We are writing to you on behalf of the Canadian Capital Markets Association (CCMA) to bring to the attention of the Wise Persons' Committee (the Committee) a number of issues that we believe the Committee should be aware of as you proceed with your work. We see your work as consistent with, and generally supportive of, the current core purpose of the CCMA, which is straight-through processing in the context of efficient and competitive Canadian capital markets.
We recognize that some of the issues discussed below may seem quite operational and technical when compared with the more general mandate of and questions posed by the Committee. However, of the questions you pose, Canada's international competitiveness, the efficiency of the current regulatory structure and the systemic capacity to innovate and be adaptive are all issues involved in the CCMA's objectives described below.
Accordingly, we believe that analysis of the broader concerns raised by those questions will benefit greatly from an increased awareness of initiatives that manifest those concerns at a more detailed level and whose success is heavily dependent on success in dealing with those broader concerns.
The CCMA and Straight-Through Processing (STP)
The CCMA is a federally incorporated, not-for-profit organization, launched to identify, analyze and recommend ways to meet the challenges and opportunities facing Canadian and international capital markets.
Our current priority is to promote STP strategies among Canadian capital market participants. Industry-wide STP means seamlessly passing financial information electronically - on a timely, accurate, system-to-system basis - to all parties in the end-to-end securities transaction chain without manual handling or redundant processing. To help the broader community learn about STP, the CCMA recently published an STP primer, STP is Everybody's Business: STP in plain language - why all securities industry participants should care about STP (see www.ccma-acmc.ca., Media/Publications page, November 19, 2002). We believe that adopting STP on an industry-wide basis will:
· Lower processing costs
· Minimize operational, market, settlement, payment and systemic risks
· Eliminate errors and fails and minimize exception processing
· Provide faster, better service and, ultimately, better prices for investors
· Position firms for future growth
· Improve the competitiveness of Canadian capital markets.
The CCMA's objectives are fully consistent with the following common themes of financial sector regulators:
1. Regulation should support clearly identified public policy goals (such as promotion of participation by informed investors and facilitation of innovation) and its benefits must outweigh the associated costs.
2. Canada's regulatory regime must be part of the country's competitive advantage as Canada competes with other jurisdictions for capital and investment opportunities.
3. Differences in regulatory requirements and the fragmentation of the securities regulatory system across the country need to be addressed if our capital markets are to remain competitive.
4. Securities regulation must be sufficiently flexible to allow regulators to react promptly to market changes and to foster further innovation in the marketplace.
Improving Canadian Capital Markets Competitiveness
As noted above, the CCMA is currently focussed on the establishment of STP and related process improvements throughout the Canadian securities industry to the maximum extent possible. This objective, and the timeframes established to meet it, are designed to parallel a similar project in the United States, which is being led by the U.S. Securities Industry Association. A November 2000 economic analysis, commissioned by the Canadian securities industry, showed that Canadian capital markets activity would shift to the U.S. if Canada did not move in tandem with the U.S. in the introduction of one-day (T+1) settlement (an objective that was adjusted in the summer of 2002 to an initial focus on STP).
Introduction of STP on a general basis requires not just doing the same things faster, but also making fundamental changes to the ways securities are handled and settlements are processed and, of course, involves considerably greater automation. To deal with the many challenges of moving to cross-industry STP, the CCMA has established a number of working groups, on which a wide variety of industry representatives participate, along with observers from a number of provincial and federal regulatory bodies, including the Quebec and Ontario Securities Commissions, federal and Quebec Ministries of Finance, Bank of Canada, Canadian Payments Association and Office of the Superintendent of Financial Institutions.
The underlying mechanics of securities trading, including the data processing arrangements and the supporting rules and informal practices that are the focus of current CCMA efforts, are little thought of or understood by most securities market practitioners of whatever professional persuasion. And yet those mechanics can be important generators of costs and risk - or, if properly addressed, of efficient operation and competitive advantage. These considerations are even more important when our closest competitor to the south is undertaking a project similar to ours.
While our focus is the U.S., Canadian capital markets must also be viewed in a broader international context. Canada is directly represented on the Committee on Payments and Settlement Systems (CPSS)/International Organization of Securities Commissions (IOSCO), which established 19 recommendations for minimum clearing and settlement standards. Canada is also indirectly involved in the Group of Thirty, which has just published 20 clearing and settlement best practices recommendations. Canadian capital markets will be measured against the minimum standards and best practices benchmarks that these and other reports provide.
As indicated, we believe that it is important that the requirements of STP (and, ultimately, of one-day settlement or T+1) be reflected in all of the recommendations for general reform of the Canadian financial services sector, including those that will flow from your work. Continued evolution of the sector will involve continually enhanced flows of both information and funds, within an appropriately developing environment of electronic media. Those enhancements and development of that environment need greater recognition and public profile in the context of efforts at general sector reform. Success in all of these efforts will, in turn, require a legal and regulatory environment that is as unobtrusive as possible but one that fully and effectively supports electronic flows of securities, information and funds to the maximum extent possible, minimizing the need for paper-based, manual operations. Attachment #1 lists key CCMA milestones - overall and on a segment-by-segment basis.
We now turn to some specific goals that we believe are relevant to your work.
· Regulatory Uniformity within Canada (goals - efficiency and cost-effectiveness): We support initiatives that would harmonize or make uniform securities (as well as other related) statutes and regulations across Canada. Inconsistencies within such a relatively small market inevitably create inefficiencies and impede the increasingly rapid operations on which STP and other related improvements are predicated. As well, a patchwork of legislation and regulations does not support the interest of securities regulators in ensuring transparency for investors. Unless there is a strong articulated reason for regulatory variation, it should be avoided. Further, it is important that our regulatory system not put Canadian market participants at a disadvantage because of unnecessary differences with U.S. regulatory standards. While eliminating the differences among regulatory regimes would be of benefit to all capital market participants, it is also important that the structure of securities regulation in Canada be reviewed to address the issue of multiple and overlapping regulation.
· Uniform Securities Transfer Act (goals - legal certainty and competitiveness): Consistent with the above, a very high priority for the CCMA (and, we believe, for the ongoing competitiveness of the Canadian capital markets) is pursuing current efforts to finish development, and then to obtain enactment, of the Uniform Securities Transfer Act (USTA) proposals. In the paperless world of STP, it is crucially important that the regulatory framework fully reflect and support a book-based environment. The competitive implications here are also important: all states in the U.S. have already enacted the needed revisions to Article 8 of the Uniform Commercial Code. There is much work yet to be done in Canada to obtain approval of the draft USTA and then to ensure rapid review, approval and enactment of amendments to the various provincial (and federal) acts and regulations required to implement the USTA. Further resources, and a heightened sense of urgency, need to be applied to these activities. We append here as Attachment #2 a copy of the CCMA's letter of May 12, 2003 to Mr. Howard Wetston, Executive Sponsor of the USTA Task Force, in support of the work of the Task Force.
· PRIMA Convention (goals - legal certainty and competitiveness): Related to the USTA, the "PRIMA" Convention negotiated at The Hague during the last year will complement the USTA, once enacted, by providing an international framework for determining which jurisdiction's law will govern the rights and obligations in securities to which the law of several jurisdictions might apply. We note in passing that the very rapid completion of work on the "PRIMA" Convention reflects the importance that international financial markets, and countries around the world, accord to establishing clear and legally enforceable rules for modern securities markets. We urge ongoing attention be directed to implementing the PRIMA Convention in Canada.
· Electronic Delivery (goals - efficiency and cost-effectiveness): As noted, electronic delivery of documents and other materials or the equivalent functionality in electronic form is essential for the operation of STP. The provisions of Ontario's Electronic Commerce Act, and similar legislation in most other Canadian jurisdictions, are certainly helpful in establishing a positive general environment. The regulatory environment should be as supportive as possible of electronic functionalities and remove uncertainties as to the use of electronic means of delivery and other electronic alternatives wherever possible.
· Dematerializing Securities (goals - efficiency, cost-effectiveness and risk reduction): A specific but very important goal related to those above is the dematerialization of securities - the replacement of physical certificates with book-entry records of ownership - to the maximum extent possible. The CCMA has recommended a number of steps toward this goal. As capital markets in a growing number of countries are becoming fully dematerialized and benefit from the related operation efficiencies, cost savings and risk reduction, Canada needs to make further progress toward this goal. Amendment of some laws is needed to ensure that all corporate statues, including those in each province, allow for issuance of ownership statements in addition to regular certificates. The CCMA has proposed alternatives to legending requirements, which better achieve the regulatory goals of those requirements, without forcing issuance of certificates. To make Canada's system as fully electronic as possible, the CCMA also believes that the default for securities issuance should be electronic and that restrictions on issuers that decide to only issue in electronic form should be removed. The legal and regulatory environment should support the issuance and holding of securities in paperless (electronic) form.
· Mandated Matching on Trade Date (goals - efficiency and risk reduction): Participants with matched/confirmed trades on September 10, 2001 had fewer problems following the terrorist attacks on the U.S. on September 11, 2001. Those from the World Trade Center that relied on paper certificates, paper cheques, paper forms and manual processes spent considerably more time and money restoring their records than those operating on a same-day to real-time electronic basis. Requiring matching of all details to a transaction by the custodian, investment manager and broker counterparties to an institutional transaction will reduce risk and improve efficiency. This is an area where Canada already badly lags behind the U.S. and where the U.S. is pushing ahead with further improvements. Mandating trade matching is required to ensure a properly functioning market.
· Mandated Payment of Entitlements by Large Value Transfer System (LVTS) (goal - risk reduction): Currently, entitlement payments on equity and some debt securities are still made by cheque, which means that payment is not final until the next day (or later), when the cheque clears. Since market practice is to give beneficiaries immediate credit for these payments (that is, immediate access to the funds), a risk that is increasingly unacceptable is created as the market moves to more rapid trading and settlement processes. The CCMA is requesting the Canadian Securities Administrators to mandate that payment of entitlements to depositories be made using the Large Value Transfer System (or equivalent), making these payments final and irrevocable for the recipient. In the U.S., the rate of payment by FedWire (their equivalent of LVTS) exceeds 99 per cent. Paying entitlements to depositories using cheques creates unacceptable risks and entitlement payments over a threshold to be agreed upon should be made using the LVTS.
· Central entitlement reporting (goals - efficiency, transparency and risk reduction): The CCMA is requesting that the filing of information regarding a broader range of entitlements in a central location in standardized format be mandated to reduce risk and costs and improve transparency for investors. Centralized filing of entitlement information is required to ensure that all investors - and the intermediaries that serve those investors - have full and complete access to this very important information.
Finally, we note that the Committee's work may intersect with a number of other efforts at financial reform, for example, the provincial First Ministers' initiatives, the Uniform Securities Law Project and the B.C. Model. We believe that it would be useful for all if the work of the Committee could include an overview of the relationship between these efforts to ensure clarity and avoid duplication and inconsistency.
A list of submissions made to the Canadian Securities Administrators by the CCMA and white papers issued by the CCMA is also appended as Attachment #3 as background on matters where we believe action by the Canadian securities industry is required. They can be found on the Media/Publications page of our Web site at www.ccma-acmc.ca, under the sections Submissions and White Papers.
Canadian Capital Markets Association
Attachment 1 (pdf)*
Attachment 2 (pdf)*
Attachment 3 (pdf)*