Canada: 2021 Oversight Report Of SROs And Investor Protection Funds Published

The Canadian Securities Administrators (CSA) publish their 2021 activities report (Report) summarizing the key activities of the CSA and their assessment of self-regulatory organizations (SROs) and investor protection funds (IPFs) for the January 1 to December 31, 2021 period.

The SROs operate under the authority of the CSA pursuant to Recognition Orders to oversee dealer activities and include the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Funds Dealers Association of Canada (MFDA). The IPFs are granted the authority to provide coverage for financial losses suffered by eligible clients in the event of the insolvency of an IIROC or MFDA member and include the Canadian Investor Protection Fund (CIPF) and the MFDA Investor Protection Corporation (MFDA IPC).

Key CSA Activities

The CSA report that their oversight activities over the year included:

• Ongoing work on the plan to create a new single SRO consolidating the functions of the existing SROs, which we previously wrote about. This work is expected to be completed by the end of 2022. The CSA are also planning the integration of the CIPF and the MFDA IPC to operate as a combined investor protection fund separate from the single proposed SRO.
• Receiving regular updates from the SROs and IPFs about their operations and meeting their regulatory responsibilities while they have been working remotely due to the COVID-19 pandemic.
• Completion of a phased project to streamline and modernize Recognition Orders and Memorandums of Understanding to enhance SRO and IPF oversight in preparation for the new SRO framework.
• The implementation of enhanced methodology on April 1, 2022 to identify and improve the CSA methodology for coordinated oversight of SROs and IPFs, including updates to the risk assessment framework and introducing a concept of core "regulatory activities" to be examined at least once every 5 years, among others.
• Conducting a risk based desk review of IIROC targeting IIROC's Equity Market Surveillance and Debt Market Surveillance functions, which we previously wrote about.

CSA Assessment of SROs and IPFs

The CSA's oversight program for SROs and IPFs consists of an annual risk assessment, review and approval of proposed new rules and changes to existing rules and by-laws put forth by SROs or IPFs to ensure they meet the public interest, and meetings and discussions with the SROs (quarterly) and with IPFs (semiannually) to discuss emerging and ongoing regulatory issues and trends. A summary of key information, oversight activities and observations for each organization noted by the CSA is set out below.

IIROC Activities

IIROC oversees all investment dealer and trading activity on debt and equity marketplaces in Canada and is an approved information processor for corporate and government debt securities. The CSA noted the following from their oversight review of IIROC:

• Market Surveillance - enhanced software for market surveillance was implemented in March 2019 improving IIROC's ability to (i) quickly detect trading anomalies across multiple products, individual traders and firms and, (ii) identify and respond to emerging trends such as monitoring daily message and trade volumes more efficiently. Upgrades to market surveillance infrastructure resulted in increased server and storage capacity to handle up to 3 billion real time messages per day and 2 billion messages per day in the end-of-day processing (1 billion prior to the pandemic). Issues raised in the risk-based desk review were resolved to the satisfaction of CSA staff through enhancements to the market wide circuit breaker process for equity market surveillance. IIROC continues to assess the need for further enhancement to the process.
• Exemptive Relief - applications for exemptive relief for hardship experienced by dealers due to pandemic measures were streamlined with the approval of the CSA.
• Order Execution Only (OEO) Platform Service Levels - a working group has been established for an appropriate response to increased service level complaints from clients related to delays in opening new accounts, system response times and service disruptions that occurred during the pandemic.
• Crypto/Digital Assets - a member intake group was created in the summer of 2021 to review and assess applications from new crypto-asset trading platforms and existing IIROC dealers planning to expand into crypto asset products and services. The first IIROC dealer to offer trading and custody of crypto assets was approved in November 2021. IIROC intends to develop new guidance and standardized compliance procedures. However, interim guidance was published in March 2021 (which we wrote about here.)
• Cybersecurity Incidents - dealer members are required to report certain cybersecurity incidents to IIROC. Past support has been provided to help small and medium sized firms with preparedness and risk management. To address the increase in cyber attacks generally during the pandemic, further guidance has been issued on how to prevent, detect, respond to and recover from ransomware attacks.
• IIROC information Processor Order - in an effort to provide post-trade transparency to the Canadian debt markets, IIROC's role was expanded in 2021 to include the publication of information about all trades in corporate and government debt securities executed that were not already subject to reporting.
• IIROC's Plain Language Rules – revised Dealer Member Rules that have been written in clear, concise and organized plain language format became effective on December 31, 2021 and are now referred to as the IIROC Rules.
• Client Focused Reforms (CFR) - the CSA and both SROs harmonized their compliance modules specific to the CFR conflicts of interest requirements that became effective in June 2021. In addition to specific questions on the annual request of information form used to assess compliance risk, CFR conflicts of interest reviews are incorporated into the regularly scheduled business conduct compliance exams. A targeted CFR conflicts of interest sweep in coordination with IIROC and the MFDA is underway and a report of findings will be published to provide additional implementation guidance to the industry.

MFDA Activities

The MFDA oversees mutual fund dealers in Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia, Ontario Prince Edward Island, Saskatchewan, Yukon, Northwest Territories and Nunavut. Based on an annual risk assessment of the MFDA, an oversight review was not conducted for 2021. CSA staff note the following from meetings and discussions with the MFDA:

• COVID-19 Regulatory Relief - the MFDA's process for granting regulatory relief to members as a result of disruptions in business operations was assessed by CSA staff to ensure that relief was within the scope of the MFDA's authority and that reasons for granting relief were properly documented.
• Cybersecurity - external IT consultants were engaged to test security controls and assess the maturity of the cybersecurity framework. A mandatory cybersecurity survey issued to all members demonstrated that smaller members tended to have resource issues in dealing with cybersecurity but were relatively prepared and invested compared to other sectors.
• Client Research Project - as in past years, the reporting of client data was mandated to obtain insight into members business models, approved persons and their clients.
• Continuing Education (CE) - a CE requirement for mutual fund approved persons and a CE accreditation process commenced in December 2021.
• Client Focused Reforms - the MFDA will use information gathered from its regular examinations to review member firms' implementation of the enhanced conflicts of interest requirement. As mentioned above, these finding will be coordinated with the CSA and IIROC and will be published along with additional guidance.
• Performance Reporting Targeted Review - the findings from a 2020 targeted review of performance reporting for accounts with highly unusual positive or negative returns was published in July 2021.

CIPF Activities

CIPF was approved to provide protection to eligible clients of IIROC dealer member firms if client property held by the member firm is unavailable due to insolvency of the dealer member. Based on an annual risk assessment of the CIPF, a risk-based oversight review was not conducted for 2021. CSA staff note the following from meetings and discussions with the CIPF:

• Statement of Member Assets by Location (SMAL) - the requirement for member firms to file an annual SMAL was resumed after being temporarily suspended during the pandemic.
• Asset Level Adequacy - a credit-based fund model is used by CIPF to project its liquidity resource requirement and setting of its fund size. To ensure the adequacy of the level of resources available in relation to the risk exposure of member firms and mitigate volatility in liquidity resource requirements, CIPF is enhancing its model by recalibration of a stress multiplier and implementing a five-year weighted average methodology.
• Simulation Exercises – simulation exercises were conducted throughout the year to expand industry knowledge of financial institution bankruptcies, focusing on the manner in which operational strategies, tools and regulatory processes changed during the pandemic (such as virtual hearings) and how they could impact the handling of a member firm insolvency.
• Insolvencies - there were no IIROC member insolvencies involving CIPF in 2021.
• New Reporting Requirements - updated requirements came into effect in 2021, and include unaudited semi-annual financial statements, annual and semi-annual operations reports, and a 2022 financial budget.

MFDA IPC Activities

The MFDA IPC was approved to provide protection to eligible clients of MFDA mutual fund dealer member firms suffering losses as a result of insolvency of a mutual fund dealer member. As a result of the 2021 risk assessment a risk-based oversight review of MFDA IPC was not conducted for their 2021 activities. CSA staff note the following from meetings and discussions with the MFDA IPC:

• Fund Size Target - the MFDA IPC has achieved its targeted fund size of $50M. A secondary layer of $20M in insurance was added for any losses to be paid in excess of $50M, on top of the existing $20M for losses in excess of $30M.
• Insolvencies - there were no member insolvencies involving MFDA IPC in 2021.
• Simulation Exercises - simulation exercises were conducted for board members facilitated by external legal counsel and third-party consultants to go through key events and decisions requiring board involvement during an insolvency.
• Governance - a new code of conduct for MFDA IPC staff was implemented to strengthen governance controls aimed at helping to mitigate any potential conflicts of interest.
• New Reporting Requirements – new Approval Orders came into effect in January 2021updating reporting requirements.

The full Report can be found here.

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