Chapter 3 | The Canadian Regulatory Environment

1. REGULATORS

-CANADIAN SECURITIES ADMINISTRATORS (CSA)

Umbrella organization of Canada’s ten provincial and three territorial securities regulators designed to improve, coordinate and harmonize regulation of the Canadian capital markets.

-SELF-REGULATORY ORGANIZATIONS (SRO)

Canadian SROs include the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA).

-THE INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA (IIROC)

IIROC oversees all investment dealers and trading activity on debt and equity marketplaces in Canada.

Financial compliance, Business conduct compliance, Registration, Enforcement, Market surveillance

-THE MUTUAL FUND DEALERS ASSOCIATION (MFDA)

The MFDA is the mutual fund industry’s SRO responsible for regulating the distribution and sales of mutual funds by its members in Canada

-THE OFFICE OF THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS (OSFI)

independent agency of the Government of Canada designed to contribute to the safety and soundness of the Canadian financial system.

-INVESTOR PROTECTION FUNDS

The securities industry offers the investing public protection against loss as a result of the financial failure of any firm in the self-regulatory system.

-CANADIAN INVESTOR PROTECTION FUND (CIPF)

The primary role of the CIPF is investor protection; its secondary role is overseeing the self-regulatory system.

-MUTUAL FUND DEALERS ASSOCIATION INVESTOR PROTECTION CORPORATION (MFDA IPC)

Provide protection for eligible customers of insolvent MFDA member firms.

-CANADA DEPOSIT INSURANCE CORPORATION (CDIC)

Federal Crown Corporation that provides deposit insurance and contributes to the stability of Canada’s financial system.

-PROVINCIAL INSURANCE CORPORATIONS

Protect the deposits of credit union members.

2. REGULATION AND SUPERVISION

-REGULATION

Consumer protection, Fairness, Economic stability, Social objectives

-PRINCIPLES-BASED REGULATION

The regulators set objectives for securities dealers and allow the firms themselves to decide how best to meet those objectives.

-SECURITIES REGULATION IN CANADA

In Canada, there is no federal regulatory body for the securities industry, unlike in the United States, where the national Securities and Exchange Commission (SEC) has considerable regulatory authority.

Protection flows from the SROs, as well as from the provincial and territorial regulatory authorities.

-DISCLOSURE

Full, true, and plain disclosure.

Methods to protect investors:

• Registration of securities dealers and advisors

• Disclosure of facts necessary to make reasoned investment decisions

• Enforcement of the laws and policies

-NATIONAL REGISTRATION DATABASE (NRD)

Web-based system used by investment dealers and employees to file registration forms electronically when applying for approval by a stock exchange, the CSA, or IIROC.

-GATEKEEPER

• Collect and record client information that is accurate and complete.

• Monitor activity in client accounts.

• Report any suspicious transactions or proposed transactions in client accounts.

-KNOW YOUR CLIENT (KYC)

• Learn the essential facts relative to every client and to every order or account accepted.

• Verify that the acceptance of any order for any account is within the bounds of good business practice. • Verify that recommendations made for any account are appropriate for the client’s investment objectives, personal circumstances, and tolerance to risk.

-CLIENT RELATIONSHIP MODEL (CRM)

The objective is increased transparency for investors regarding the fees they pay, the services they receive, potential conflicts of interest, and the performance of their accounts.

-RELATIONSHIP DISCLOSURE

• The types of products and services offered by the firm

• The terms of the account relationship to which the client has consented

• The process used by the firm to assess investment suitability and the client’s KYC information

• The date on which account suitability will be reviewed

• All fees and charges associated with operating, transacting, and holding investments in the account

• The firm’s complaint handling procedures

-CONFLICT OF INTEREST MANAGEMENT

• Avoiding the conflict

• Disclosing the conflict

• Otherwise controlling the conflict situation

-SUITABILITY ASSESSMENT

• A trade is accepted.

• A recommendation is made.

• Securities are transferred or deposited to an account.

• There is a change of representative or portfolio manager responsible for the account.

• There is a material change to the KYC information for the account.

3. REMEDIATION

-ARBITRATION

• Attempts have been made to resolve the dispute with the investment dealer.

• The claim does not exceed $500,00

-OMBUDSMAN FOR BANKING SERVICES AND INVESTMENTS (OBSI)

This organization investigates customer complaints against financial services providers, including some banks and other deposit-taking organizations, investment dealers, mutual fund dealers, and mutual fund companies. OBSI is independent of the financial services industry.

4.ETHICAL STANDARDS

EXEMPLES

• Deceiving the public, the buyer, or the vendor as to price of any transaction or the value of any security

• Creating, or attempting to create, a false or misleading appearance of active public trading in a security in an effort to make a profit

• Entering, or attempting to enter, into any arrangement to sell and repurchase a security in an effort to manipulate the market

• Making a fictitious trade that involves no change in the beneficial ownership of a security in an effort to mislead the public

• Using high-pressure or otherwise undesirable selling techniques

• Violating any statute applicable to the sale of securities

• Misleading a client as to the risk involved in purchasing a specific security

• Trading in one’s own account before effecting the same trade for a client (a practice known as front running)

• Conducting oneself in a way that would bring the securities business, the exchanges, or IIROC into disrepute

-PROHIBITED SALES PRACTICES

Such regulations are designed to curb unethical behaviour, dishonest conduct, and high-pressure selling tactics.

NATIONAL DO NOT CALL LIST (DNCL)

The DNCL rules prohibit telemarketers and clients of telemarketers from calling any number that has been registered on the DNCL for more than 31 days.

Chapter 2 | The Capital Market

1. INVESTMENT CAPITAL

Characteristic of capital: mobility, sensitivity to its environment, and scarcity

Components of country risk factors: political environment, Economic trends, Fiscal policy, Monetary policy, Investment opportunities, labour force.

Suppliers of capital: Individuals, Non-financial domestic corporations, Governments, Foreign investors

The Sources and Users of Investment Capital

Sources of Capital

-Retail investors are individual clients who buy and sell securities for their personal accounts.

-Institutional investors are organizations, such as pension and mutual fund companies, that trade in large-share quantities or dollar amounts. They typically have a steady flow of money to invest.

-Foreign direct investment in Canada tends to concentrate in manufacturing, petroleum, natural gas, mining, and smelting. Some industries have restrictions on foreign investment.

Users of Capital

-Individuals need capital to finance large purchases such as houses, cars, and major appliances. They usually obtain it in the form of personal loans, mortgage loans, and charge accounts.

-Businesses require massive sums of capital to finance day-to-day operations, renew and maintain plants and equipment, and expand and diversify their activities. They generate much of that capital internally, in the form of profits retained in the business. They borrow from financial intermediaries for other needs, and they raise the remainder in securities markets.

-Governments are major issuers of securities in public markets, either directly or through guaranteeing the debt of their Crown corporations. When revenues fail to meet expenditures, or when they undertake large capital projects, governments must borrow.

2. THE FINANCIAL INSTRUMENTS

The Different Types of Financial Instruments

-Fixed-income securities (also called debt securities) formalize a relationship in which the issuer promises to repay the loan at maturity and, in the interim, makes interest payments to the investor. The term of the loan varies depending on the type of instrument.

-Equity securities (commonly called stocks, equities, or shares) represent some form of ownership stake in the company that issued them. For example, if the value of a company increases, the owner of stock in that company receives a capital gain upon selling it.

-A derivative is a product whose value is derived from the value of an underlying instrument, such as a stock or an index. Unlike stocks and bonds, derivatives are more suited to sophisticated investors.

-Managed products (also called investment funds) are typically pools of capital gathered from investors to buy securities according to a specific investment mandate.

-A structured product is a financially engineered product with the characteristics of debt, equity, and an investment fund.

3. THE FINANCIAL MARKETS

The capital market is made up of many individual financial markets, including stock markets, bond markets, and money markets. Only short-term fixed-income securities with a term of one year or less trade in the money market.

Primary markets and secondary markets

-In the primary market, newly issued securities are sold by companies and governments to investors. IPO

-In the secondary market, investors trade securities that have already been issued by companies and governments.

Auction market

In an auction market, securities are bought and sold by investors. Investment dealers, who typically act as agents, execute the buy and sell orders on behalf of their clients.

Stock exchanges

A stock exchange is an auction market where buyers and sellers of securities meet to trade with each other and where prices are established according to the laws of supply and demand.

Exchange liquidity

• Frequent trades

• Narrow price spread between bid and ask prices

• Small price fluctuations from trade to trade

Canadian exchanges

• Toronto Stock Exchange (TSX)

• TSX Venture Exchange

• TSX Venture Exchange

• TSX Venture Exchange

• ICE NGX Canada

• Canadian Securities Exchange

• NEO Exchange

Dealer market OTC

OTC consist of a network of banks and investment dealers. Unlike an auction market, where the orders of individual buyers and sellers are entered in a centralized marketplace, a dealer market is a negotiated market where market makers post bid-and-ask quotations via electronic platforms and computer networks. In the OTC market, investment dealers typically act as principals.

-Almost all bonds and debentures are sold through dealer markets.

-Dealer markets are also called unlisted markets.

TRADING IN THE UNLISTED EQUITY MARKET

Investment dealers, who act as market makers, quote their own bids and offers. These market makers hold an inventory of the securities in which they have agreed to make a market.

OVER-THE-COUNTER DERIVATIVES MARKET

They can be custom designed by the buyer and seller, with special features added to the basic properties of options and forwards.

Open 24 hours a day

REPORTING TRADES IN THE EQUITY UNLISTED MARKET

In Canada investment dealers do not have to report unlisted trades except in Ontario.

-web-based system named the Canadian Unlisted Board Inc.

ALTERNATIVE TRADING SYSTEMS ats

Electronic marketplaces that provide automated matching and execution of trades in both the equity and fixed-income markets.

EQUITY ELECTRONIC TRADING SYSTEMS

Alternative trading systems in the equity markets provide automated trade matching and execution of orders from multiple buyers and sellers, a role once performed exclusively by stock exchanges.

FIXED-INCOME ELECTRONIC TRADING SYSTEMS

All bond and money market securities are sold through dealer markets.

• CanDeal

• CBID

• MarketAxess

• CanPX

Chapter 1 | The Canadian Securities Industry

SECTION 1: THE CANADIAN INVESTMENT MARKETPLACE

1. Describe the relationships between the major participants in the Canadian securities industry.

• Suppliers and users of capital trade financial instruments through financial markets such as stock exchanges and money markets.

• Investment dealers (also called brokers) act as intermediaries by matching investors with the users of capital. Each side of a transaction has its own dealer who matches the trades through the markets.

• Trades and other transactions are cleared and settled through organizations such as CDS Clearing and

Depository Services Inc. and banks. Clearing is the process of confirming and matching security trade details; settlement is the irrevocable moment when cash and securities are exchanged.

• The SROs set and enforce rules that govern market activity and monitor the markets to ensure fairness and transparency.

• The Canadian Investor Protection Fund and similar organizations provide insurance against dealer insolvency.

• Provincial regulators oversee the markets and the SROs.

• The Canadian Securities Institute and similar organizations provide education for industry participants.

2. Distinguish among the three categories of investment dealers including how they are organized.

• Retail firms include full-service investment dealers and self-directed brokers (also known as discount brokers). Full-service retail firms offer a wide variety of products and services for the retail investor. They also provide various levels of advice, depending on the financial and wealth management concerns of their investor clients. Self-directed brokers, on the other hand, are considered the do-it-yourself approach to investing. They execute trades for clients at reduced rates, but they do not provide investment advice.

• Institutional firms are investment dealers that serve exclusively institutional clients, organizations that trade large volumes of securities. Institutional clients include pension funds and mutual funds, and may be domestic or foreign institutional firms. In Canada, foreign firms account for about one-third of all institutional clients. Foreign firms include affiliates of many of the major U.S. and European securities dealers.

• Integrated firms offer products and services across the industry and participate fully in both the retail and institutional markets. Most integrated firms underwrite all types of federal, provincial, and municipal debt, as well as corporate debt and equity issues. They are active in secondary markets, including the money market, as well as on all Canadian stock exchanges and some foreign exchanges.

Front Office

Performs all staff functions pertaining directly to portfolio management activities

• Portfolio management, Trading, Sales, Marketing

Middle Office

Performs functions critical to the efficient operation of the firm

• Compliance, Accounting, Audits, Legal

Back Office

Settles the firm’s security transactions

• Trade settlement

3. Explain the difference between principal and agency transactions.

PRINCIPAL TRANSACTIONS

• Investment dealers may own the securities as part of their inventory.

• Underwriting

• Maintaining an inventory of already issued securities.

AGENCY TRANSACTIONS

• Broker

SERVICES PROVIDED BY INVESTMENT DEALERS

• They provide informed advice about the terms and features for new issues in the primary market, based on their knowledge of current conditions in the secondary markets.

• They add liquidity to the market with relative ease by making transactions from their inventory, rather than waiting for simultaneous matching buy-sell orders from other investors.

• They sometimes act as market makers and carry out market making duties by taking positions in assigned listed stocks to enhance market liquidity and smooth out undue price distortions.

• They sometimes buy listed stocks as principals, thus accumulating large blocks of shares, becoming more competitive in serving their larger institutional clients.

• The liquidity they add to the secondary market enhances the primary market by assuring that buyers of new securities will be able to sell their holdings at reasonable prices.

• Investment dealers also trade from their own account to make a profit.

THE CLEARING SYSTEM

• In Canada, securities are cleared through CDS Clearing and Depository Services.

• Participants with access to the clearing and settlement system primarily include banks, investment dealers, and trust companies.

• The netting process compiles each firm’s clearing settlement sheets and informs each member of the securities or funds it must deliver to balance its account.

4. Distinguish among the roles of the various financial institutions.

CHARTERED BANKS

All chartered banks in Canada operate under the Bank Act.

• Schedule I : 23 banks, Savings deposits are eligible for deposit insurance, which is provided by the Canada Deposit Insurance Corporation (CDIC). Firewalls between services.

• Schedule II : Incorporated and operate in Canada as federally-regulated foreign bank subsidiaries.

• Schedule III : Federally-regulated foreign bank branches of foreign institutions that have been authorized under the Bank Act to do banking business in Canada.

CREDIT UNIONS AND CAISSES POPULAIRES

• The federal legislation governing credit unions is the Cooperative Credit Associations Act (CCAA).

TRUST AND LOAN COMPANIES

• Trust companies act as a trustee in charge of corporate and individual assets such as property, stocks, and bonds.

INSURANCE COMPANIES

Insurance Companies Act

• Life insurance : Health and disability insurance ,Term and whole life insurance, Pension plans, Registered retirement savings plans, Annuities

• Property and casualty insurance : Home, Auto, Commercial business

OTHER FINANCIAL INTERMEDIARIES

• Investment funds

• The Alberta Treasury Branches (ATB Financial)

• Consumer finance companies

• Sales finance companies

• Pension plans

5. Discuss the trends affecting the financial services industry in Canada and globally.

FINANCIAL TECHNOLOGY

Fintech

• Online loans

• Electronic wallets

• Automated financial planning software

ROBO-ADVISORS

• They provide clients with goal-based online investment management.

• Portfolios are created using algorithms based on modern portfolio theory and on online client questionnaires.

• A telephone call with an advisor verifies that the computer-generated portfolio is suitable for the client.

• Advisor support is offered to varying degrees, typically online or by phone.

• Portfolios are built primarily with exchange-traded funds.

• Portfolios are regularly rebalanced.

• Financial planning may be offered in varying degrees.

• Service may be provided to the end client as well as to intermediaries such as advisors and employers.

• Competitive positioning is based on the client experience, which typically encompasses the following services:

• Portfolio management is optimized with tools such as tax-efficient rebalancing across account types.

SHIFTING DEMOGRAPHICS

Aging population in Canada