21 septembre 2007

« Two cheers for canada’s securities regulatory framework »

Yvan Allaire et Pierre Lortie | IGOPP

« Calls to eliminate the current architecture of the securities regulatory apparatus in Canada and replace it with a single, national securities commission have reached fever pitch over the last few weeks. Unsubstantiated claims that “Canada is the laughing stock of the rest of the world” are bandied around as if that were a compelling argument likely to silence opponents.

However, independent international studies tell a very different story. Canadian capital markets rank amongst the best, particularly on the dimensions related to the quality of securities regulations. For instance:

  • In a 2006 international comparison, the World Bank and Lex Mundi have rated Canada third in terms of protection of investors. The USA ranked 7th and the U.K. 9th;
  • Canada was ranked 2nd in terms of the quality of overall securities regulation in the OECD 2006 report “Going for Growth”, ahead of the US (4th), the U.K. (5th) and Australia (7th).
  • Based on the largest, and most authoritative study on the subject (LaPorta, Lopez-de-Silanes, Shleifer and Vishny , “What works in Securities Laws”, Journal of Finance, February 2006), Hail and Leuz (2006) have computed scores for the effectiveness of securities regulations in 40 countries. The results: Canada gets the second best score (0.91) on a scale where 1.00 is the maximum score. The U.S. scores 0.97, the UK, 0.73, Australia, 0.77 and so forth.

Then, to the plethora of arguments put forward by advocates of a single commission, a new red herring was added over the last few weeks: Canadian public companies incur a higher cost of equity capital than US firms, possibly because Canadian securities regulations are inferior to those in the United States, a result, possibly, of the architecture of our system. This higher cost of equity capital would impact Canada to the tune of “around $10 billion in annual GDP and 65,000 jobs”. These fantasy numbers were greeted with a willing suspension of disbelief.

Whether the cost of equity capital is higher in Canada than in the United States and other developed economies is a serious policy issue as a higher cost of equity directly affects the cost of capital of firms and, hence, their investment hurdle rate and a country’s economic growth.

However, empirical studies bearing on the cost of equity capital in Canada do not generally support the conclusion that the cost of equity for Canadian firms is higher than in the United States, once relevant factors are taken into account.

For instance, a working paper published by two researchers at the Bank of Canada earlier this month (Witmer and Zorn) concludes that, when adjusted for differences in risk-free rates (essentially the yields on government securities), the Canadian cost of equity does not differ significantly from the American cost of equity! In another study, Hail and Leuz (2006) compare the cost of equity capital across forty countries. They estimate the cost of equity capital was 10.53% in Canada, 10.24% in the US, 10.64% in the UK, 10.72% in Australia. There is little empirical support for a blanket statement that the cost of equity capital is higher in Canada and no support whatsoever for the claim that any difference with the US cost of equity is caused by differences in regulatory regimes.

Beyond these sensational claims, the arguments in support of a single national securities regulator are flawed in three important aspects.

First, proponents never demonstrate how a single, national system would correct what they claim are the costs inefficiencies in the present system (lack of harmonization, duplication, uncertainty and delays). It is remarkable that there is no credible analysis of the cost savings with a single national securities commission committed to operate well-staffed local offices in each Province and Territory, plus a well-staffed central office.

No doubt that we must strive to get the best, most efficient, regulatory system in Canada. Indeed, to that aim, provincial securities regulators have established systems (SEDAR, SRDI, NRS, NRD) and harmonized policies to such an extent that they are now truly national in scope. It is incumbent upon the proponents of a single national system to demonstrate how the costs of their proposal would compare with the passport system currently being implemented.

Second, any system of regulation must be adaptive to different circumstances and flexible as markets change over time. A strong case can be made that the passport model the Canadian Securities Administrators have committed to implement by 2008 (save Ontario) is much more dynamically efficient than would be a centralized regulatory body. The Canadian system, after the full implementation of the passport model, would combine greater flexibility, a better capacity to adapt to changing circumstances and greater responsiveness to particular industry or regional needs.

Professor Suret and his colleagues at Laval University have reviewed the evidence in a CIRANO research paper (2003) and in an article in Canadian Public Policy (No. 4, 2003). Their analysis points to major flaws in the arguments supporting a single commission in Canada. For instance, Suret et al. present data on the cost of IPO issues, which show significantly higher costs in the United States than in Canada. They argue that our decentralized system has been a contributor to several innovations and a spur to adaptation to the varied regional circumstances in our country.

A good example of cost-saving adaptation is provided by the fact that companies (often smaller ones, western-Canada based) which do not need to call upon Quebec investors do not have to bear the considerable costs of translating (and legal vetting) into French all documents filed on SEDAR. (It is hard to conceive of a single, national commission not requiring that all filings be in both languages.)

Third, the competitiveness of the Canadian capital markets is determined in large part by the efficiency of the various players of the industry. The cost inefficiencies in regulations, be that as they may, constitute a small proportion of total “overhead costs”. More attention should be paid to the efficiency of the Canadian securities industry relative to that of other countries.

Canada is ill served by official sweeping statements to the effect that the present Canadian securities regulations are gravely deficient and, as the chairman of the B.C. Securities Commission lamented, “by the spinning of the same misinformation abroad that they do at home”. Canada deserves a more sober assessment of the state of its securities regulations.  »