It’s not clear whether governments have a sense of irony or not, but in the case of the proposed new disclosure regime for principal-protected notes, the federal government could sure use one. Ottawa is remaining tight-lipped about the input it’s receiving on a regime that’s supposed to ensure investors are well informed.

In last year’s budget, the federal government promised that it would address the need for better disclosure by issuers of PPNs, which are considered banking products despite the fact that — from the investor’s point of view — they act much like securities. The notes are generally issued by banks, but their return is geared to an underlying asset, which may include anything from a simple index to an incomprehensibly complex vehicle such as a fund of hedge funds.

This past November, the Depart-ment of Finance finally published its proposed new regime for comment. At the time, Finance indicated that it had consulted with both regulators and industry lobbyists. It had sought input from the Canadian Bankers Association, as well as regulators such as the Ontario Securities Commission, Quebec’s Autorité des marchés financiers, the federal Financial Consumer Agency of Canada (which will ensure compliance with the new regime) and the Office of the Superintendent of Financial Institutions.

The opportunity for public comment on the proposed rules ended in mid-December. However, these comments have not been made available for public inspection. Finance refuses even to divulge who has commented on the proposed rules. “A person’s correspondence with his or her government is considered private,” says a Finance spokesperson. “The names of individual participants are protected by the Privacy Act.”

This position is at odds with securities industry practice, in which policy-making occurs in a more transparent environment. In the securities world, comments on policy initiatives are routinely published for public consumption. The provincial securities commissions require that self-regulatory organizations publish comments they receive on rules that affect the public interest, unless the commentator specifically requests confidentiality.

And in a paper for the Task Force to Modernize Securities Regulation in Canada that examines ways to improve consumer involvement with policy-making, Julia Black, professor of law at the London School of Economics and Political Science, recommends that regulators publish the results of all consultation processes unless privacy is specifically requested.

A transparent comment process allows interested parties such as market players, investors, advocates (both for consumers and the industry) and regulators to examine others’ thinking on the issue. It helps make clear who expects to benefit and who may suffer at the hands of a particular rule. And it gives the regulators an opportunity to explain their position on various issues, as they often provide responses to the comments they receive. Moreover, an open public comment period serves as a check on possible behind-the-scenes lobbying by powerful interests that could try to influence public policy unduly.

Indeed, the Five-Year Review Committee in Ontario recommended that the finance minister be required to reveal the names of commentators that raise concerns about a particular proposed rule when the minister is reviewing it, as well as the nature of the concerns that are raised.

As the review committee said in its recent report: “It is fundamentally important that there be transparency with respect to the issues directly raised with the minister during the ministerial review period, so that the integrity and transparency of the public notice and comment process are not undermined.”

In contrast, the federal approach leaves investors, firms and even other regulators in the dark, which is ironic in the case of rules intended to improve transparency. It’s also notable because this is an issue in which securities regulators have had to consider whether they should attempt to claim some jurisdiction or whether they can rely on the federal initiative to ensure investor protection.

The question of whether securities regulators need to get involved in the oversight of PPNs arose when some of the risks inherent in PPNs came to light after Portus Alternative Asset Management Inc. collapsed. That debacle alerted both investors and regulators to PPNs’ complexity, the lack of disclosure from issuers and the shortage of due diligence by some of the dealers selling these products. In response, the SROs made an effort to ensure dealers are meeting their responsibilities, and to do away with some of the practices that may have enabled those dealers to shirk their obligations.

@page_break@The provincial securities regulators also have pondered what they could do to ensure appropriate investor protection in this area. Ultimately, they concluded that the new federal regime — along with the efforts by the SROs to tighten up on any dealer issues — would probably be sufficient to assuage their concerns about the quality of investor protection for buyers of PPNs.

Despite the fact that Finance isn’t releasing the comments it has received on its proposals,
the Canadian Securities Ad-ministrators did publish its letter, indicating that after reviewing the proposed regulations, it concluded “they will substantially enhance the current disclosure regime governing PPNs.”

However, the CSA also outlines a couple of concerns. One relates to the disclosure of so-called “knock out events,” which refer to the possibility that the underlying asset on which a PPN is based is no longer available to determine the return on the note. The CSA recommends that the rules be clarified to require prompt disclosure of the occurrence of such an event, so that investors know they can expect only the return of their principal at maturity.

Additionally, CSA also worries about the need to ensure strict compliance with the proposed regime. As its letter points out, because PPNs are considered banking products, not securities, they do not fall under the statutory civil liability provisions in provincial securities legislation “without the resulting market discipline on the quality of disclosure. This, in our view, heightens the importance of ensuring strict compliance with the regulations.”

The CSA letter also invited Finance to engage in further consultations on the subject.

Erez Blumberger, chairman of the CSA’s PPN committee, says that the CSA hasn’t had any further consultations. Nor has it had access to the other comments that were submitted on the rules.

That being said, Laurie Gillett, manager for public affairs at the OSC, says the CSA’s experience on this initiative has been a positive one so far: “There has been an open dialogue between CSA and federal Department of Finance staff. Based on our past experience, we anticipate that [Finance] staff will discuss with the CSA any proposed changes to the regulations emanating from letters received in the federal comment process or elsewhere.”

As to who else submitted letters, that remains a mystery. The Mutual Fund Dealers Association of Canada, the Investment Dealers Association of Canada and OSFI all say that they didn’t comment.

The CBA, however, did comment, reports its manager of media relations, Melanie Minos. “We support federal regulation in this area, but there are a few final important operational details that we need to sort out with Finance,” she says, adding that the CBA isn’t making its submission public for now.

Investor advocacy firm Kenmar Associates of Toronto also commented. It doesn’t favour the principles-based approach adopted by Finance, according to its submission: “A principles-based approach to regulation that meets the goals of regulation while being flexible enough to adapt to changes in the marketplace is very difficult to achieve for complex products like PPNs.”

It remains to be seen if the proposed regime is revised. As it stands, it is scheduled to come into effect on April 1. Hopefully, when it does arrive, it will not prove to be a joke at investors’ expense. IE