Self-regulatory Organization Challenges

Transcription

1 Autorregulador del Mercado de Valores Five years of AMV Self-regulatory Organization Challenges Susan Wolburgh Jenah President and Chief Executive Officer Investment Industry Regulatory Organization of Canada July 13, 2011 Club El Nogal - Bogotá, Colombia Check against delivery.

2 Good morning. Thank you for that kind introduction. And thank you Carlos for the invitation to join you in celebrating the fifth anniversary of the AMV in Colombia. This morning I would like to talk about the role that IIROC, the Investment Industry Regulatory Organization of Canada, plays in securities regulation in Canada. I would also like to talk about some of the challenges we have and are addressing. Many of these challenges are being faced by regulators around the world and I am sure will be familiar to you. IIROC s Role IIROC is a national SRO. Our mandate is to establish and enforce regulatory and investment industry standards, protect investors and strengthen market integrity while maintaining efficient and competitive capital markets. We set, monitor and enforce rules regarding the business and financial conduct of all investment dealers in Canada as well as proficiency standards governing individual registered representatives. We also regulate trading activity on Canada s 3 equity exchanges and 7 alternative trading systems. We carry out our responsibilities under the oversight of the Canadian Securities Administrators (the CSA), Canada s provincial and territorial securities regulators. With a staff of 400 in four offices across Canada (Toronto, Vancouver, Calgary and Montreal), we oversee 212 member firms (investment dealers and ATSs), with approximately 28,000 registered employees in 5,900 head and branch offices across Canada. As a market conduct regulator, we set standards for the handling of client accounts and undertake compliance reviews (financial, business conduct, surveillance and trade desk) to ensure that member firms have appropriate procedures in place and are properly supervising the handling of client accounts. As a prudential regulator, we monitor the financial safety and soundness of member firms to ensure they have sufficient capital for the nature and volume of their business activities and that client assets are protected in the rare event of a firm insolvency. We, of course, have an investor protection mandate. We investigate complaints against dealer firms or other market participants and, when appropriate, we take disciplinary action. We require all of our regulated firms to participate in a free dispute resolution Ombuds service (known as OBSI), as well as an independent arbitration program, both of which are accessible, at the option of the client, to resolve disputes between a client and his or her advisor. Recent events the global financial crisis prompted by the U.S. subprime mortgage failure; high profile financial failures like Lehman Brothers and AIG; and a number of 1

3 frauds and Ponzi schemes have all raised the profile of capital markets and not in a positive way. 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 focused 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. Just over 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. Key Challenge building investor confidence Investor trust and confidence in the capital markets has been sorely tested over the past three years. I believe, and I am sure others in the audience share the view, that Self-Regulatory Organizations have a critical role to play in re-building trust and confidence in capital markets. IIROC, and other SROs such as the AMV, have strong lines of communication with industry participants and with other securities regulators nationally and internationally. We are in a strong position to implement necessary regulatory reforms and re-shape the way that business is conducted. This morning I d like to share some examples where IIROC has leveraged its role as a national SRO to contribute to the process of re-building confidence in the markets in Canada. Advisor and Firm Regulation Complex product innovation has posed challenges for regulators, investors and the industry as a whole. 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. 2

4 Knowing your client and knowing your product are the foundation for making suitable recommendations. We provided regulated 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. We are also nearing finalization of the Client Relationship Model 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, strengthen conflict management standards, improve disclosure of account opening information and advisor/firm compensation practices, and provide account performance information. We expect to adopt the proposal this year with staged implementation. Fair, timely and consistent treatment of client complaints by IIROC regulated firms is key to earning and maintaining investors confidence in the financial services industry. We have introduced a complaint handling framework with clear standards and timelines for firms to acknowledge, investigate and respond to client complaints. The result has been a dramatic improvement in the timely disposition of client complaints at our member firms. 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 helps to foster 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. It is time to focus more of IIROC s regulatory resources on the large and growing fixedincome market in Canada. 3

5 Recent statistics show that approximately a quarter of retail client assets entrusted with investment dealers in Canada is invested in fixed-income securities. Statistics also 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 approval of the securities commissions. 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. Enforcement As I mentioned previously, one important role we play as part of our investor protection mandate is the investigation of complaints and the prosecution of alleged wrongdoing. As an SRO, our disciplinary powers are based on the contractual relationships that we have with member firms and the approved persons that work at these firms. We are the front line regulator for regulated firms and the trading that takes place on the equity marketplaces. However, we do not directly oversee other important market participants such as issuers or portfolio managers (unless they also operate as investment dealers). Where we become aware of questionable activity by some of these entities and individuals through the oversight of IIROC regulated firms, we work closely with the securities commissions to ensure that inappropriate activity is properly addressed. We also continue to build our relationships with regulators outside of Canada. We regularly exchange knowledge and information with our counterparts in countries around the world through MOUs and through our participation in the Intermarket Surveillance Group. As regulators, it is important that we have policies and processes in place for cross-border cooperation to ensure that individuals who seek to defraud investors are not able to take refuge behind borders. Marketplace Regulation The pace of change in our equity markets has been 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. 4

6 Not so long ago virtually all equity trading in Canada took place on the TSX and TSX Venture exchanges. Today, trading takes place on ten different marketplaces, including three equity exchanges and seven Alternative Trading Systems (or ATSs). Other marketplaces are also seeking approval to operate, so this number will likely grow in the coming months. These multiple markets are characterised by higher volumes, faster trading, complex products, new trading strategies, more sophisticated technologies and greater volatility. Some examples follow. Market Surveillance Challenges Trades have doubled in the past two years. Last year, IIROC monitored over 350 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 market regulators like IIROC is to continuously search for more costeffective ways to ensure that trading rules and market oversight 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. Although Canadian equity trading is 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 unique strength. 5

7 STEP Of course, cross market monitoring and analysis wasn t necessary when the TSX and TSXV made up virtually 100% of equity market volumes. With multiple equity market trading venues now operating in Canada, we have 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 through a single portal, enabling 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. May 6 Flash Crash 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 review or identify the factors that led to the events of May 6 th without the consolidated view that STEP provides. We made five recommendations including a proposal to implement single-stock circuit breakers that would trigger a brief trading halt in a particular security after shortterm price changes beyond a certain threshold. This is a measure we are able to implement fairly immediately. In the meantime, we will continue to monitor other approaches such as a Limit Up-Limit Down model as 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 otherwise deemed to be unreasonable. 6

8 Most recently, we issued proposals for comment regarding the establishment of an updated framework for regulating short selling. With our colleagues at the provincial securities commissions, IIROC is also examining developments related to dark pools and the role they play in today s market. In November, 2010, we jointly issued proposals for comment relating to the regulatory framework for Dark Pools and Dark Orders. Several proposals were outlined in the position paper including the proposal that only orders which meet a minimum size threshold should be exempted from the pre-trade transparency requirements imposed on market places in Canada. In addition, we recommended that meaningful price improvement be required in certain circumstances and that generally visible orders should be executed before Dark Orders at the same price on the same marketplace. Our objective is to promote transparency and price discovery and enhance fair and equal access to liquidity for all investors while, at the same time, recognizing the legitimate role that Dark Pools play in facilitating the execution of large orders. High-frequency trading has also been a topic of great interest of late. We are monitoring the scope of algorithmic and high-frequency trading to better understand their impact on the Canadian marketplace. Meeting the Challenges 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. We are also aware that building trust and confidence in capital markets depends on stakeholders having trust and confidence in IIROC as a SRO with important responsibilities. We are therefore 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. 7

9 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. A critical challenge we all face is to allow innovation and competition, while ensuring that our policies and rules support fair, accessible and open markets. These are the key principles that drive policy and rule making. Finding and maintaining this balance has never been more challenging. In the end, regulation alone cannot rebuild and maintain investors trust in the financial system. SROs must continue to focus their efforts on ensuring that industry leaders adopt the right tone at the top and encourage a strong and ethical corporate culture. This is critical to re-building trust and confidence in the financial services industry. Thank you for inviting me to join you here today. 8