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IMF wrong in the way it assesses Canada’s decentralized system

This year the IMF will update Canada’s assessment under the Financial Sector Assessment Program (FSAP), which includes the entire financial sector. The most controversial aspect will likely be Canada’s securities regulatory system, especially since the federal government’s recent budget affirms its commitment to a single regulator. If this year’s FSAP update is anything like what happened during the last update in 2007, sparks will fly over the IMF’s objectivity and competence in commenting on Canada’s securities regulatory structure.

FSAPs are essentially report cards and, as with all report cards, some complaints about their accuracy may be expected. But what if the complaint is not about some technical error but about the politicization of the assessment process itself ? What if the complaint is that the IMF went beyond its mandate and departed from normal assessment methodology in order to support the federal government’s factually challenged political assertions? Those were the complaints about the 2007 FSAP update and, since unexamined history has a tendency to repeat itself, it is useful to review what happened the last time.

By 2007, the federal government’s purported constitutional claim over securities regulation had reached a fever pitch. That claim hinged on the assertion that a single regulator was necessary for the system to function properly, and that Canada’s decentralized system was incapable of doing the job due to its structure. The federal government needed the IMF’s FSAP to support that claim.

But there was a major obstacle. Although the IMF performed the assessment and wrote the report card, it used an Assessment Methodology developed by the International Organization of Securities Commissions (IOSCO) which measured the level of implementation of IOSCO’s Objectives and Principles of Securities Regulation. IOSCO’s methodology assesses functional performance only — it does not assess structure and says “there need not be a single regulator.”

That didn’t stop the IMF. In June 2007, even before the FSAP on-site examinations began, the managing director of the IMF told a Toronto audience that it would be “good policy” for Canada to establish a single securities regulator. For the provinces (except Ontario), those comments signalled that the federal government would use the IMF and the FSAP to advance its constitutional claim. By the fall of 2007 the IMF had confirmed (privately) its intention to go beyond the IOSCO methodology and express support for a single regu-

The IMF must explain the discrepancy in its methodology

lator structure. The provinces, other than Ontario, objected that such comments were outside the IMF’s mandate for the FSAP and, moreover, that the IMF was simply repeating the federal government’s constitutional rhetoric, which was based on “myths, not facts.”

In February 2008, the IMF released the FSAP assessment of Canada’s securities regulatory system based on IOSCO’s methodology. It made no mention of the single regulator debate but reported, accurately, Canada’s very high level of functional performance — significantly higher than the U.S., U.K., Germany or France. However, the IMF simultaneously released its Financial System Stability Assessment (FSSA), which repeated the constitutional rhetoric and recommended Canada move to a single securities regulator.

A week later, the federal government established the Expert Panel on Securities Regulation in Canada chaired by Thomas Hockin (currently the executive director of the IMF representing Canada). To no one’s surprise, the panel’s final report ignored the FSAP results but agreed with the FSSA and recommended a draft federal Securities Act. That precipitated constitutional references launched by Quebec, then Alberta, and finally the federal government. All three references were decided in 2011, with 18 of the 19 justices (including all nine at the Supreme Court) finding the proposed federal legislation unconstitutional. The references included thousands of pages of evidence, based on which the courts explicitly rejected much of the federal government’s rhetoric (and implicitly rejected the rest).

Although the constitutional decision did not turn on this point, the evidence clearly suggested that Canada’s existing securities regulatory system excels because it is decentralized. Still reeling from that result, the federal government has so far refused to abandon its quest for a single regulator or its rhetoric (ironically, while also promising to better “promote the Canadian brand” and the Canadian financial sector internationally). We shall soon see how far the IMF is willing to go in supporting the federal government. If the IMF chooses to continue down this path (assuming it has a choice) it will face a more difficult challenge than in 2007.

The IMF cannot ignore the elephant in the room but must explain the discrepancy between its mythology and its methodology — how can a single regulator structure be optimal when Canada’s decentralized system outperforms single regulators? Will the IMF explain why it thinks IOSCO is wrong to say there is no need for a single regulator?

Will the IMF produce a methodology for assessing regulatory structures against an optimal model, and start recommending structural changes to other countries’ regulatory systems? Will the IMF disagree with the Canadian courts and the thousands of pages of evidence presented in the securities references, which contradicted the rhetoric being repeated by the IMF? It will be interesting to see them try.