Healthy competition fosters fair and efficient capital markets by creating an ecosystem that can provide more choice for investors and opportunities for entrepreneurs. The Taskforce envisions a regulatory framework that leads to a level playing field between small and large market participants, where an appropriate level of competition helps grow Ontario’s economy.

In our consultations, smaller intermediaries have noted the challenges and frustrations they face when they are unable to continue to assist their growing clients’ needs in accessing capital. To ensure an appropriate level of competition, the Taskforce includes recommendations that aim to increase capital raising opportunities for small intermediaries and increase the variety and quality of independent investment products available to retail investors.

Globally, the relationships between investors and issuers continues to evolve. Companies and their shareholders are realizing that diverse boards and executives provide more effective and capable oversight and strategic direction.

These recommendations are aimed to drive competition among intermediaries and products and provide investors with more choice in their investment decisions.

34. Enhance restrictions on tying commercial lending services and capital markets activities to facilitate growth of independent dealers and ensure issuer choice

Facilitating the incubation of entrepreneurial and venture issuers is critical for the growth of our primary market in Ontario. Independent investment dealers and issuers have repeatedly raised the issue of intermediaries engaging in practices that may impede competition, such as arrangements where a commercial lender requires clients to retain the services of an affiliated investment dealer for their capital raising and advisory needs, as a condition in commercial lending transactions. As a consequence, issuers do not maintain existing relationships with the independent investment dealer or exempt market dealer who intermediated their early capital raising activities.

Although tied selling is restricted under the Bank Act, as well as National Instrument 31-103, the Taskforce has heard repeatedly from dealers and issuers that commercial lenders, through their affiliated dealers, continue to engage in these practices. We heard from multiple stakeholders that these practices are having significant negative impacts on the viability of independent dealers and on the ability of issuers to receive independent advice and on competition. However, we also learned that some intermediaries indicate that their bundling of capital markets services and other services may result in lower financing costs for issuers.

Furthermore, the Taskforce heard that some commercial lenders and their affiliated investment dealers calculate their return on capital across product lines. Then, in order to meet an internally specified client threshold return, they are requiring issuers and clients to which they have extended credit to transfer capital markets business to their affiliated investment dealer.

In addition, it may not always be in the best interest of issuers to procure their underwriting and advisory services from their lender — they may benefit from independent advice.

Recommendation:

To address this concern, the Taskforce recommends the following:

1. Enhance the Tied-Selling Restriction in National Instrument 31-103

The Taskforce recommends making legislative amendments to Ontario securities legislation, including amendments to National Instrument 31-103 and/or through the adoption of a local rule, to prohibit registrants, as a consequence of an exclusivity arrangement, from providing capital markets services under certain circumstances.

An exclusivity arrangement would be defined to exist when:

  • There is an outstanding loan, a loan proposed to be made or the continuation of an outstanding loan including any modification thereof, with an issuer or any affiliate; and
  • In connection with such loan, a bank practically or legally imposes a requirement for such a loan to be made or maintained pursuant to an agreement, commitment, or understanding that an affiliate of the bank (typically a bank-owned dealer) be retained to provide capital markets services, as defined, for the issuer or an affiliate thereof, or be required to be retained for future capital markets services.

Capital markets services would be defined to include debt and equity financing activities such as acting as a dealer or underwriter in an equity or debt offering or negotiating a new or existing credit facility, as well as M&A advisory activities such as providing a fairness opinion on a transaction.

The Taskforce believes that providers of capital markets services should compete on their merits and that an issuer should be free to choose the registrant that best suits its needs without a concern that its choice of registrant may negatively impact the availability of credit to the issuer. Accordingly, it would be prohibited for a registrant affiliated with a commercial lender to provide capital markets services to an issuer in circumstances such as the exclusivity arrangement defined above, where the affiliated commercial lender has previously tied a decision to extend, renew or limit credit to the issuer on whether the issuer provides capital markets business to the affiliated registrant.

2. Attestation

A senior officer of a registrant such as the Ultimate Designated Person, would be required to attest that no such prohibited conduct has occurred each time the registrant provides such capital markets services to a reporting issuer with whom the affiliated commercial lender has a banking relationship.

As part of the attestation, the registrant should engage with the affiliated commercial lender to ensure that such conduct did not occur. The Taskforce would expect that commercial lenders provide meaningful support and cooperation to their affiliated registrant firms in complying with this attestation requirement. If it becomes apparent that this is not occurring, the OSC should consider imposing terms and conditions on the registration of the affiliated registrant that would restrict its ability to act as a dealer or underwriter in offerings involving an issuer that has a relationship with a commercial lender affiliated with the registrant.

3. Amend NI 33-105 to require an Independent Underwriter with a Connected Issuer

The Taskforce recommends that the OSC work with the CSA to amend National Instrument 33-105 and/or through the adoption of a local rule to require an Independent Underwriter in prospectus offerings:

  • The issuer would be considered a “connected issuer” to one or more of the underwriters involved in the offering by virtue of any commercial lending relationship between an affiliate of the underwriter and the issuer.

The Taskforce recommends adding a definition that considers an issuer that has a commercial lending relationship with an affiliate of the registered firm as a “connected issuer” and thus, under the new amendment to NI 33-105, at least one Independent Underwriter would be required in a syndicate. The Independent Underwriter would be required to underwrite at least 20 per cent of the offering or receive at least 20 per cent of the total fees. These steps are carefully tailored to ensure that this requirement would be in line with provincial jurisdiction over registrants.

The Taskforce recommends that the OSC work with the CSA to update the Companion Policy to NI 33‑105 to clarify that commercial lending relationships that would rely on the underlying credit of the issuer would be presumed to give rise to a connected issuer relationship.

Where part or all of the proceeds of the offering are intended to be used to repay indebtedness to a commercial lender affiliated with an underwriter involved in the offering, there exists an acute potential conflict of interest between the underwriter and the issuer. In these cases, the role of an independent underwriter in structuring and pricing the transaction is particularly important. Accordingly, the OSC should consider introducing a new requirement that an independent underwriter act as the lead manager or co-lead manager (or “bookrunner” or “co-bookrunner”) for offerings in these circumstances.

For greater clarity, if the proceeds of the underwriting are used to pay down a commercial loan (of a syndicate member), the Independent Underwriter would then be required to be a book runner.

4. Ban on Restrictive Clauses

Finally, where a registrant of an affiliated lender provides capital markets services, the Taskforce recommends a ban on certain restrictive clauses in capital markets engagement letters. This includes agreements that restrict a client’s choice of future providers of capital market services (as defined above), such as “right to act” and “right of first refusal” clauses, where a commercial lending and capital markets relationship exists. This would align with the U.K. Financial Conduct Authority’s similar enacted ban in 2017.

The above recommendations in relation to the provision by registrants of capital market services to issuers are focused on non-investment fund issuers and exemptions for investment funds should be provided where similar competitive concerns do not arise.

These recommendations would create competition in Ontario’s capital markets, incubate a diverse and healthy intermediary market and increase choices for issuers, without dampening existing economic activities. The objective of these recommendations is to significantly increase the amount of competition in Ontario’s capital markets. In this regard, the Taskforce recommends that the OSC be mandated to review the effectiveness of these recommendations in achieving this objective after implementation. If it is determined that the recommendations are not having the intended outcome, then the OSC would proceed with further reforms.

35. Increase access to the shelf system for independent products

Ontarians saving for their retirement should have access to the best products available in the market, given their personal financial position, sophistication and circumstances. Currently, a majority of the distribution of investment products to investors is through bank-owned shelf distribution channels. There have been concerns raised that such product shelves incentivize the sale of proprietary products and restrict access to products from independent product manufacturers. In the case of smaller independent manufacturers, their products are often suggested to be of higher risk and, as such, excluded from the shelf.

In October 2019, the OSC released the CFRs, which include conflicts of interest requirements that, as of June 30, 2021, will require dealers that offer independent products in addition to related products to ensure that their shelf development and know-your-product processes, as well as their advisors’ product recommendations, are not biased towards proprietary products.

Recommendations:

The Taskforce supports the OSC’s CFRs initiative. It is critical that recommendations in this area support the CFRs and the requirement that all registered firms address conflicts of interest, including those related to product shelves and the sale of proprietary products, in the best interest of their clients. The Taskforce recommends increased OSC and SRO oversight of product shelf issues, including targeted reviews and publication of guidance regarding conflicts of interest as a result of shelf composition.

The Taskforce recommends the following measures be taken, in addition to the CFRs, to help ensure that conflicts of interest relating to product shelf development are addressed in the best interest of clients and that there is a level playing field for all products in gaining access to distribution channels and competing on their merits as investment products.

1. Guidance on New Product Committees

The Taskforce recommends that the OSC publishes guidance to address product shelf issues and outline the makeup of New Product Committees. This guidance would prohibit input from related and proprietary product divisions in the decision-making of these committees. As well, New Product Committees should include dealing representative representation. In addition, the Taskforce recommends that dealers with open shelves be required to consider new securities to be made available to clients where those securities are proposed for inclusion on the shelf by their dealing representatives, and that they include them on their shelves unless there is a reasoned basis for exclusion.

2. Title Clarification for Proprietary Product

Investor protection stems from an effective compliance system, which includes disclosure obligations, and is established through internal controls. Any firm selling proprietary products is required to have internal controls that address the material conflicts of interest raised by selling proprietary products. It is critical that investors are aware that they are not receiving independent advice when purchasing in a proprietary channel. To assist with investor awareness, the Taskforce recommends that the OSC work with the SROs to develop a regime that will clarify titles for all registrant categories and will provide additional clarity to investors with respect to proprietary channels.

3. Shelf Documentation and Proprietary Product Tracking

The Taskforce recommends that all dealers that sell proprietary products be required, by OSC rule, to document, in detail, their rationale when independent products are refused access to their product shelves. The Taskforce also recommends, by OSC rule, that dealers that sell proprietary products report to the OSC, on a quarterly basis, the percentage of proprietary versus independent products on their product shelves, segmented by channel and product category, and the percentage of proprietary versus independent products sold to clients in the same format. The OSC shall in turn publish a summary of these findings on an annual basis.

4. Independent Manufacturer OSC Reporting

Independent product manufacturers should be encouraged to report to the OSC, on a confidential basis, instances where their products are refused access to a product shelf and the Taskforce recommends that the OSC track this information. The OSC should provide a dedicated channel and format for these concerns to be submitted.

5. Limited Market Check

As part of the OSC/SRO compliance reviews, the Taskforce recommends that OSC/SRO review the findings of a limited market check analysis (outlined below) conducted by the dealer and the remediation implemented by the dealer to ensure that the analysis is robust and the remediation is suitable and timely.

All dealers that offer proprietary products must have a process in place to, on an annual basis:

  • Conduct periodic due diligence on a number of comparable unrelated products available in the market;
  • Evaluate whether the proprietary products are competitive with the alternatives identified, by examining factors including cost, risk and returns; and
  • Determine what action the dealer should take in respect of its proprietary offerings or otherwise if it determines that those proprietary products are not competitive, in order to demonstrate that it has addressed conflicts of interest associated with offering proprietary products in the best interest of clients.

Dealers would be able to discharge this requirement in a way that is proportionate to the size and scope of their product offerings. Records must be kept by dealers of the due diligence, evaluations and outcomes under their processes, and these would be examined during OSC/SRO compliance reviews. In their evaluations, dealers must exclude any discounts on execution costs that they provide to clients for purchases and sales of securities of related products from consideration when conducting a cost analysis of comparable unrelated products.

The objective of these recommendations is to significantly increase non-proprietary products in distribution channels. The Taskforce is mindful that these measures and CFRs may lead some institutions to consider closing or narrowing their product shelves. However, it is in the public interest that distribution channels are open architecture, including both proprietary and non-proprietary products. In this regard, the Taskforce recommends that the OSC be mandated to review the effectiveness of these recommendations in achieving this objective within three years after implementation. If it is determined that the recommendations are not having the intended outcome then the OSC would proceed with further reforms, including banning proprietary channels.

36. Improve corporate board diversity

In accordance with National Instrument 58-101 Disclosure of Corporate Governance Practices, since 2014, TSX-listed companies have been required to disclose their approach to gender diversity, including data regarding the representation of women on boards of directors and in executive officer positions. The disclosure follows a “comply or explain” model and does not require TSX-listed companies to adopt any gender diversity policies and practices, including targets. Progress has been slow, with the OSC reporting that the total board seats occupied by women in their review samples only increased from 11 per cent in 2015 to 17 per cent in 2019.footnote 41 Based on the CSA’s 2019 review, only 22 per cent of companies in their review sample had adopted targets regarding the representation of women on boards.footnote 42

A recent study by Catalyst and the 30% Club Canada found that in 2019,footnote 43 women only represented 19.4 per cent of boards and 17.0 per cent of executive teams in companies that disclosed themselves as TSX‑listed issuers. A recent study highlighted that of the 213 CBCA companies that disclosed board diversity data, only 5.5 per cent of all directors were visible minorities. Indigenous directors and directors with disabilities made up 0.5 per cent and 0.4 per cent of board diversity, respectively.footnote 44

Investors are increasingly demanding data on diversity on boards and in executive officer positions to make informed investment and voting decisions.footnote 45 As of this year, all public companies governed by the CBCA are required to report representation of the following designated groups on boards of directors and in senior management: women, Indigenous peoples, persons with disabilities and members of visible minorities. Diversity disclosure information must be sent to shareholders (with the notice of the meeting) and Corporations Canada.footnote 46

From the Taskforce’s public consultation, many commenters support corporate board diversity beyond gender and agree that board renewal is important to enhancing diversity.

Recommendation:

The Taskforce recommends:

1. Board Diversity Targets and Timelines

Amend Ontario securities legislation to require publicly listed issuers in Canada to set their own board and executive management diversity targets (aggregated across both groups) and implementation timelines, and annually provide data in relation to the representation of those who self-identify as women, BIPOC, persons with disabilities or LGBTQ+ on boards and executive management. For greater clarity, this would apply to directors and executive management, the latter of which is defined as those who are executive officers or Named Executive Officers of publicly listed issuers.

The Taskforce recommends that publicly listed issuers set an aggregated target of 50 per cent for women and 30 per cent for BIPOC, persons with disabilities and LGBTQ+. Implementation of these targets should be completed within five years to meet the target for women and seven years to meet the target for the other diversity groups, placing specific focus and emphasis on representation of Black and Indigenous groups.

2. Written Policy for Director Nomination Process

Amend Ontario securities legislation to require publicly listed issuers to adopt a written policy respecting the director nomination process that expressly addresses the identification of candidates who self-identify as women, BIPOC, persons with disabilities or LGBTQ+ during the nomination process.

3. Maximum Board Tenure Limits

Amend Ontario securities legislation to set a 12-year maximum tenure limit for directors of publicly listed issuers, with an exception for: (a) 15-year maximum tenure limit for the Chair of the board; (b) non-independent directors of family-owned and controlled businesses, where such nominees represent a minority of the board; and, (c) no more than one other director who will be deemed not to be independent, and will still have a 15-year limit. Issuers must implement this recommendation within three years of this amendment taking effect. This is aimed to encourage an appropriate level of board renewal. The issue of board entrenchment and board renewal is a concern from a governance perspective as continued refreshment of the board helps to ensure that independent, fresh and diverse perspectives and skills are brought into the boardroom.

4. Diversity at the OSC

The Taskforce recommends that diversity — including racial diversity — be similarly represented at the board and executive level of the OSC, which will be responsible for discharging this important mandate. As part of the OSC’s Statement of Priorities (which was published for consultation in November 2020), the OSC committed to take actions as outlined in the Black North Initiative CEO pledge to end anti-Black racism.

37. Introduce a retail investment fund structure that pursues investment strategies in less liquid private equity and debt markets, including in early-stage businesses

The Taskforce heard that there is a funding gap for small issuers that want to raise capital for their business and that it is becoming prohibitively costly for an issuer to become publicly listed. In addition, there are many retail investors who want to invest in these types of investments. However, retail investors are often prohibited by securities regulation from investing in early-stage, private market opportunities and have difficulty navigating a complex environment.

Institutional and high net worth investors have increasingly been allocating investment capital to private market opportunities — an investment space that remains largely inaccessible to retail investors. There has been an increasing trend for private companies to stay private longer, thereby creating even further disparity between retail and non-retail investor experiences…the OSC should be focused on promoting a broader range of investment accessibility and choice for retail investors.

AGF Management Limited / AGF Investments Inc.

Retail investors often require the investment expertise of asset managers using established distribution channels of public funds. The same investment fund model that has been used in the public markets, which provides retail investors with cost-effective and diversified investments can be further applied to the private markets.

Through the consultations, many stakeholders were supportive of providing retail investors with access to private equity investments, provided that appropriate investor protection mechanisms are incorporated.

Recommendation:

The Taskforce recommends that the OSC establish a retail private equity investment fund proposal for public input to incorporate private equity investing best practices, and the advantages of the retail investment fund model. This proposal should examine other jurisdictions for examples, such as the interval fund concept in the U.S. Such a proposal must be appropriately balanced with investor protection safeguards.

In traditional mutual funds, investors have the right to redeem on a frequent basis, so mutual funds must be primarily invested in liquid investments to meet those redemption obligations. In an interval fund, retail investors do not have the right to redeem. Instead, the fund has the control to provide liquidity to investors at pre-determined times (e.g., every three, six or twelve months) by offering to buy back a stated portion of its shares (typically 5 per cent to 25 per cent) from investors. Investors are not required to accept these offers.

Given the periodic repurchase schedule of an interval fund (as opposed to the daily redemption associated with a conventional mutual fund), portfolio managers can take a longer-term investment view and take advantage of investing in less liquid, potentially higher-return asset classes that may not be suitable for a conventional mutual fund offering daily liquidity. This may enable a portfolio manager to invest in more “private equity” type investments.

Footnotes