Reports on Observance of Standards and Codes

Canada and the IMF

Canada ROSC
I.  Banking Supervision
II.  Securities Supervision
III.  Insurance Supervision
IV.  Payment System
V.  Transparency of Monetary and Financial Policies

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REPORT ON THE OBSERVANCE OF STANDARDS AND CODES (ROSC)
Canada

  Queries/Comments  
   should be directed to:
   Director
   Western Hemishere Department
   700 19th Street, NW
   Washington, DC 20431
   202-623-7000
   http://www.imf.org
   scu-comment@imf.org
II.  Securities Supervision
 
Prepared by a staff team from the International Monetary Fund in the context of a Financial Sector Assessment Program (FSAP), on the basis of information provided by the Canadian authorities.

June 2000

Canada: Observance of the IOSCO Objectives and Principles of Securities Regulation1

This report provides an assessment of Canada's observance of and consistency with relevant international standards and core principles in the financial sector, as part of a broader assessment of the stability of the financial system. This assessment work by the IMF was undertaken under the auspices of the IMF-World Bank Financial Sector Assessment Program (FSAP) based on information up to October 1999. This has helped to place the standards assessments in a broader institutional and macroprudential context, and identify the extent to which the supervisory and regulatory framework has been adequate to address the potential risks in the financial system. The assessment has also provided a source of good practices in financial regulation and supervision in various areas.

2. The assessment covered (i) the Basel Core Principles for Effective Banking Supervision; (ii) the International Organization of Securities Commissions' (IOSCO) Objectives and Principles of Securities Regulation; (iii) the International Association of Insurance Supervisors' (IAIS) Supervisory Principles; (iv) the Committee on Payment and Settlement Systems' (CPSS) Core Principles for Systemically Important Payment Systems; and (v) the IMF's Code of Good Practices on Transparency in Monetary and Financial Policies. Such a comprehensive coverage of standards was needed as part of the financial system stability assessment for Canada in view of the increasing convergence in the activities of banking, insurance, and securities firms, and the integrated nature of the markets in which they operate. It should be noted that some of the standards are still in draft form, and some do not yet have a complete methodology to systematically assess compliance or consistency.2 This module was prepared in consultation with the Canadian authorities in the context of the IMF FSAP mission that visited Canada in October 1999, and constitutes a summary of the detailed assessments prepared by the mission. The summary was part of the Financial System Stability Assessment (FSSA) report that was considered by the IMF Executive Board on February 2, 2000, in the context of the IMF's Article IV consultation discussions with Canada.

3. The assessment of standards and codes draws on the self-assessments of the Canadian authorities, and on the field work undertaken October 11-22, 1999, based on a peer review process by Kai Barvll (Payment Systems, Sveriges Riksbank), Karl Driessen and Charles Siegman (Transparency Code, IMF), Alvir Hoffmann (Banking Supervision, Banco Central do Brasil), Rodney Lester (Insurance, World Bank), Michael Martinson (Banking Supervision, Board of Governors of the Federal Reserve System), Stefan Spamer (Banking Supervision, Deutsche Bundesbank), and Shane Tregillis (Securities, Australian Securities and Investments Commission). The expert team was coordinated by the IMF FSAP mission, led by V. Sundararajan, and comprised R. Barry Johnston, Karl Driessen, Haizhou Huang and Martin Cerisola. The assessment has been communicated to the authorities.

4. Overall, the assessment found a high degree of compliance that had contributed to a stable financial system. Minor deviations from Basel Core Principles of Effective Supervision were detected, which are addressed by proposals contained in the Policy paper.3 Full compliance with the Core Principles for Systemically Important Payment Systems was noted for the Large Value Transfer System. Canada is broadly compliant with all principles of insurance regulation, and is broadly consistent with IOSCO Objectives and Principles of Securities Regulation. The complexity of federal/provincial regulatory arrangements, oversight of mutual funds, and resource limitations on the enforcement capacity of some securities commissions are areas of concern that are being addressed. There is a high degree of consistency with the Code of Good Practices on Transparency in Monetary and Financial Policies. The more specific findings in the area of securities supervision are discussed below.

A. Background and Overview

5. The Canadian securities industry, consisting of the exchanges, securities dealers and mutual funds, is modern and undergoing rapid change. The Canadian Exchanges represent around 2 per cent of world market capitalization with the TSE, by far the largest securities exchange in Canada with 1433 listed companies and a market capitalization of Can$1.3 trillion at end-1998, accounts for 90 per cent of the value of shares traded on Canadian stock exchanges. Securities dealers are well capitalized. Mutual funds have been the fastest growing sector of the financial system in recent years reflecting changing investor preferences. Competitive pressures from the larger and more liquid US exchanges and alternative trading systems are forcing a significant restructuring of the exchanges and adaptation of the regulatory framework.

6. At its 1998 Annual Conference, the International Organization of Securities Commissions (IOSCO) adopted the Objectives and Principles of Securities Regulation, setting out 30 core principles of securities regulation, which could be used as a guide for supervisors of regulatory financial institutions dealing in securities trading. The principles are based on three fundamental objectives of securities regulation: (a) the protection of investors; (b) ensuring that markets are fair, efficient and transparent; and (c) the reduction of systemic risk.

7. Canada has a well developed general legal and securities regulatory framework which on the basis of the questionnaire response and review process undertaken is consistent in most significant respects with implementation of the IOSCO Objectives and Principles of Securities Regulation. The current review identified a number of outstanding issues relating to implementation of the Principles. In nearly all the areas where implementation issues have been identified, there are active reform initiatives underway or proposed by securities regulators in Canada. There is a general concern of adequacy of resources—in particular for securities commissions that are not yet self-funded—and the associated limitations on capacity for enforcement. Also, in the context of the federal/provincial regulatory structure and reliance on self-regulatory organizations (SROs), there are issues related to the clarity of roles and responsibilities, including the absence of a formal structure bringing together federal and provincial regulators.4 Current limitations on sharing of information with other regulators, to some extent due to the provisions of the Canadian Charter of Rights and Freedoms, are at odds with principles 11-13 on cooperation in regulation. There are also weaknesses in the adequacy of disciplinary procedures for auditors, and the level of compliance in the area of financial reporting and corporate disclosure. The rapid growth in mutual fund activity increases the relevance of several IOSCO principles, in particular those related to the governance requirements and oversight arrangements for mutual fund dealers. This has been addressed by the planned creation of the Mutual Funds Dealers Association, MFDA. In Quebec, the Bureau des Services Financiers will regulate the mutual fund intermediaries.

8. This section provides a summary of the main findings of a more detailed assessment of IOSCO Objectives and Principles of Securities Regulation. A tabular summary is provided in Table 1.

Table 1. Canada: Implementation of IOSCO Objectives and Principles 1/

Principles

Practice

FC 2/

BC 3/

NC 4/

Mat. NC 5/

Comments

Principles

Relating to the Regulator (1-5)

In general, there is clarity of roles, independence and accountability; and the regulators have adequate powers and capacity. There is a strong emphasis, often mandated in law, on the regulator adopting clear and consistent regulatory processes and there are requirements for the regulator and its staff to meet high professional standards.

 

X

   

There remain some residual issues as to clarity of roles of responsibilities in the context of the federal/provincial regulatory structure and reliance on SROs; the adequacy of the resources for those commissions that do not yet have self funding status; and the absence of any formal structure to bring together provincial securities and federal regulatory authorities.

Principles of Self-Regulation

(6-7)

There is a well-developed scheme of self-regulation. Where there is formal recognition of SROs, the SRAs have adequate powers to conduct oversight. There are clear recognition criteria consistent with the matters identified in the IOSCO Principles, and the securities commissions are developing a coordinated review program.

 

X

   

There are some issues about the differences in formal status and oversight arrangements for SROs among the provinces and territories.

The CSA is developing a national oversight program for SROs.

Principles for the Enforcement of Securities Regulation

(8-10)

The inspection, investigation, surveillance, and enforcement powers are generally comprehensive. Where the securities commission is structured as an administrative tribunal, the commission itself has the ability to make compliance orders and impose other sanctions.

 

X

   

The self funded SRAs are still in the process of reaching target levels in the enforcement area, and a number of the other SRAs are pursuing self funding status. In a number of jurisdictions, the securities commission cannot impose fines or recover the costs of an administrative proceeding.

Principles for Cooperation in Regulation (11-13)

The major Canadian SRAs have information-sharing memoranda of understanding with a number of foreign regulators and share information informally with others.

 

X

   

    There are limitations on the sharing of information with other regulators. Some provinces currently have proposed legislative amendments designed to address some of these limitations.

Principles for Issuers (14-16)

There are comprehensive standards for full, timely, and accurate disclosure of information to investors, and there is a comprehensive liability regime for prospectuses. The rules for change of control transactions are based on the treatment of security holders in a fair and equitable manner. The accounting standards enforced by the SRAs are comprehensive and based on GAAP.

 

X

   

    Two remaining issues are the adequacy of the disciplinary procedures for auditors and level of current real compliance and enforcement activity in the area of financial reporting and corporate disclosure.

Principles for Collective Investment Schemes

(17-20)

There is a comprehensive regime for product disclosure, distribution, and safekeeping of mutual fund assets established by national policies and instruments that operate throughout Canada. The rules also regulate redemption and valuation issues and restrict transactions between related parties. The current regime is currently being revised following extensive consultation. Moreover, a self-regulatory organization for mutual fund dealers is in the process of being established.

 

X

   

There are no requirements relating to the structure or governance of the manager, although there are restrictions on related party transactions and an obligation to use a qualified custodian.

Principles for Market Intermediaries (21-24)

There are detailed registration requirements for intermediaries. There is an active oversight program for intermediaries. The Canadian Investor Protection Fund (CIPF) provides a compensation scheme for customers. The CIPF, in conjunction with the SROs, has established national standards and reviews each SRO's examination process and conducts reviews of individual members on a rotational basis. An active monitoring and review process for intermediaries includes an early warning system for the financial condition of members. The Canadian Depository for Securities Limited (CDS) and CDCC have extensive risk management and well-defined default procedures in place.

 

X

   

In some jurisdictions, some dealers are not subject to any systematic compliance review activities by a regulatory authority. This is currently being addressed by the formation of the Managed Funds Dealers Association and proposals that all dealers belong to an SRO.

Principles for the Secondary Market (25-30)

The SRAs have broad oversight powers in relation to exchanges and secondary markets. The SRAs have the power to review any changes in rules or by Laws of the exchanges. The exchanges have an active process of market monitoring and the clearinghouses have well-developed risk management and default procedures in place.

X

       
1/ IOSCO has not yet endorsed an assessment methodology in relation to the Objectives and Principles for Securities Regulation.
2/ FC: Fully compliant
3/ BC: Broadly compliant
4/ NC: Non-compliant
5/ Mat. NC: Materially non-compliant

B. Assessment of IOSCO Principles

Principles 1-5
Relating to the regulator: (1) clarity of responsibilities; (2) independence and accountability; (3) powers and resources; (4) regulatory process; and (5) professional standards.

9. The responsibilities and mandates of the provincial securities regulatory authorities are clearly stated in the legislation and other public documents. The regulators have wide-ranging functions and powers under statute, including in some cases, extensive rule-making powers. The responsibilities and relationships between securities regulatory authorities (SRAs) and other parts of the regulatory structure, such as SROs, are governed by a range of mechanisms including statutes, formal agreements, conditions attached to recognition criteria and a variety of informal arrangements.

10. The Canadian Securities Administrators (CSA) provides a structured forum for cooperation among provincial securities regulators where there appears to be well-developed formal and informal arrangements between the SRAs, SROs and other participants. The Joint Forum of Financial Market Regulators involving the CSA, the Canadian Council of Insurance Regulators (CCIR) and the Canadian Association of Pension Supervisory Authorities has also been formed to promote greater cooperation amongst market regulators.

11. Self-funding has improved the capacities of the five largest securities commissions, including in some cases, their ability to retain and attract high quality staff, increase their resources devoted to compliance, and upgrade their enforcement activities. Currently, however, these commissions remain below their target level of overall resources. Despite increased funding, the ability of some commissions to attract experienced, skilled staff remain constrained by limitations on employment conditions.

12. Assessment: The regulatory system is broadly consistent with implementation of the IOSCO principles for clarity of roles, and independence and accountability; and securities regulators have adequate powers and capacity. Some issues remain in relation to: (i) the clarity of roles of the federal/provincial regulatory structure and reliance on SROs; (ii) the adequacy of their resources for those commissions that do not yet have self funding; and (iii) the lack of any formal structure to bring together provincial securities and federal regulatory authorities.

Principles 6-7
Relating to self regulation: (6) use of self-regulatory organizations; and (7) SRO oversight and standards.

13. The Canadian system has a well-developed scheme of self-regulation, and places considerable reliance on SROs. Where there is formal recognition of SROs, the SRAs have adequate powers to conduct oversight. There are clear recognition criteria consistent with the matters identified in the IOSCO Principles, and the securities commissions are developing a coordinated review program.

14. Assessment: The Canadian regulatory system is broadly consistent with the implementation of IOSCO principles in this area, although there are some issues about the differences in formal status and oversight arrangements for SROs among the provinces and territories.

Principles 8-10
Relating to the enforcement of securities regulation: (8) inspection powers; (9) enforcement powers; and (10) effective compliance program.

15. While there are differences between the legislative provisions across the provinces and territories, the inspection, investigation, surveillance, and enforcement powers are generally comprehensive. Where the securities commission is structured as an administrative tribunal, the commission itself has the ability to make compliance orders and impose other sanctions. In a number of jurisdictions, the commission cannot impose fines or recover the costs of an administrative proceeding.

16. Assessment: The Canadian regulatory system is broadly consistent with implementation of the relevant IOSCO principles, although some issues about the adequacy of enforcement resources for some SRAs remain.

Principles 11-13
Relating to cooperation in regulation: (11) information sharing authority; (12) information sharing mechanisms; and (13) assistance to foreign regulators.

17. Information sharing between securities commissions in Canada is conducted informally at the operational level. In addition, a number of agreements with foreign securities regulators have been entered into. Memoranda of Understanding have been created to establish mechanisms of information sharing, including between several securities commissions and OSFI.

18. Assessment: Current limitations on the sharing of information with other regulators, resulting from constitutional protections, freedom of information legislation, and privacy legislation, are not fully consistent with implementation of the relevant IOSCO Principles. In Quebec and Ontario there are currently proposals to deal with some of these issues.

Principles 14-16
Relating to issuers:(14) disclosure of material information; (15) fair treatment of holders of securities; and (16) accounting and auditing standards.

19. National policies and instruments establish comprehensive standards for full, timely, and accurate disclosure of point of sale, periodic and other information to investors in the Canadian system, and there is a comprehensive liability regime for prospectuses. The SRAs actively review prospectus documents before a distribution can commence; they also have the power to prevent the issue of a prospectus into the market by not granting a receipt or ordering a cease in trading. Exchange rules and securities regulations require material information to be provided to the market. The SEDAR system allows prospectus and other disclosure documents to be lodged and made available to the public electronically.

20. The rules for change-of-control transactions are based on the treatment of security holders in a fair and equitable manner. There are general protections in corporate and securities law designed to prevent any discrimination against minority shareholders.

21. The accounting standards enforced by the SRAs are comprehensive-based on generally accepted accounting concepts-and are comparable to financial reporting standards in other major jurisdictions.

22. Assessment: The Canadian regulatory system is consistent with implementation of the IOSCO principles for issuers in most significant respects. The two issues were the disciplinary procedures for auditors and the level of current compliance and enforcement activity in the area of financial reporting and corporate disclosure. The nature of the review did not allow a conclusive view on either issue to be reached.

Principles 17-20
Relating to collective investment schemes: (17) eligibility and regulation standards; (18) rules on form and structure, segregation and client asset protection; (19) disclosure for suitability and value of investor's interest; and (20) asset valuation, pricing, and redemption.

23. The mutual funds industry is a rapidly growing segment of the retail financial market in Canada. There is a comprehensive regime for product disclosure, distribution, and safekeeping of mutual fund assets established by national policies and instruments that operate throughout Canada. The rules also regulate redemption and valuation issues and restrict transactions between related parties. The current regime is currently being revised following extensive consultation. Moreover, a self-regulatory organization for mutual fund dealers is in the process of being established.

24. Assessment: The Canadian regulatory system is broadly consistent with the relevant IOSCO principles. In Canada, product and distribution activities of mutual funds are regulated rather than the fund manager. There are no requirements relating to the structure or governance of the fund manager, although there are restrictions on related party transactions, an obligation to use a qualified custodian to hold fund assets and general fiduciary obligation. The IOSCO principles are not explicit in this area, but the Canadian system does differ from most major jurisdictions in this respect. Although there is a legislated standard of care for mutual fund managers, the lack of explicit governance requirements for mutual fund managers is an issue.

Principles 21-24
Relating to market intermediaries: (21) minimum entry standards; (22) capital and prudential requirements; (23) standards for internal organization and operational conduct; and (24) procedures for dealing with failure of market intermediary.

25. There are detailed registration requirements for intermediaries that establish minimum entry standards, including those on financial and liquidity matters. There is an active oversight program for intermediaries, which includes annual renewal of registration, comprehensive monitoring of financial and capital standards, and regular compliance inspections. The Canadian Investor Protection Fund (CIPF) provides a compensation scheme for customers of up to $1 million in the case of insolvency of a member.

26. The CIPF, in conjunction with the SROs, has established national standards covering capital, liquidity, insurance, internal controls, customer asset segregation and a range of other matters. While the primary responsibility for compliance reviews of members rests with the relevant SRO, CIPF annually reviews each SRO's examination process and conducts reviews of individual members on a rotational basis. An active monitoring and review process for intermediaries includes an early warning system for the financial condition of members. The Canadian Depository for Securities Limited (CDS) and Canadian Derivatives Clearing Corporation (CDCC) have extensive risk management and well-defined default procedures in place that are consistent with good practice in this area.

27. Assessment: The Canadian regulatory system is broadly consistent with implementation of the relevant IOSCO principles. Although a number of gaps in oversight arrangements remain, these are currently being addressed by the formation of the Managed Fund Dealers Association and proposals in several provinces that all dealers be required to belong to a SRO.

Principles 25-30
Relating to the secondary market: (25) authorization and oversight of trading systems; (26) ongoing regulatory supervision of trading systems; (27) transparency of trading; (28) manipulation and other unfair trading practices; and large exposures, default risk, and market disruption; and (30) oversight of clearing and settlement systems.

28. The SRAs have broad oversight powers in relation to exchanges and secondary markets. The SRAs have the power to review any changes in rules or by-laws of the exchanges. The exchanges have an active process of market monitoring and the clearing houses have well developed risk management and default procedures in place. While the securities commission routinely reviews changes to exchange rules and by-laws, a more general program reviewing exchange regulatory activities is a new development. The OSC has only recently established an infrastructure for exchange oversight and has commenced such a review of the Toronto Stock Exchange (TSE). In British Columbia, the British Columbia Securities Commission has reviewed the Vancouver Stock Exchange in the last few years.

29. Assessment: The Canadian regulatory system is broadly consistent with implementation of the relevant IOSCO principles.


1 The work of the mission was coordinated by an FSAP team led by Mr. V. Sundararajan (IMF). Mr. Shane Tregillis (Australian Securities and Investments Commission) was the principal contributor to this module.

2 The Basel Core Principles were issued in September 1997; a Core Principles Methodology was released in October 1999 by the Basel Committee on Banking Supervision. The Code of Good Practices on Transparency was adopted by the Interim Committee in September 1999; work on a supporting document is in progress. The IOSCO Objectives and Principles were issued in September 1998, and a detailed self-assessment methodology is being developed. A draft of the Core Principles for Systemically Important Payment Systems was issued for public comment in December 1999. The IAIS Insurance Supervisory Principles were issued in September 1997; a self-assessment program has been developed to assist member countries in evaluating compliance.

3 Department of Finance, Canada (1999), "Reforming Canada's Financial Services Sector: A Framework for the Future," June 25.

4 OSFI and the provincial securities regulators have formal information sharing arrangements and there are informal consultation and liaison arrangements involving provincial securities regulators, OFSI, and the Department of Finance. These include six-monthly informal discussions between the Superintendent of Financial Institutions and CSA, as well as regular liaison meetings between Finance and securities regulators. Informal liaisons on policy issues occur on an ongoing basis.

 

I. Banking Supervision        Canada ROSC         III. Insurance Supervision

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