Academic

Does the Credit Crisis Implicate the Need for a National Securities Regulator?

There are strong arguments in favour of a national securities regulator  which have been voiced numerous times over the past few decades: greater efficiency in transactions, consistent and coherent presence  internationally, single enforcement body, uniform securities legislation, lower costs for issuers and registrants,  etc.  Flowing from a series of federal, provincial and industry reports, these arguments make a coherent case for a national regulator notwithstanding the usefulness of the passport system of regulation over the  past few years.

Recently, Finance Minister Flaherty provided another reason for a national securities regulator: current market turmoil (see Toronto Star, Nov. 2).  However, while a number of financial market issues are on centre stage in this context, only some of these issues fall within the jurisdiction of securities
regulation per se.  Thus, the need for a national securities regulator is not obvious from current financial market conditions alone.

Importantly, a main focus of the financial market meltdown has been the banking area. In particular, the failure of large US investment banks (e.g. Bear Stearns, Lehman Bros) led to the introduction of a massive US federal government bailout plan under which the US government authorized the Department of Treasury to purchase troubled assets and other financial instruments with a newly-created body to oversee the program.

In Canada, intervention on this scale has to date proven to be unnecessary and indeed has been limited (e.g. the federal government has purchased a bulk of CMHC mortgages, the Bank of Canada has intermittently injected liquidity into Canadian markets over the past few months). This relatively limited response speaks to strength of the Canadian economy and its institutions. It is unlike the US and many European countries (e.g. UK, France, Belgium  and Greece) where governments have intervened not only to create liquidity but also to guarantee deposits in their respective economies.

The key is that credit markets have stagnated in these jurisdictions and the focus of much government reform will likely be in the banking  sector. In Canada?s banking sector, it is not clear that additional or  new regulation will be necessary; while credit markets are undoubtedly tight and deals have slowed, Canadian investment banks have been relatively insulated from the economic turmoil that has crippled their  US counterparts. There are various reasons for this -- one of which is that the structure of Canada?s banking system has historically differed from that in the US. In particular, our investment banks also have a retail ? or depository ? arm which provides cheap capital. In the United States, the investment  banks that failed were by and large banks that did not have this retail  base of cheap capital.  Thus, while Lehman Brothers and Bear Stearns collapsed, Bank of America remained relatively stable. (We should note  that after the repeal of the Glass Steagall Act in 1999, the legal  regime in the US actually permits the combination of retail and  investment banking, but many banks chose not to adopt that structure.)

Why would the creation of a national securities regulator be more important at this time in financial market history? One issue that stands out from a securities standpoint is the regulation of derivatives such as credit default swaps  (CDSs).  The way in which financial institutions were extended because of CDSs calls into question whether securities regulation appropriately addressed trades in these instruments. In the US, the Chair of the Securities and Exchange Commission (SEC) has indicated that greater transparency in the CDS market is warranted. This, and the proper regulation of derivatives generally, is without question an important issue to examine in the Canadian context. However, it is not clear that this issue in and of  itself warrants a national regulator given that the Canadian Securities  Administrators (CSA) have generally been effective in issuing national policy  statements and instruments that all jurisdictions have agreed to. A coordinated approach to the regulation of derivatives could emerge through this body (following on Quebec's lead in issuing legislation regulating derivatives.)

A further possibility is that Minister Flaherty views a national  response to securities market issues as being crucial.  When the SEC temporarily banned short-selling in September 2008, the Ontario  Securities Commission (OSC) followed suit immediately thereafter. The CSA  issued a press release supporting the OSC?s temporary ban. Arguably, it  would be more effective to have one statement that affects all  securities trading and markets in the country. Coordination on this and other issues would be de rigeur under a national securities regulator. However, the CSA response is indeed a useful  second best solution at the current time. It has been quite vigilant in issuing  guidance to capital market participants, including investors, about the  risks inherent in trading under current financial conditions.

A final argument underpinning the need for a national securities  regulator relates perhaps to enforcement issues.  In the US, a number of  issues have arisen from a governance perspective relating to golden  parachutes of management of failed investment banks. Enforcing financial  markets crimes may come to be important in this context. But again, we  have not seen the failure of investment banks in Canada and the corresponding enforcement issues that have been brought to the fore in the US. It is  not clear that a national securities regulator is necessary because of  enforcement issues arising from the credit crisis alone.

All of this is not to undermine other valid arguments in favour of a national securities regulator. Indeed, foremost among these is structural change to bring more effective securities law enforcement as I have argued elsewhere (Lawyer?s Weekly March 21, 2008). However, the issues emerging from the credit crisis extend beyond the reach of securities regulation and implicate banks and credit markets generally. Minister Flaherty has indicated himself that Canada has strong markets and strong institutions. Thus, any discussion about possible reform measures should include a focus on more than securities regulation per se.

Anita Anand

anita.anand@utoronto.ca

Full post as published by University of Toronto Law School Faculty Blog on November 03, 2008 (boomark / email).