Jim Flaherty Wants National Market Regulator

Jim Flaherty Wants National Market Regulator

Just days before releasing the most important budget of his career, Finance Minister Jim Flaherty still found time to work on what has become his own personal crusade. With Parliament Hill consumed by both election speculation and the standoff between the Conservatives and Liberals over Afghanistan, Flaherty quietly named a panel, to be led by Tom Hockin, a former president of the Investment Funds Institute of Canada, and tasked it with recommending how to improve Canada's archaic system for policing the markets. Though it didn't explicitly say so, the panel's real mandate is much more controversial: lay the groundwork for legislation to set up a single national market regulator - one that would save business the time, money and headaches of operating under a multitude of different provincial rules and that might finally wash away Canada's international reputation as a haven for scammers, hucksters and sleazy businessmen. Just as importantly, Flaherty has now nudged Ottawa one step closer to a major showdown with the provinces - a feud that may define his legacy in politics, for better or for worse.

Last week, the notion that Flaherty might succeed in this seemed remote to many on Bay Street. Flaherty spent the better part of his summer and fall raging against the nation's 13 different regulators, calling the system everything from fragmented to an "embarrassment." If his intention was to shame them into accepting a national regulator, it backfired. The provinces and territories are dead set against ceding control of their regulatory fiefdoms to Ottawa, or worse yet, the powers that be on Bay Street in Toronto. Flaherty may have fired up the passions of investor advocates, who've long demanded a national regulator, but on this issue, relations between Ottawa and the provincial capitals have never been worse. Asked last week if there was any chance a deal might be struck, Quebec Finance Minister Monique Jérôme-Forget was unequivocal. "Never. Is that clear?"

But the naming of the panel confirmed what those close to Flaherty have been saying for months: that he is girding for a fight and is committed to doing whatever it takes to ram through provincial objections and create a regulator capable of shoring up confidence in Canada's capital markets. Flaherty is said to have been studying the constitutional law on the subject, and is convinced that Ottawa has a legal right to regulate the markets. He has made it clear that he does not want a convoluted, academic report. The expectation is for a quick eight-month study that will lay out exactly what a single regulator should like look and how it will work.

Still, amid all the tough talk in Ottawa and intransigence among the provinces, industry observers say that a historic bargain may yet be in the cards - one that might avoid a messy confrontation and still manage to bring Canada into the big leagues of financial regulation.

Last week's report from the INTERNATIONAL MONETARY FUND landed as an embarrassing yet familiar rebuke of Canada's capital markets, like a schoolmarm scolding a slow-learning, disobedient child. In an otherwise glowing review of the country's banking sector, the IMF criticized the "weak" criminal enforcement of markets here and the need for a single regulator capable of tackling increasingly complex investigations into sophisticated cases of financial chicanery. The message was nothing if not familiar - these criticisms have been around for 75 years now. Time and again, independent reviews and experts have said the same thing - Canada's patchwork system needs to be more efficient and better policed. As a former governor of the Bank of Canada, David Dodge, famously described it, Canada has a reputation for being the "Wild West" of the world's financial markets, and the endless debate over how to reform the system has put Canada far behind international financial standards. "While we talk about it, the world is overtaking us," says Edward Waitzer, a former head of the Ontario Securities Commission and lawyer at Stikeman Elliott in Toronto.

The long list of high-profile scandals, from Bre-X and Nortel to dozens of smaller scams over the years, has given foreign investors plenty of reason to suspect Canada's patchwork system lacks the heft and the resources to fight white-collar crime. Critics say it's like relying on a dozen small sheriff's departments to prosecute sprawling crimes that sometimes play out all over the world. But provincial regulators argue their system isn't nearly so flawed as it's made out to be. Donne Smith, chairman of the New Brunswick Securities Commission, is one of the more passionate defenders of the status quo. "We know the geography," he says. "We know the people and the challenges of entrepreneurs and businesses here." Why, critics ask, hand control over to a big national organization that only understands Bay Street?

Where previous governments have looked at this impasse and opted to steer clear, Flaherty is the first finance minister to tackle it head-on. His first big leap into the murky waters of securities regulation came last June, when he summoned the provinces to a meeting at Meech Lake. Perhaps the choice of setting should have been a harbinger of the meeting's doomed agenda. All the provinces save for Ontario were adamantly opposed to Flaherty's plan. But the minister would not be easily dissuaded.

Less than two weeks later, Flaherty appeared at a conference at the University of Toronto and delivered one of the most biting criticisms ever by a public official. "There is a perception that Canada's system is not performing as it should," he said. "That too many breaches of rules are not being prosecuted in Canada." If nothing else, Flaherty's blunt and consistent message has convinced many on Bay Street that he's sincere. "I think he's very well-meaning and very serious and committed to it," says Purdy Crawford, a lawyer with Osler, Hoskin and Harcourt, who chaired a 2003 study advocating a common regulator.

What remains less clear is just how much support he has from his boss, Prime Minister Stephen HARPER. There is little political currency in the issue - for the average Canadian, talk of securities regulation is more a cure for insomnia than something to take to the streets in protest over. And it hardly ranks as a subject over which a government would want to open a constitutional war with the provinces. But Finance officials insist it is a key element in Ottawa's plan to stake out a bigger position of leadership over the economy and capital markets. "There's a very solid recognition at the highest levels that this matters and has to be dealt with," says a senior Finance official, who spoke on the condition his name not be used. Even opponents of the idea acknowledge the seriousness of the push. Says Quebec's Jérôme-Forget, "I'll be very blunt. I think Ottawa wants to be involved, wants to take over."

And if Ottawa does want to take over, there are plenty of constitutional experts who believe it has the authority to make it happen. This scenario was looked at by the Wise Persons' Committee in 2003, which studied the constitutionality of such a move. Three prominent law firms concluded it could be done. Under the Constitution, the federal government has the power to oversee trade and commerce. And in the event federal law conflicts with provincial legislation, federal law prevails. Still, the courts have recognized for decades the provinces' jurisdiction in this area and there's no clear precedent to strip them of such powers. Experts say a fight over a national regulator wouldn't be easily resolved. In fact, it would likely have a steep political and economic cost, for which there is little appetite these days. "There'd be a fight, a lot of market uncertainty, a lot of market dislocation," says Ian Russell, president of the Investment Industry Association of Canada. "We have enough to contend with in the capital markets right now." Few are convinced that Ottawa would go to such lengths anyway. Within the finance industries, there is a pervasive sense of fatigue and defeatism surrounding a national regulator. "It's hard to argue against doing another study, but it doesn't get us over the barriers," says Waitzer.

A more likely endgame is that Flaherty will use the panel's results as a strong bargaining tool to somehow hammer out a deal with the provinces. The two sides are, in the end, closer together than they appear to be. In recent months, all of the provinces and territories except Ontario, which supports a common regulator, have been working on their own reforms, called Passport, to streamline their rules and regulations. The agreement, which takes effect on March 17, is widely seen as a huge step forward - an acknowledgement from the provinces that things need to change. Among Flaherty's allies it's being viewed as a stepping stone toward a common regulator. While the provinces and territories argue that Passport makes a national regulator unnecessary, without the support of Ontario, which has by far the biggest and most important securities regulator in the country, it is no panacea. "The reality currently is that practically speaking, the Ontario Securities Commission is the dominant regulator in Canada," says Janet Salter, a securities lawyer at Osler who worked on the Crawford Panel. "If that's not what you want to see, that's what you've got right now."

If Flaherty can tempt a few of the other larger provinces, like Alberta or British Columbia, to go one step beyond Passport and opt into whatever system the federal panel creates, the momentum would be there for a common regulator, says Russell. There has, at various times, been support at the higher levels of several provincial governments. "The real resistance to change is down in the ranks," says Crawford. As recently as last summer, Alberta's former finance minister Lyle Oberg spoke out in favour of a common regulator until the idea was shot down by Premier Ed Stelmach. British Columbia is said to be warmer to the idea than it lets on publicly. Even Quebec, despite the war of words between Flaherty and Jérôme-Forget, shouldn't be written off, says Russell. "It has shown itself very far-sighted on a lot of economic and FINANCIAL POLICY." The Quebec government's lack of opposition to the proposed merger of the TSX and Montreal Exchange was seen by many as evidence of this warmer streak.

But the real grease to get a deal done, as always, is likely to come down to money. There will be a price to pay to entice each and every province and territory into joining a national regulator. "The provinces have an economic agenda with Ottawa," says Russell. "There are things they want." In some smaller provinces, like Nova Scotia, regulators raise significant revenue for public coffers. They may agree to fold into a common system, but only if they are compensated for their loss of income by Ottawa. Other provinces could well be tempted to accept a common regulator if it is somehow packaged as part of a larger federal-provincial deal, whether over equalization, taxes, or even health care.

Fears that a national regulator would be dominated by Central Canada could also be relatively easily assuaged. The Crawford report, released in 2006 and which the federal panel would likely build off of, was careful to take into account these concerns, outlining how regional offices and staff could be maintained in a common system. Indeed, the headquarters needn't be in Toronto, argues Crawford. Why not, for instance, Montreal? Ultimately, some element of provincial jurisdiction will almost certainly remain under a common regulator. "That's the nature of Canada," says New Brunswick's Smith. "Even with all the proposals being talked about, there is a connection and a requirement that the provinces be involved in some capacity."

The hope is that whatever blueprint the new federal panel comes up with, it will provide the spark that's missing to get negotiations rolling again. "I think you need to put a straw man in place and say this is what it would look like," says Nancy Hughes-Anthony, president of the Canadian Bankers Association, a proponent of a common regulator. "At the moment there's more momentum than there's ever been."

With all this talk about compromise and momentum, perhaps the toughest question now centres on Flaherty himself: has the champion of reform become an obstacle to it? Flaherty's fight with the provinces has rattled cages, and his less-than-diplomatic methods have badly undermined his cause, say supporters and critics alike. "He has politicized it. Any time a senior cabinet minister who's as strong in his convictions as the finance minister starts pushing an issue hard, the provinces get their backs up about that," says one proponent who has been highly involved in the push to create a common regulator. "It's not helpful," says Smith. "It makes it very difficult for regulators, and I suspect for [provincial] ministers, to respond in a constructive way and in a constructive dialogue."

Perhaps that's why, in recent weeks, Flaherty's public attacks against the current system have all but disappeared. Even the long-awaited announcement of the panel last week was made without fanfare and at a time when all eyes were on his budget. And that change in tactics by the minister may be the surest signal yet that this time, progress is really, finally being made.

Maclean's March 10, 2008