IIROC s Regulatory Agenda: Market and Dealer Regulation

Transcription

1 The Canadian Institute s 21 st Annual Securities Superconference Securities Regulation & Compliance Navigating New Rules across Canada and the U.S. IIROC s Regulatory Agenda: Market and Dealer Regulation Susan Wolburgh Jenah President and Chief Executive Officer Investment Industry Regulatory Organization of Canada Thursday, April 7, 2011 Check against delivery.

2 Good morning. Thank you for that kind introduction. I appreciate the opportunity to share with you some observations about the state of the industry and markets and highlights of IIROC s regulatory agenda as we begin our new fiscal year. Over the years, I cannot recall a more challenging, faster-paced environment. This applies to both dealer and market regulation. Each year at this time, we update our Strategic Plan to identify new trends we should address, new strategies to enable us to deliver against our organizational goals and specific areas we should be focused on. In fact, our revised Plan will soon be posted on our web site. There is a common theme that runs through our priorities, operations and policy initiatives to ensure that industry standards are fair and robust. This is essential to building confidence and trust in the capital markets. This trust has been sorely tested in the past three years. While recent events in the global capital markets have shown that the Canadian regulatory and supervisory framework for financial institutions was effective and well managed, investor confidence was shaken. Canada cannot afford to be complacent in the face of global financial market reforms. Almost three years ago, we experienced unprecedented market turmoil, variously described as a liquidity crisis, a credit crisis and, fundamentally, a crisis of confidence. Since that time, regulators and market participants in Canada and abroad have pursued a variety of measures to shore up a global system which as a whole was dangerously under-capitalized and over- leveraged, and one in which new, complex and often poorly understood products proliferated. Less than one year ago, investors experienced the unfortunate events known as the May 6th Flash Crash. Some hoped the cause was a fat finger or similar order entry error. The explanation both in the U.S. and in Canada was not that simple. This very brief but very severe drop in prices in the US and Canadian markets dramatically underscored the increased volatility that is inherent in today s multi market environment and raised concerns about market stability and reliability. This morning I would like to tell you what we have been doing to address the fallout from these historic events and to enhance confidence in our capital markets. Complex product innovation has posed challenges for regulators, investors and the industry as a whole. 1

3 The advisor s obligations in the current regulatory environment are clear: they must take appropriate steps to know their client and to understand the risks of the products they recommend in order to ensure that they are appropriate for the clients needs and circumstances. Knowing your client and knowing your product are the foundation for making suitable recommendations. Last year we provided dealer firms with guidance and best practices on the introduction and supervision of new products. We continued this compliance focus on new product due diligence by providing guidance on leveraged and inverse traded funds; know your client and suitability obligations; and the distribution of non arms length products. This year we will implement a new approach to tracking and testing for suitability issues in our compliance reviews of dealer firms. In the aftermath of the global credit crisis, policy makers and regulators have also been considering how to address gaps that create an unlevel playing field and which expose markets and investors to systemic risk. These discussions have focussed on redefining the perimeters of regulation, including how to define and effectively oversee significant market sectors, activities and practices which have grown in scope and importance over the past couple of decades. In recent years, attention has been focussed on issues relating to retail investor participation in equity markets. More recently we have seen greater scrutiny of the over -the -counter derivatives markets. I believe that it is time to focus more of our regulatory resources on the large and growing Canadian fixed-income market. Recent statistics show that approximately a quarter of retail client assets entrusted with investment dealers in Canada is invested in fixed-income securities, according to the Investment Industry Association of Canada. Statistics from CDS Clearing and Depository Services Inc. reveal the value on deposit in the Canadian debt market stands at more than $2.1 trillion, compared to $1.6 trillion in the equity market. We have finalized our new fair pricing rule for fixed-income and other over-the-counter securities which awaits CSA approval. The rule sets out standards for firms to ensure that prices paid or received by clients are fair and reasonable. It will improve our ability to conduct oversight and enforce compliance with clearly articulated, principle-based standards. We are developing a plan for effective surveillance and risk-based oversight of Dealer members trading activity and sales practices in the fixed income market. 2

4 We have advanced the Client Relationship Model proposal aimed at strengthening investor protections in the critical client/advisor relationship. CRM builds on the current statutory duty of loyalty - to deal fairly, honestly and in good faith - owed by registrants to their clients. CRM will enhance current suitability requirements, give more definition to existing conflict management standards, provide clients with better disclosure of account opening information and advisor/firm compensation practices, and provide new account performance information. We expect to adopt the proposal this year. These initiatives will contribute to building investor confidence and trust. Fair, timely and consistent treatment of client complaints by IIROC regulated firms is also key to earning and maintaining investors confidence in the financial services industry. Last year we introduced a complaint handling framework with clear standards and timelines for firms to acknowledge, investigate and respond to client complaints. Through our compliance review program, we will be reviewing member firm practices to assess compliance with these new standards. We have also begun a restructuring of our internal public complaint intake and resolution process so that we can better respond to investors and other stakeholders when they have a complaint or inquiry. Investor access to a timely and accessible dispute resolution system fosters confidence in capital markets. We have recently revised our arbitration program which all member firms must participate in for the benefit of their clients. We undertook improvements in operations and reporting, increased the award limit from $100,000 to $500,000 and removed a major deterrent to participation by allowing clients to waive the awarding of legal costs. We are now monitoring the results to see if more clients of our member firms opt for arbitration to resolve disputes. Now let me turn to marketplace regulation, where the pace of change is dramatic, bringing with it challenges for investors, the marketplaces, industry participants and regulators alike. The events of May 6th served as a catalyst for broader debate about marketplace structure, trading activity and the reliability and stability of our equity trading venues. Technology, innovation and competition have transformed equity trading in Canada. 3

5 Not so long ago virtually all equity trading in Canada took place on the TSX and TSX Venture exchanges. Today, trading takes place on nine different marketplaces, including three equity exchanges and six Alternative Trading Systems (or ATSs). These multiple markets are characterised by higher volumes, faster trading, complex products, new trading strategies, more sophisticated technologies and greater volatility. Let me provide some examples. Trades have doubled in the past two years. Last year, IIROC monitored over 262 million trades. The advent of algorithmic trading programs and high frequency trading strategies is also driving an explosion in the number of daily trading messages (message traffic includes orders, quotes, and cancellations, in addition to trades.) Today IIROC monitors on average some million messages a day. Four years ago that number was 10 million. Speed of trading today is measured in milliseconds and there is a technological race to offer even faster trading to reduce latency and secure a competitive edge. The challenge for regulators like IIROC is to continuously search for more cost-effective ways to ensure that trading rules and market surveillance keep pace with a fragmented equity-trading environment and a fundamentally changed electronic trading reality. Canada s market regulation framework provides some unique regulatory advantages. In the US, trading and regulatory oversight is split among 16 public exchanges, more than 30 dark pools, three electronic communication networks and more than 200 internalizing broker dealers. Although Canadian equity trading is also dispersed across multiple trading venues, monitoring oversight of the trading activity on all equity marketplaces is centralized through IIROC. Part of our mandate is to ensure compliance with a single set of market integrity rules which address, among other things, best execution and client priority, market manipulation, and front running. In today s rapidly evolving, high tech and fast moving environment, Canada s consolidated and centralized oversight of trading activities on multiple markets and one set of market integrity rules is a strength which is virtually unique to Canada. 4

6 As you will appreciate, cross market monitoring and analysis wasn t necessary when the TSX and TSXV made up virtually 100% of equity market volumes. We made investment in technology a key priority for IIROC. We created STEP, the Surveillance Technology Enhancement Platform. This new surveillance system includes direct regulatory feeds from all Canadian equity marketplaces and combines them, for simultaneous surveillance, into a single virtual marketplace, allowing us to conduct intra and cross market surveillance and analysis. STEP helps us keep pace with the dramatic increase in volume and speed that I described earlier. This single and complete picture of trading activity is a huge step forward towards more efficient and cost effective market oversight. The benefits were demonstrated in the aftermath of the May 6th Flash Crash. (We launched STEP on May 5th so this was the ultimate stress test.) We conducted a thorough review of the unexpected events of that day. We issued a comprehensive report with practical recommendations designed to help mitigate volatility and enhance the reliability and stability of markets. It would have been extremely difficult for us to have conducted this important review without the consolidated view that STEP provides. We have followed up on virtually all of our findings and recommendations including a proposal to implement single-stock circuit breakers that would trigger a brief trading halt in a particular security after short-term price changes beyond a certain threshold. This is a measure we are able to implement fairly immediately even as we consider other approaches such as a Limit Up-Limit Down model as recently proposed in the U.S. to replace single stock circuit breakers. We also issued guidance to dealer firms and investors on the appropriate use of certain order types in particular, stop loss market orders in this fast-paced, multi-market environment. And we published for comment IIROC s practices with respect to trade cancellation and/or variation when transactions are deemed to be in violation of trading rules or appear to be unreasonable. Most recently, we issued proposals for comment regarding the establishment of an updated framework for regulating short selling. 5

7 As market structure evolves, IIROC will continue to support the work of the Canadian Securities Administrators and consult with investment industry stakeholders to assess current and emerging market structure issues including dark pools, dark orders, broker preferencing and direct market access. We and the CSA will also continue to monitor the scope of algorithmic and high frequency trading to better understand their impact on the Canadian marketplace. * * * This morning, I have outlined how robust regulation of Dealer firms, their registered representatives and advisors contributes to investor protection and confidence in the securities industry. I have also discussed the ever-increasing importance of effectively responding to changes in the marketplace in order to maintain confidence in its integrity. But there is another factor to consider. We are very much aware that building trust and confidence in capital markets also depends on stakeholders having trust and confidence in us as a self-regulatory organization. Here are some of the ways we are working toward that goal. We are committed to attracting and developing the specialized knowledge and expertise necessary to respond to new issues and to refine existing approaches. We have extended the scope of our policy consultation process to be more inclusive of various stakeholders. Transparent and inclusive policy making helps to ensure more meaningful stakeholder input and results in better regulatory outcomes. We are leveraging technology to help us deliver expert and cost-effective regulation and keep pace with innovation in the marketplace. While STEP is perhaps the most obvious example, our investments in strategic information technology are also integral to our compliance and enforcement activities. We are working hard to build trust and confidence both in IIROC and the industry we regulate. Thank you for the opportunity to speak with you this morning. I would be happy to take questions. 6