Let 'passport' work

A national securities regulator has proven unacceptable. Let's get on with the alternative, favoured by all except Ontario

by Jeffrey MacIntosh 

This commentary was first published in the Financial Post on Thursday, June 29, 2006.

Ontario wants it. The federal government wants it. The business community has been beating its chest about it. The quixotically named "wise persons committee" went gaga about it. Most recently, the Crawford Panel, sporting more blue ribbons than Northern Dancer, has provided us with a blueprint for how to get there. So why is a national securities commission still as elusive as Ponce de Leon's fountain of youth?

In a word -- politics. For reasons that scarcely need recounting, Quebec's participation in a national securities regulatory body has approximately the same likelihood as George Bush acquiring humility. In public speeches, Bill Rice, the Alberta regulator's new chair, has clearly signaled continued opposition to a national body. And despite some conciliatory noises from B.C.'s Attorney-General earlier in the year, it seems clear that British Columbia is still committed to a passport system for the foreseeable future. While 80% of Canada's capital market activity takes place in Ontario, it does not seem realistic to think that a "national" commission can succeed with three of Canada's four major securities markets on the sidelines.

The Crawford Panel's Blueprint for a Canadian Securities Commission, delivered on June 7, is an ambitious attempt to address the major stumbling blocks that have historically stood in the way of a national body.

No doubt in order to appease Quebec's visceral opposition to expanded national powers, the panel recommends that a Canadian Securities Commission (CSC) be provincially, rather than federally, constituted. To address Western fears that a national body would be little more than the Ontario Securities Commission with longer claws, the report suggests that each province (including Ontario) be given a single vote on a "council of ministers" that would have ultimate control of the commission (and that the actual governance of the organization be overseen by an independent board of directors, appointed by the ministers).

To allay Western concerns that their small cap/mining/oil and gas markets would not be properly understood by plenipotentiary Eastern satraps, the report recommends a division of the policy-making function between "centres of excellence" -- the subtext being that the policy-making function for these aspects of securities regulation be situated in Alberta or B.C. To address the issue of holdouts, the panel has suggested that the requirement for unanimous participation be dropped. Interested provinces, the panel suggests, should go ahead and form a multi-jurisdictional CSC.

The hope is that once the recalcitrants see how ill-founded their fears are, they will opt in as well. Finally, while not expressly addressed in the report, the recommendations effectively circumvent the application of the Official Languages Act, allowing for a wider range of talent to be considered for various CSC posts.

The report was scarcely laid in its bassinet, however, before being put on IV. Nearly two years ago, all of the Canadian jurisdictions -- save Ontario -- agreed to work toward a passport system (more fully described below), in preference to a national commission. In a meeting that took place only a week after the tabling of the report, all of Canada's provincial and territorial securities ministers -- again, save Ontario's -- politely thumbed their noses at a national regulator and affirmed their continued commitment to a passport system.

In all of this, Ontario has consistently refused to participate in the passport system, maintaining that a national commission is the only way to go, and that upgrades to the passport system will only make a national commission less likely. This petulant "my way or the highway" attitude ill serves capital markets not only in Ontario, but all across Canada. It does not seem to have occurred to Ontario's political mavens that if a passport system can successfully allay the pressure to create a national commission, perhaps this is because it is a fully functional alternative to a national commission. Moreover, Ontario's position can only have the effect of stoking fears in other provinces that, consistent with its past behavior, Ontario will assume the role of junkyard dog in any national commission. Way to go, Ontario.

One of the keenest ironies in relation to Ontario's bullying tactics is that for many years we have had in place a rudimentary passport system that applies to the review of prospectuses, annual information forms and certain types of exemptive relief. Ontario has been a full participant in, and supporter, of this system. What inky cloud of fuzzy thinking caused it to assume the role of obstreperous belligerent?

Of course, the real issue in all this is: Why not a passport system? Without question, the biggest shortcoming in the current system is that a single transaction might fall under the jurisdiction of more than one regulator, requiring multiple review and approval. But a passport system solves this problem every bit as efficaciously as a national regulator. In a passport system, only one provincial regulator and only one set of laws govern any given transaction. The identity of the regulator might be determined by the application of mechanical rules (such as the location of an issuer's head office), or by allowing market actors to select their regulator. But however the regulator is determined, there is only one review and approval necessary. All other jurisdictions agree to abide by that regulator's decision (which constitutes a "passport" good everywhere in Canada). End of story.

Detractors suggest that a passport system will degenerate into a "race-to-the-bottom," with business flowing to the least restrictive (or competent) regulatory authority. This seems highly unlikely. Canada has in fact had a passport system in corporate law for a century and a half, and nothing remotely like this has occurred. It is possible to incorporate in any of the provinces or territories (or federally), but no jurisdiction has abused its incorporation privilege by enacting a "you can do anything you want" statute.

Indeed, it's not clear that such a strategy would work to attract business in any case. The experience of Delaware is instructive. Delaware has long been criticized for seeking out incorporation business (which supplies Delaware with about 20% of its state revenue) by tailoring its corporate laws to manager, not shareholder, needs. But the funny thing is, when a corporation reincorporates into Delaware from another jurisdiction, on average share prices go up, not down. It turns out that the revenue-maximizing strategy for a jurisdiction seeking to attract business is to craft efficient laws that maximize shareholder wealth, rather than mindlessly catering to manager preferences. After all, as one wag put it, you have to attract shareholders before you can cheat them -- and who will want to invest in a corporation that locates in a jurisdiction that facilitates cheating?

The reality is that not every Canadian jurisdiction even wants to be a regulator. Those provinces and territories that lack the resources will drop out -- and allow other jurisdictions to regulate transactions within their borders. In the end, we might thus see five regulators offering their services: B.C., Alberta, Ontario, Quebec and the Maritimes.

The Crawford Report is an elegant and well-considered attempt to succeed where failure has been a commonplace. However, it aims at bridging what still appears to be unbridgeable: the political hostility in Quebec, the western provinces and apparently everywhere else in Canada (save Ontario) to a national commission.

At this juncture, the only sensible thing for Ontario to do is to become an enthusiastic participant in efforts to create a truly effective passport system. The scary thing is, it might just work.