Anita Anand and Grant Bishop
In its recent decision, the Supreme Court nixed the federal proposal for a national securities regulator, finding that its proposed scheme was unconstitutional. Admittedly, the federal government’s proposal largely (and intentionally) uploaded the current provincial regime to a federal statute. The Court held that, while aspects of the proposed legislation were within the federal wheelhouse, these could not justify a “wholesale takeover” of securities regulation in Canada.
Nonetheless, the Court’s decision should not be read as foreclosing on a federal role in securities regulation. The judgment specifically observes that provinces would be incapable of enacting legislation to effectively address systemic risk and comprehensive data collection. Indeed, the Court expressly stated that “[t]he need to prevent and respond to systemic risk may support federal legislation pertaining to the national problem raised by this phenomenon”.
While the Court has barred one proposal, we note Minister Flaherty’s recent statements that the federal government remains committed to a presence in securities regulation to address a glaring regulatory gap with respect systemic risk. But we seem to have moved in Canada from the specific notion that “systemic risk” is the interconnected financial breakdown where a triggering event causing default by one market participant in turn impacts others’ ability to fulfill their legal obligations causing a chain of negative economic consequences. As Governor Carney has suggested, “systemic risk” can be used more broadly to refer to the financial system’s inability to support economic activity.
The recent (and arguably ongoing) financial crisis underscores how financial contagion can spread from securities markets to financial institutions and back again, threatening the integrity of the entire economy. In Canada, our regulatory framework has not kept pace with the increasing integration of financial institutions and securities markets. In particular, banks are frequent counterparties in over-the-counter derivatives – products for which provincial securities regulators have yet to enact a coherent regime.
Many commentators rightly point to the efficacy of Canada’s regulation of financial institutions in safeguarding against financial contagion. Certain commentators urge that what we have is good enough, arguing that the U.S. had a federal regulator (i.e. the Securities and Exchange Commission) but little good did this do. Such an inference is dangerously simplistic and conveniently forgetful.
Canada’s own Asset-Backed Commercial Paper (ABCP) crisis highlights the gaps in our present regulatory structure. The solution hinged an arrangement fashioned under the thoughtful guidance of Purdy Crawford using a federal insolvency statute. Contagion from ABCP was forestalled but, had the $32 billion market collapsed, the default would have propagated throughout our financial system.
This weakness in our regulatory armour was underscored by former Superintendent of Financial Institutions, Nick Le Pan: “If anyone should have been on top of this, it was securities regulators. They expressed ‘surprise’ ex post at aspects of the issue, such as the extent of ABCP sales to individuals. … In Canada, we don’t have one national securities regulator that could be a partner for federal authorities in financial stability monitoring and crisis management.”
The Office of the Superintendent of Financial Institutions (OSFI) is ill-placed to regulate such systemic risk emanating from securities markets (so-called “macro-prudential regulation”). Lumping prudential supervision of securities markets into OSFI’s mandate would confuse its specialization and pose a worrisome conflict of interest: would concern about keeping banks healthy lead to over-cautious and ham-fisted interventions in securities markets? Good regulation requires well-coordinated but specialized regulators that each have a clear mandate.
With its more ambitious scheme deemed unconstitutional, the federal government should now move to enact a federal regime in areas that are clearly within federal jurisdiction. Taking the lead from the Supreme Court, the federal government should create a Financial Markets Regulatory Agency (FMRA) and mandate such a national regulator specifically with the oversight of systemic risks in securities markets, investing it with powers to intervene where particular products or activities threaten financial stability.
So what specifically would the FMRA do? Notably, the Supreme Court’s judgment sketches a statutory scheme which would form the backbone of such a body. This would involve the regulation of over-the-counter derivatives, credit rating agencies, record-keeping, short-selling and urgent regulation relating to “substantial risk of material harm to investors or to the integrity or stability of capital markets.” As the Supreme Court recognized, comprehensive data collection on potential risks in securities markets is similarly a function that only the federal government can accomplish.
Provincial securities regulation, even under the opt-in umbrella of the Canadian Securities Administrators, cannot achieve a comprehensive and standardized regime for these systemically critical areas of law. There is provincial jurisdiction to protect investors and ensure companies can access capital markets, but with their admitted focus on local markets, provinces lack uniform incentives not to mention constitutional ability to safeguard Canada’s financial system as a whole. The Supreme Court was clear on this point.
The Canadian Securities Transition Office has already done a good deal of groundwork towards establishing such a national-level securities regulator. In addition, the Bank of Canada has been primarily responsible for the systemic risk oversight of clearing and settlement systems, is involved in international fora (such as the BIS and the FSB) and is playing a leading role in the reform of derivatives markets. Revised federal legislation constituting the FMRA could leverage that foundation while conforming to the constitutional constraints articulated by the Supreme Court.
There is clear direction from the Supreme Court and a pressing rationale for the federal government to enact a national regime to address systemic risk in securities markets. The peace and order of Canada’s economy demand no less.
Anita Anand, Associate Professor, Faculty of Law, University of Toronto and Grant Bishop, JD Candidate, Faculty of Law, University of Toronto. An edited version of this editorial appeared in the Financial Post on February 10, 2012.
