Analysis: Canada may settle for markets watchdog with less bite


Canada is pushing ahead with plans to create a new but watered-down version of a national securities regulator as its campaign to create a more powerful watchdog like the U.S. Securities and Exchange Commission appears to be headed toward failure.

The Conservative government's new plan would bypass the country's powerful provinces and focus on detecting market risk, sources familiar with the process told Reuters. This alternative, however, is unlikely to impress investors and the financial industry given its limited powers and the potential for duplication and more bureaucracy, industry officials say.

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Ottawa has tried for decades to replace a patchwork of 13 provincial regulators with a single agency more in tune with today's globalized markets, arguing it would reduce costs and give it more clout to deal with the cross-border effects of reforms like the U.S. Volcker Rule.

It would also make it easier to prosecute corporations such as Sino-Forest Corp, one of several North American-listed companies with Chinese operations whose accounting or disclosure practices have come under scrutiny.

Although Canada is recognized internationally for its robust banking sector, it has been criticized by the International Monetary Fund for being the only advanced economy without a national securities regulator.

Canadian Finance Minister Jim Flaherty has pushed harder on this issue than his predecessors, but hopes last year of a breakthrough deal have all but died.

Flaherty has since spoken publicly about taking unilateral action on a far less ambitious plan -- a federal body with a narrow mandate to monitor capital markets for "systemic risk," or threats to financial stability.

"We have tried greatly and repeatedly to get a majority of the provinces ... to join with us in a joint regulator," a visibly frustrated Flaherty recently told lawmakers.

"We've been unable to reach that kind of consensus," he said. "So we feel we have to act ... and we will, if we have to, create a federal securities regulator to deal with those areas of jurisdiction that the Supreme Court of Canada told the federal Parliament that it has," he said.

As talks with the provinces faltered, Flaherty quietly instructed his officials to focus on hammering out the details of an additional federal body to oversee systemic risk, said the sources who are not authorized to speak publicly on the matter.

Flaherty's office declined to comment on the status of talks with the provinces and plans for a potential alternative.


The Supreme Court in December 2011 ruled it unconstitutional for Ottawa to impose a common regulator and said each province was responsible for day-to-day regulation while the federal government had powers over national concerns only, such as responding to systemic risk.

So Flaherty launched "Plan B" -- a cooperative approach for a joint federal-provincial body that would respect everyone's respective powers. Ontario, the dominant market, has always agreed with the idea and two other major players, Alberta and British Columbia, showed tentative signs of interest. Quebec, home to a large derivatives market, was opposed.

Flaherty failed to get a critical mass of support and his self-imposed deadline for reaching a deal has passed.

The third option now in the works is far from ideal, said Ian Russell, chief executive officer of the Investment Industry Association of Canada, which represents the country's investment dealers.

"That clearly risks the possibility of duplication, overlap and inconsistency in the rules, as two regulators collide with each other," he said.

"That's exactly what the industry doesn't need. There is the likelihood that these fourteen regulators will result in an increase in overall fees. That again is something the industry doesn't need."


Finance officials are in the early stages of drafting legislation for the new systemic risk body and few details have been finalized, sources said.

It would most likely be a standalone organization that would collect data on different regions and types of securities to detect things like asset bubbles or risky trading.

The government argues that the 2007 meltdown of Canada's non-bank asset-backed commercial paper market could have been avoided if such a watchdog had existed then.

Analysts speculate that its tasks could include market surveillance and rules governing trading and capital requirements for market participants. It will also likely have powers of intervention, for example to suspend trading in an emergency, and an enforcement role.

The tricky part for Flaherty will be to not overreach, triggering another legal battle with wary provinces.

Distrust among provinces runs high. The head of the Quebec securities regulator, Mario Albert, worried that the new regulator could be a "Trojan horse" to sneak onto Quebec's turf.

"You can agree that the federal government has a role with respect to systemic risk. It doesn't mean that you can regulate the whole sector of securities with that. And that's where we disagree," Albert told Reuters in an interview.


From a policymaker's perspective, keeping the fragmented system in place means Canada cannot speak with a single voice on some aspects of global financial reform.

And it hinders Ottawa's ability to negotiate with Washington over the Volcker Rule, a pending piece of the 2010 Dodd-Frank Wall Street reform law that Canada says would impose restrictive and unnecessary rules on Canadian banks operating in the United States and shrink the market for Canadian government bonds.

"There is a tsunami of new regulation around the world and a lot of it is coming at us extra-territorially and it needs a strong federal presence to deal with it," said Peter Brown, founder of Canaccord Financial Inc , an investment bank and wealth manager.

Proponents of the current system say it works well and governments should focus on enhancing it rather than replacing it. Nine of the 10 provinces, excluding Ontario, have agreed to a so-called passport system whereby a company seeking approval in one province will be automatically approved in another.

U.S. regulators declined to comment on Canada's regime but James J. Angel, a capital markets professor at Georgetown University warned against copying what he called the "dysfunctional" SEC, which failed to prevent fraud, Ponzi schemes or full-blown market crises.

"Look at the mistakes we've made, and don't repeat them. Nobody has come up with the perfect regulatory scheme, and I don't believe one size fits all," he said.

(Editing by Jeffrey Hodgson, Mary Milliken and Diane Craft)