On the geopolitical stage, Canada has made a name for itself through its peacekeeping prowess. In the international sports arena, it’s renowned for hockey supremacy. Its niche in the global capital markets is less clear. But, in the year ahead, that question will be at the heart of many of the issues facing the Canadian financial services industry and its regulators.

There is no shortage of issues facing regulators in 2008 — from global phenomena such as the worldwide credit market disruption to local developments such as the emergence of a genuine multi-market trading environment. Even well-worn debates such as whether it’s finally time for a single securities regulator will rear their ugly heads in 2008. But the common thread running through many of these issues is how the regulatory response affects the Canadian industry’s ability to participate and compete in the global marketplace.

“When you think about what’s going on in the world around us, it’s unprecedented,” marvels Susan Wolburgh-Jenah, president and CEO of the Investment Dealers Association of Canada. “Globalization, technological developments in our own marketplace, the proposed launch of Alpha — what do they mean for traditional exchange venues? We don’t know yet. There’s just so much change happening around us.”

She rhymes off a list of other fundamental shifts that are taking place: institutional consolidation, changing investor demographics, product innovation and heightened demand worldwide for streamlined, modernized securities regulation, which is being met with resistance from investor advocates seeking tougher regulation. All of this change is inevitably challenging regulators to find solutions that meet local needs without sacrificing global competitiveness.

In the case of a worldwide event such as the credit crunch, policy responses by necessity must be global. Several of the world’s major central banks — including those of Canada, the U.S. and Europe — have found it necessary to coordinate efforts to maintain liquidity in the financial system.

Similarly, the initiative to determine whether a regulatory response to the crisis is warranted is taking place at the global level, via the International Organization of Securities Commissions. (See page 31.) But while a global body such as IOSCO can sketch out broad policy objectives, the implementation of reforms must come at the local level. And it’s those details that determine the effects of any regulation.

Domestic regulators often insist that a made-in-Canada solution best serves our markets. For example, rather than responding to the corporate scandals that occurred several years ago by slapping a maple leaf on the U.S.’s Sarbanes-Oxley Act, regulators borrowed some concepts, such as CEO certification and tougher corporate governance standards, and developed other, less onerous rules and guidelines. They also gave smaller companies a pass entirely on some measures.

Bill Rice, chairman of the Alberta Securities Commission, frames the issue as a fundamental question that regulators must face: “Should the focus be internal or external to maximize the interests of Canadian participants in the financial markets?”

In the case of the Canadian response to Sarbanes-Oxley, regulators arguably started with an external focus — a desire to show that they could hold Canadian companies to the same governance standards as the U.S. — but that slowly evolved toward a more internal focus, and a concern for the effect on the small companies that make up a large part of the Canadian capital markets.

Looking ahead to 2008, similar choices are looming. Consider the prospect of securing free trade in securities. It has been touted for some time by market players such as TSX Group Inc. and more recently by the Investment Industry Association of Canada and federal Finance Minister Jim Flaherty.

There also appears to be interest in the free-trade idea at the global level. Flaherty reports the issue was discussed at the last meeting of the G-7, and Canada is drawing up a proposal that will be considered at the next meeting of the G-7 finance ministers.

Proponents of free trade saw an opportunity to make progress on that front last year when staff of the U.S. Securities and Exchange Commission broached the idea of employing mutual recognition to facilitate freer cross-border trading in securities. The concept — if the two jurisdictions’ regulatory systems are more or less comparable — is that firms from either jurisdiction can deal in either location without being subject to both regulatory regimes.

@page_break@The trick is determining whether two regulatory systems are comparable. Can Canada meet a U.S. standard for mutual recognition by crafting rules purely with the needs of local firms in mind? Or will Canadian regulators have to deliver U.S.-level investor protection (including much tougher enforcement) before U.S. regulators are willing to give the Canadian system that status? And, if it’s the latter, is the benefit of better cross-border access worth the cost of a much different regime for all firms, including those that have no interest in cross-border dealing?

Some argue that Canada needs a single regulator before it can make bilateral free-trade deals. Canada can’t expect large jurisdictions such as the U.S. or the European Union to deal on a province-by-province basis. To gain mutual recognition, the argument goes, Canada needs to present a unified face to the world.

Speaking to the standing Senate committee on banking, trade and commerce in early December, Flaherty argued just that: “If we are to move forward with international mutual recognition of security regulators, we need to get ourselves together and have a common securities regulator system here in Canada.”

By itself, a single regulator won’t ensure free trade, but it might be a prerequisite. While the decision is ultimately a political one, there is little support for a national regulator outside of Ontario. Gaining greater access to large foreign markets is certainly appealing, but the questions for regulators are: what would it take to get there, who would benefit and who would suffer?

Certainly the immediate benefits would probably flow to large firms that can afford to deal across borders effectively. Longer term, the hope is that increased liquidity will lead to more efficient markets and a lower cost of capital for issuers, which would benefit everyone.

However, most jurisdictions see their ability to attract capital best served by maintaining their autonomy. British Columbia and Alberta have long warned that a single regulator would lead to inappropriate regulation for their small resources companies, stifling capital formation. Indeed, smaller players take a much more active role in promoting the flow of capital to their provinces — and they oppose a single regulator. Donne Smith, chairman of the New Brunswick Securities Commission, says that the single regulator debate “is a purely political matter, driven by Central Canadian political imperatives and business elites.”

Smith maintains the current system is very effective and, with the adoption of a passport model, is getting better. He worries that a common regulator would not serve the interest of markets in his province: “There is no doubt in my mind that a centralized regulator will have neither the interest nor the ability to foster, promote and advocate for the critical capital market development necessary to meet the stated challenges of New Brunswick’s self-sufficiency agenda.”

It is still a long way from mutual recognition to free trade in securities, but the notion is out there. Open cross-border markets is something Canadian regulators have to confront, particularly as competitive pressures build. In this case, it’s the threatened competitive position of the U.S. markets, which, in turn, is driving interest in regulatory reform.

In the past, the U.S. saw itself as a big market that could set its own rules; the lure of its markets would be powerful enough that issuers and investors would gladly comply with its regime. Now, there are concerns that the U.S. is falling from its perch at the top of the world’s capital markets. A lack of foreign initial public offerings and competition for listings from foreign financial centres has sparked calls for reform to make the U.S. markets more hospitable to foreign players.

That same debate is a semi-permanent feature of the Canadian landscape. The domestic industry is perpetually caught between the imagined benefits that could flow from a simpler system and making less dramatic but more achievable gains within the current structure.

Currently, regulatory flexibility is based on geography. Retiring Bank of Canada Governor David Dodge, among others, has argued that the system should be uniform across the country, but tiered to allow for lighter regulation for smaller firms. “There has not been as much progress here as I would have hoped,” Dodge noted in a mid-December speech. “So, Canada remains at risk of seeing its capital markets eroded as business migrates to other financial centres.”

Similar competitive pressures are bubbling up in the global trading business. The exchange sector has been on the leading edge of globalization. The apparently successful transatlantic merger of the New York Stock Exchange and Euronext NV has prodded Nasdaq to seek its own European acquisition. At the same time, the regulatory environment in Europe is opening the field to alternative trading systems, and moving away from the traditional exchanges that have dominated that business.

These same trends are evident in Canada, where ATSes are finally launching, and industry and regulators are coming to terms with the emerging multi-market environment. This presents huge issues for market regulation at a time when Market Regulation Services Inc. is merging with the IDA.

“We have all these new marketplaces springing up,” says Wol-burgh-Jenah. “Each has a slightly different business model. What does this mean in the absence of a data consolidator? How do dealers connect to these markets, in the context of best execution, trade-through protection and direct market access [rules]?

“These are big questions,” she adds, “and we don’t really have firm answers for a lot of them yet. The market is already there — now we have to figure out how all the pieces work together.”

The proposed merger of TSX Group and Montreal Exchange Inc. (see page 26) poses more challenges to regulators, and represents an opportunity to define Canada’s position within the global market. There’s the question of whether this deal will win regulatory approval: will Quebec’s Autorité des marchés financiers sign off on a deal that may ultimately lead to a migration of derivatives trading activity out of Montreal?

Moreover, there’s the question of foreign bidders swooping in on the merged group. Assuming that the TSX/MX deal goes ahead, the combined firm may become an attractive takeover target for foreign rivals. Here, again, the question is: how will regulators handle a bid from an international exchange?

In 2008, therefore, the challenge for the industry and regulators is going to be finding Canada’s place in the world. Is it going to stick with its insular, introspective approach? Or more fully embrace the threats and opportunities posed by global competition? Only time will tell. IE