​Capital Markets
The consultation draft of the federal Capital Markets Stability Act (CMSA) issued in September 2014 proposes a novel regulatory regime directed at protecting the stability and integrity of Canada’s financial system through the management of systemic risk, which was discussed in a number of public comment letters.
The CMSA is companion legislation to the proposed Provincial Capital Markets Act (PCMA) that has been issued under the memorandum of agreement entered into by the Canadian government and the governments of British Columbia, Ontario, Saskatchewan, New Brunswick, Prince Edward Island and Yukon (collectively, the Participating Jurisdictions). The PCMA relates to a proposed cooperative capital markets regulatory system (Cooperative System) controlled by a single regulatory body, the Capital Markets Regulatory Authority (Authority).
Generally, commenters expressed support for the appropriate oversight and management of systemic risk. However, the scope of the proposed systemic risk regulatory scheme combined with the lack of legislative guidance as to how, in practice, it will apply to market participants has resulted in comments that offer little support for the proposed draft CMSA. Commenters were concerned by the Authority’s broad power to impose regulations and restrictions on capital markets intermediaries, trading facilities, clearing agencies and credit rating organizations that are designated to be “systemically important”. Numerous comment letters outlined concerns with the breadth of discretion provided to the Authority, the risks of overlap with other regulatory regimes and the lack of safeguards and due process for entities that may be impacted.
Given the scope of the CMSA and PCMA consultation drafts and the comment letters submitted in November 2014, Blakes has published a number of Bulletins reviewing issues raised by the comments received. This Bulletin addresses comments on the framework providing the Authority with broad powers under the CMSA to regulate capital markets in connection with systemic risk. For a description of the CMSA’s regulatory regime, see our December 2014 Blakes Bulletin: A War Measures Act for Canada’s Financial System: Regulation of Systemic Risk by Cooperative Capital Markets Regulator.
The ministers in the Participating Jurisdictions have announced that updated consultation drafts of both the CMSA and PCMA along with draft initial regulations under the PCMA (but not under the provisions of the CMSA related to systemic risk) will be released this summer for public comment for a period of 120 days. For more information on the Cooperative System, please see the various Bulletins posted on our Cooperative System website.
The concept of systemic risk to capital markets is the cornerstone of the Authority’s regulatory powers under the CMSA. Under the CMSA the Authority may designate particular capital markets intermediaries, securities and derivatives trading facilities, clearing agencies and credit rating organizations and products as systemically important and particular practices as systemically risky. The Authority may also make regulations with respect to entities, products and practices it designates as systemically important or systemically risky.
The CMSA defines systemic risk as “a threat to the stability or integrity of Canada’s financial system that originates in, is transmitted through or impairs capital markets and that has the potential to have an adverse effect on the Canadian economy”.
Commenters expressed concern that the CMSA did not provide a more rigorous process for identifying systemic risk, including objective criteria and procedural protections. Commenters noted that the CMSA, as drafted, would result in a powerful national Authority operating with little legislative guidance and broad discretion in respect to the designation process and management of systemic risk. 
Stakeholders also raised specific technical concerns that the definition of “systemic risk” was vague and could create the conditions for regulatory overreach. Commenters noted that “integrity” is only vaguely defined and there is no definition of “stability”. Concerns were also raised that there was no materiality or significance qualifier and that the phrase “potential to have an adverse effect” provided very broad discretion to the Authority and little guidance either to the Authority or market participants. 
Consistent with comments provided with respect to the PCMA, commenters took issue with the platform approach to regulation under the CMSA, which involves setting out in the legislation a bare framework of types of rules that the Authority may impose, while leaving the Authority broad rule-making power that is not subject to legislative review.
Some comment letters stated that it was impossible to provide meaningful comments on the CMSA’s proposed regulatory structure without the benefit of reviewing the regulations that are to be introduced. The regulators had previously indicated that they do not intend to introduce any draft or final regulations related to the CMSA’s regulation of systemic risk before the law comes into force. Commenters noted that the lack of draft regulations underscores concerns that there is insufficient guidance or limitations in the CMSA on the powers of the Authority, in particular as a result of the Authority’s broad rule-making powers over a list of types of entities that might be regulated. 
Specific concerns were raised that the enumerated factors in the CMSA that the Authority must consider when evaluating an entity, product or practice in the designation process are too vague; and the open-ended list of factors provides too much discretion to the Authority and little clarity to the market. Some commenters argue that regulations on how the Authority will evaluate and weigh such factors should be published concurrently with the revised draft CMSA or procedural requirements should be included in the CMSA to ensure that the process is transparent and consistently applied.  
The breadth of the Authority’s rule-making authority is reflected in its powers to make urgent orders prohibiting a person “from trading in a security or derivative, reducing their capital or financial resources, engaging in a practice or doing anything else” (emphasis added) if the Authority considers the order necessary to address a “serious and immediate systemic risk.” One commenter pointed out that such an ex parte order may be issued without reasons, and remain in force for up to 30 days without right of response or appeal.
Several market participants including a number of pension funds, investment fund managers, a credit rating organization and the TMX Group set out arguments regarding why they and other entities of the same type did not pose systemic risk, that introduction of an additional level of regulation would be disruptive and superfluous and that the Authority should not have the power to designate them as systemically important.
Representatives of pension funds provided extensive arguments that such entities are qualitatively different from market intermediaries that may pose systemic risk. In particular, they noted that pension funds are prudentially regulated and subject to prudent portfolio investment management standards, have long-term investment horizons with significant ability to withstand short-term volatility and liquidity stresses and do not utilize significant leverage. It was submitted that any risks to capital markets from pension funds’ trading activity will be adequately addressed under generally applicable provincial capital markets regulation, including mandatory derivatives central clearing and margining requirements.
Investment fund stakeholders objected to the potential designation of investment funds as systemically important capital market intermediaries on the basis that investment funds are funded by equity and subject to limits on investment fund leverage and face little to no risk of financial distress or insolvency as compared to risks posed by other financial market intermediaries. It was suggested that the Authority should instead focus on regulating specific products and activities that may give rise to systemic risk.
A large number of comments related to the lack of procedural protections in connection with the process for designating entities as systemically important and other due process concerns. The draft CMSA only provides entities proposed to be designated as systemically important with “an opportunity to make representations” and there is no greater specificity as to what such right entails. Commenters proposed that the regime be revised to provide additional procedural protections, including timely notice provisions, the right to make oral arguments, access to data used in the designation process and a right of appeal to a neutral body or the courts.
Commenters requested the development of a framework for how the Authority would exercise its power in cooperation with the non-Participating Jurisdictions. Concerns were also raised regarding the legitimacy of the Authority’s regulation of entities subject to provincial regulatory oversight in non-Participating Jurisdictions.
Another commentator proposed that the regime should adopt an approach similar to that of other international regulators managing systemic risk, such as the U.S. Financial Stability Oversight Council, where the Authority would act mainly as a consultative and coordinating body of regulators, including regulators from non-Participating Jurisdictions and the Bank of Canada.
Given the scope of the proposed CMSA and PCMA, the number of changes from existing legislation and the number and breadth of comments, readers are cautioned that our Bulletins may not summarize all matters that may be of interest or concern to them. Readers are encouraged to consider reviewing the comments and draft legislation published on the Cooperative System website or contacting Blakes to discuss.
For further information, please contact:
Gordon McKenna       416-863-4017
Aaron Palmer             416-863-4227
or any other member of our Capital Markets group.
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Tags: Capital Markets, Financial Services

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