Q & A with OSC Vice-Chair James Turner
1 ) Since becoming Vice-Chair of the OSC in 2007, a lot has happened in the capital markets and subsequently policy development. What do you think the biggest changes have been in the regulation of capital markets since the financial crisis of 2008?
Today’s capital markets are more complex, more sophisticated, more international in scope and driven by technology more than ever before. At the OSC, our objective is to modernize the regulatory framework to meet the realities of today’s markets and maintain high quality capital markets in Ontario.
Our approach to capital formation is informed by changing attitudes, needs and desires of entrepreneurs and investors, innovations in the markets and changes in technology. New technological capabilities to support capital raising, such as crowdfunding sites and other internet-based systems and new regulatory proposals like our proposed new prospectus exemptions, reflect a fundamental change in how capital is raised and how investment decisions are made.
2 ) When do you see the proposed exemptions becoming law and available to industry and investors?
Introducing rules to implement the proposed exemptions has been identified as high priority in the OSC’s statement of priorities, and we are devoting very significant resources to achieve that outcome. We value stakeholder feedback in the development of effective regulation and we are spending a considerable amount of time reviewing and considering the more than 780 comment letters we received on the proposed new exemptions.
We are moving very quickly to make these fundamental changes to the regulation of the exempt market. Those changes raise many regulatory issues that must be assessed before we implement the new rules. We are committed to introducing these exemptions as quickly as possible and our objective continues to be to publish the exemptions in final form by the end of the first quarter next year (assuming that a second comment period is not needed). However, we are equally committed to getting it right – to striking the appropriate regulatory balance.
3 ) How do you feel about the maturation of the retail Exempt Market in the other jurisdictions in Canada since implementation of NI 31-103? Has that played a role in the OSC’s allowing of a retail Exempt Market?
We believe that the OM exemption has had a positive impact in terms of capital raising in other Canadian jurisdictions. However, some of the original investor protection concerns have been borne out. Our decision to propose new capital raising exemptions in Ontario has followed extensive consultations with our stakeholders and reflects our attempt to find an appropriate balance between the wishes of SMEs for better access to capital and the need for adequate investor protection.
4 ) Given its historic reluctance to do so, what has ultimately led the OSC to develop a framework for a retail Exempt Market (particularity the adoption of the OM exemption)?
Securities regulation distinguishes between the raising of capital in the more regulated public market and the exempt market. In Ontario, the exempt market is well developed, but has generally been restricted to a smaller group of investors who qualify as accredited investors. Accredited investors generally do not need the same regulatory protection because they are considered sophisticated enough to understand the risks of the exempt market, have sufficient resources to be able to protect themselves or have the ability to withstand losses. The total number of individuals who qualify as accredited investors under the current income and assets thresholds is generally less than 4% of the Ontario and Canadian populations. Traditionally, issuers that want to access a broader range of retail investors have had to comply with more costly and rigorous reporting issuer requirements.
We recognize that many issuers, particularly small and medium sized issuers (SMEs), are finding it difficult to access capital
under our present regulatory regime. SMEs play a significant role in driving economic growth. In 2008, SMEs accounted for approximately 52% of Canadian private sector GDP, and approximately 39% of total Canadian GDP. In 2012, about $37 billion was raised through the exempt market in Ontario by non-investment funds, out of a reported total distribution of about $104 billion.
The key priority for us has been to review the regulatory framework for capital raising in Ontario to facilitate capital raising for issuers, particularly SMEs, while providing an appropriate level of investor protection and maintaining confidence in our markets.
5 ) How do you see adoption of the OM exemption impacting the Ontario capital markets and economy?
We have proposed four new prospectus exemptions that we believe will improve the ability of businesses, especially start-ups and SMEs, to raise capital from a broader range of investors without the need to comply with the detailed disclosure requirements for a public offering and ongoing obligations of a public company.
The ultimate impact of our proposed exemptions, including the OM exemption, on the Ontario capital markets and economy will depend on whether we strike the appropriate regulatory balance. We want to facilitate capital raising but in a manner that protects investors and preserves investor confidence in our capital markets.
There is no question that investments in the exempt market carry with them higher risks that investors must appropriately assess.
We also recognize there has to be enhanced regulatory oversight of the exempt market to maintain quality markets in which investors have confidence.
6 ) With regards to the OM exemption, our members have had a strong response against investment limits, the perception being that limits ignore suitability principles already in place. What are your thoughts on that?
Our view in proposing investment limits was that they strike the appropriate regulatory balance between capital raising for businesses relying on the OM exemption while providing an appropriate level of investor protection. The investment limits are intended to limit the risks associated with an investment by a retail investor with more limited financial means and assets in illiquid securities. Investment limits also promote diversification for investors.
We are currently considering whether registrants such as exempt market dealers (EMDs) should have an obligation to act in the best interests of clients. That reflects the concerns raised in recent compliance reviews that found that the actual execution of the suitability obligation does not always sufficiently protect investors.
We received significant feedback regarding our proposal for an OM exemption and, in particular, the proposed investment limits. We are still in the process of carefully considering that feedback.
7. Recently you have spoken out about the risks of crowdfunding to investors. You were quoted as saying: “This is extremely high risk capital. Ninety-nine per cent of start-ups won’t succeed. You’re not investing for your retirement. We want people to know that.”
Crowdfunding is likely to be used by start-ups and early stage businesses and, as a result, there are significant business and regulatory risks associated with these investments. In our investor survey, 53% of investors recognized these risks and were not interested in crowdfunding as a result. That is an appropriate conclusion.
However, investors have different risk appetites, levels of sophistication, resources and ability to withstand loss. An investor should carefully consider whether they are prepared to incur the high degree of risk associated with a crowdfunding investment and the ability to withstand the loss they may incur. To reinforce this self-assessment, an investor who purchases securities under the proposed crowdfunding exemption will be required to sign a risk acknowledgment form that draws their attention to the considerable risks associated with this type of investment. Investors should recognize that crowdfunding is not a way to save for retirement.
I would add that investors may well be interested in participating in a crowdfunding investment for social and other reasons and less as a financial investment for a rate of return.
8 ) What do you see as the strengths of the retail Exempt Market? What are the areas that the retail Exempt Market needs to work on?
In designing our proposed exemptions, we were sensitive to the difficulties that businesses, particularly start-ups and SMEs, experience in raising capital. We also tried to address the fundamental and pervasive impact of the internet on capital raising, and a generational shift to investors who have been raised in the internet age and are tech savvy.
There are risks in broadening access to capital in the exempt market. We view investor protection as a shared responsibility with industry and, in order to introduce the new exemptions, we need a commitment from issuers and registrants to work with us to promote investor protection.
As OSC Chair Howard Wetston stated at a June, 2014 industry conference:
“We are willing to consider the introduction of new tools in the exempt market, but to make it work, we need a commitment from industry to ensure that investors are protected. We view investor protection as a shared responsibility.
As you know, the OSC recently conducted a suitability sweep of portfolio managers and exempt market dealers. In particular, we found substantive and procedural issues at certain exempt market dealers with respect to Know Your Client and suitability obligations, as well as the sale of securities inappropriately to non-accredited investors.
… In our view, more work needs to be done by industry to, at a minimum, consistently meet existing requirements.”
In addition, financial literacy and investor education becomes increasingly important for retail investors who invest in the exempt market, where there are limited reporting requirements, liquidity and investor protections.
9 ) What is your opinion on how associations like NEMA can help improve the Exempt Market for industry and investors?
We recognize industry associations such as NEMA can serve as an important ‘voice’ for their members and play an important policy-making role through bringing their members’ perspectives and concerns to the attention of regulators, other market participants and investors. As an example, Craig Skauge, the President of NEMA, has actively participated as a member of the OSC Exempt Market Advisory Committee. I would like to take this opportunity to thank Craig and all of the members of our Advisory Committees for their many constructive contributions.
10 ) Are there any other ideas you would like to share with our members and readers?
As evidenced by the number of comment letters we received on our proposals, there are strongly held views about many aspects of the proposed new exemptions. These views are often divergent, and sometimes mutually exclusive. Some investor advocates have expressed strong concerns with respect to our exempt market initiative.
It is important that we recognize that it is in the interest of all market participants that we get it right; that our proposals facilitate capital raising while ensuring an appropriate level of investor protection. Retail investors will abandon the exempt market if they suffer unanticipated adverse consequences from investments in that market. That is in no one’s interest.