-regulatory system is horribly inefficient. An SRO may be quick to respond to a new market development with a new rule, or an amendment to an existing rule. But the securities commissions’ approval process can take years as it is debated among the provincial regulators, and batted back and forth between the commissions and the SRO in search of approval.

This is partly a function of the unwieldy provincial system in Canada, which inevitably adds complexity and delays to any decision. But is also a consequence of the two layers of approval needed for an SRO rule. If an SRO could be trusted to devise and approve its own rules, then the rule-making process could speed up significantly.

And, if it works as hoped, the fragmented provincial system may become less of an obstacle, as the combined SRO would provide a truly national authority.

To get rule-making powers, the provincial regulators would presumably have to be comfortable that an SRO is not only making rules quickly, but that it is also getting them right and balancing the interests of all market players. That’s easier said than done.

Indeed, a legislative committee in Ontario recently recommended that the government review the current system of self-regulation, with an eye toward determining what powers SROs should have, including whether they should have any powers at all. Ontario has yet to act on this recommendation.

The provincial commissions also have their own group looking at self-regulation. The Canadian Securities Administrators’ SRO oversight committee is working on a report that is expected to be released this winter. It will probably deal with some of the other issues that have bedevilled SROs, such as their inability to enforce their judgments and their lack of statutory immunity.

In the meantime, the CSA has begun talking with the IDA and RS about the process of recognizing the new combined SRO. While recognition is a provincial matter, a group of CSA chairs is working on this together, with the hope that they can agree on a common recognition order for all provinces to adopt.

It’s not yet clear to what extent the CSA will be open to innovations such self-certification. Some commissions are surely more progressive than others. The idea of self-certification was proposed by Quebec in its discussion paper on a new system of derivatives regulation, so it certainly seems to like the idea. It remains to be seen how receptive the rest of the CSA is.

Expanding powers isn’t the only way self-regulation could be improved. Waitzer suggests that consolidation will improve the system by establishing a national point of contact for players from other markets, easing confusion in the public and creating a more meaningful, effective institution that could, in turn, attract higher-quality personnel who are passionate about regulation. Bourque adds that a consolidated regulator will have a more complete picture of trading activity, and that should make it easier to monitor the market.

Moreover, the outcome of this deal will determine whether still more SRO consolidation takes place. The Mutual Fund Dealers Association was also included in Oliver’s plea for consolidation, but rebuffed the initial offer to make the proposed IDA/RS marriage a ménage à trois. The MFDA remains a skeptical outsider. IE