Ontario is making great strides to create a favourable innovation and FinTech ecosystem. However, the continued rise in market participants with innovative business models and the evolution of new types of digital assets, necessitates that Ontario’s capital markets regulatory regime continue to adapt to emerging business models and products.

Stakeholders support the need for a nimble and flexible regulator that embraces new and novel products and services. In response to stakeholder feedback, the Taskforce recommends, among others, that the regulators create an Ontario Regulatory Sandbox that would benefit companies with innovative business models, a strategic focus of the OSC’s Office of Economic Growth and Innovation to facilitate economic growth and innovation, and allow greater access to capital for start-ups and entrepreneurs through the assistance of angel groups.

…innovation is playing an important and growing role in Ontario’s economy and regulation needs to support this.

Toronto Finance International

Fostering innovation in Ontario’s capital markets not only helps attract new businesses to Ontario, but also global investment into Ontario businesses.

49. Create an Ontario Regulatory Sandbox to benefit entrepreneurs and in the longer-term, consider developing a Canadian Super Sandbox

Many securities regulators, including the OSC, having recognized the emergence of FinTech, have established dedicated teams to provide further regulatory guidance and assistance to businesses with innovative business models.

Globally, regulatory sandboxes have allowed businesses to test new and innovative products, services, business models and delivery mechanisms with real consumers through expedited blanket relief orders. Sandboxes have been introduced by international regulators, such as the U.K. Financial Conduct Authority and the Australian Securities and Investments Commission, to encourage new and established companies to introduce innovative financial products and services to the market.

Through the Taskforce’s consultations, stakeholders were supportive of the sandbox proposal that would help spur the growth of start-ups and businesses with innovative models. Stakeholders suggested that further collaboration with industry and market participants would be beneficial in developing and ensuring the success of the sandbox testing in Ontario.

Recommendation:

As part of the Ontario Regulatory Sandbox, the OSC and FSRA should design an approach that would offer rapid exemptive relief or use other available regulatory tools to permit companies with innovative business models operating across the financial services sector in Ontario to test new financial services and products. There are several business models that are subject to regulatory oversight that overlaps between the OSC and FSRA.

This new sandbox should allow businesses to test new and innovative products, services, business models and delivery mechanisms in the real market, with consumers:

  • The Ontario Regulatory Sandbox should be a supervised space that provides businesses with:
    • Reduced time-to-market at potentially lower cost;
    • Appropriate consumer and investor protection safeguards built into new products and services; and
    • Tools such as restricted registration, guidance, and exemptions.
  • The sandbox tests would be:
    • Inclusive of firms participating in different aspects of the financial services sector, ranging from capital markets activity (regulated by the OSC) to sectors such as insurance and mortgage brokering (regulated by FSRA); and
    • Time- or customer-limited, so businesses could test their innovation for a limited duration or with a limited number of customers. This may be achieved through: (i) blanket relief orders applicable to a group of similar businesses, (ii) relief orders applicable to a single business, or (iii) in limited circumstances, “no action letters.”
  • The Ontario Regulatory Sandbox would also provide the province’s two primary financial services regulators with greater opportunities to collaborate and identify areas where they could evolve regulatory requirements to better reflect the changing needs and abilities of businesses operating in this new era of digital innovation.

The Taskforce recommends that the OSC and FSRA continue engaging with market participants, such as new and existing start-ups and incubators/accelerators, so that the sandbox not only sufficiently identifies and addresses challenges and concerns faced by businesses, but also balances the need to protect investors, and maintain fair and efficient capital markets.

In the longer term, the Taskforce recommends considering an expansion of this Sandbox into a Canadian Super Sandbox in which all provincial and federal financial services regulators allow Canadian financial services businesses to test their innovative ideas. This would spur innovation nationally.

Within five years after the implementation of the Ontario Regulatory Sandbox, the OSC and FSRA must consider if this initiative merits continuation or can be eliminated.

50. Highlight that a strategic focus of the OSC’s Office of Economic Growth and Innovation (Innovation Office) should be on facilitating economic growth and innovation, including being an advocate for smaller innovative businesses, and expand the range of the Innovation Office’s services

In June 2020, the OSC announced the launch of the Innovation Office aimed at expanding the work of OSC LaunchPad through deeper engagement with businesses and support for a strong innovation ecosystem in Ontario. It will be accountable for driving the implementation of the initiatives set out in the OSC’s 2019 Reducing Regulatory Burden in Ontario’s Capital Markets report, and for driving other changes to its rules, regulatory operations or processes to reduce burden. In addition, the Innovation Office will conduct extensive outreach with the market, innovation hubs, other regulators and government to identify opportunities for the OSC to champion innovation and economic growth.

Aside from providing a more innovative regulatory environment for FinTech businesses, an expansion of the Innovation Office’s services would also align with and support the recommendation to expand the OSC’s mandate.

Recommendation:

The Taskforce recommends that the Innovation Office place a primary strategic focus on facilitating economic growth and innovation, including fostering and testing new and innovative methods to improve transparency in financial product intermediation, improving the cost-benefit of providing investment advice and advocating for smaller innovative businesses.

Similar to the U.S. Securities and Exchange Commission’s Office of the Advocate for Small Business Capital Formation, and its Strategic Hub for Innovation and Financial Technology, recently announced by the SEC to become a stand-alone office, the new Innovation Office should also consider:

  • Identifying and researching challenges that smaller businesses, including those with innovative business models, experience when raising capital;
  • Conducting outreach to businesses and their investors to solicit views and solutions to lower access and trading costs, increase transparency and foster capital formation issues;
  • Assisting business, including innovative and smaller businesses and their investors in resolving significant problems with capital markets regulation; and
  • Identifying capital markets regulation changes that would benefit smaller and innovative businesses and their investors.

In addition, to provide greater support for businesses participating in the Ontario Regulatory Sandbox, the Taskforce recommends that the Innovation Office should seek more timely input and feedback on its services.

Examples of services the Innovation Office may consider include:

1. Enhanced Engagement with the Innovation Community

The Innovation Office could consider more in-depth engagement with venture capital firms, law firms, advisors and angel investors to create a community for novel businesses to assist early-stage companies.

For example, akin to matching services, partnerships with external organizations such as incubators and accelerators that have resources for early-stage businesses looking for business expertise and capital; and legal and advisory service providers that provide start-ups with access to legal services in areas such as capital raising, preparing offering documents, and intellectual property and patents.

2. Educational Resources

The Innovation Office could also host webinars and develop e-learning resources targeted at addressing common issues that innovative businesses face in their early stages for topics including, but not to, limited registration process and requirements and capital raising for start-ups, such as preparing offering documents.

These educational resources may later also be made available to all businesses and not only to FinTech companies.

3. Regulatory Technology (RegTech) and Supervisory Technology (SupTech) Tools

The Innovation Office should consider how RegTech and SupTech solutions such as automated compliance tools can benefit market participants and the OSC. For example, technology solutions that assist firms in onboarding clients, including digital identity, fulfilling Know-Your-Client obligations and conducting suitability assessments would reduce the regulatory burden (potentially duplicative efforts and resources being expended). SupTech solutions may help to improve the OSC’s regulatory oversight and enforcement, as well as enhancing investor protection.

These RegTech tools may later be accessible to other businesses outside of FinTech.

The recommended services could be expanded so that all businesses, regardless of sector affiliation, can take advantage of the added support

51. OSC to consider how an open data framework could be applied to Ontario’s capital markets

Advancements in technology have not only assisted businesses to operate more efficiently and seek new and innovative business models, but also enabled the distribution, collection and sharing of data globally and instantaneously. Open data is defined as structured data that is machine-readable, freely shared, used and built on. Data governance standards are required to maintain the integrity and confidentiality of data. One of the primary benefits of open data is its support and alignment with fostering innovation and building technology solutions. Many FinTech solutions require open data to create efficiencies and offer better technology solutions for businesses and services to customers/investors.

In July 2020, it was announced that 31 financial services organizations joined in participating in the launch of the Financial Data Exchange (FDX) in Canada, including banks and credit card companies. These organizations are committed to working together to develop a secure, common, interoperable, flexible and royalty-free industry standard for financial data sharing.footnote 53

Through the consultations, stakeholders agreed with the importance of having data and the role it plays in fostering innovation, but suggested further study is required to develop an open data framework.

Recommendation:

Other global jurisdictions, including the U.K. and E.U., mandate open data to increase competition and promote alternatives to consumers giving them choice, while other jurisdictions, such as Japan, India and Singapore, have promoted data-sharing arrangements. Data sharing is also consistent with privacy principles generally accepted in developed countries that data belongs to the client and not the institution gathering the data.

Given the complexity of open data, the OSC should work with capital market participants and federal regulators to consider developing an open data framework outlining details including, but not limited to, the scope of open data, data protection, and the level of industry participation.

Data sharing arrangements can then be further encouraged and facilitate more FinTech solutions for businesses (thereby reducing costs and minimizing duplication of processes) and investors. Greater accessibility to data would assist businesses in providing new products/services and long-term solutions to support innovative business models, but it must be done while key concerns, such as data protection, privacy standards, and investor protection, are not compromised.

Any appropriate safeguards must be put in place to ensure privacy concerns are addressed during the implementation phase. The development of an open data framework should also consider any existing and new national and provincial open data initiatives.

An area of consideration may be to create a test environment with synthetic data, similar to the approach currently being undertaken by the FCA in the U.K. As part of the FCA’s DataSprint, the FCA collaborated with over 120 participants, including organizations, researchers and data scientists, to create a synthetic ecosystem of financial data that produced reference data for millions of synthetic individuals and businesses, including investor profiles and transaction data. The synthetic data will be made available in a Digital Sandbox Pilot for participants to utilize the financial datasets and develop products and solutions that would benefit the U.K. financial services industry.

52. Allow for greater access to capital for start-ups and entrepreneurs

The COVID‑19 pandemic has reinforced the importance of capital formation for start-ups and entrepreneurs in ensuring a sustainable economic growth. Formal angel investor groups or networks may be viewed as “investment clubs” for accredited investors. They attract quality earlier-stage issuers for investment consideration, professionalize and share due diligence, share domain knowledge and assist in reducing the cost of capital. Angel investor groups generally invest in a diversified portfolio of start-up businesses, where smaller investments are made by many investors, thereby mitigating risk.

Angel investors are not clients of their angel groups, as they make their decisions on an independent basis, and they provide scarce early-stage funding and mentorship to entrepreneurs. Certain angel groups seek to be structured to earn a fee from working with their members to collaboratively finance these start-ups, which may, in certain circumstances, trigger registration under the traditional concept of registration.

Through the consultations, stakeholders were supportive of additional capital-raising opportunities for start-ups and entrepreneurs and some agreed with providing relief from registration requirements, subject to conditions.

Recommendation:

The Taskforce recommends that the OSC modernize the rules to support early-stage financing of start-ups that can be undertaken by angel groups to assist with capital formation. Amendments to the current registration requirements would enable angel groups to work with their “accredited investor” members to encourage investments in early-stage issuers. To prevent any circumvention of registration requirements, in the short term, the OSC could consider providing blanket order relief or discretionary relief to angel groups that meet certain specific criteria.

As suggested by stakeholders, key criteria could include but not be limited to the following:

  • The angel organization must be a not-for-profit organization;
  • The angel organization must limit its membership to accredited investors;
  • No promotion of any investment takes place;
  • No advice is given on the suitability of any investment opportunities and no activity akin to advising activity is provided to investors;
  • Fees collected by the angel organization are limited to reasonable membership fees for the ongoing operational expenses of the angel organization; and
  • The angel organization cannot hold, handle or have access to investor funds or securities.

This recommendation recognizes that angel networks may be able to help bridge financing gaps that early-stage businesses face.

53. The CSA should conduct its planned consultation on the regulatory framework concerning the distribution of and access to equities market data and initiate a consultation around other impediments to an efficient and competitive exchange environment

The capital markets have evolved over time, from a structure in which trading in a particular security was concentrated on a single listing exchange to one in which multiple marketplaces compete for trading in the same securities and the exchanges compete for listings. This has meant that having access to real-time equities market data from multiple marketplaces is a necessity to both trade effectively and service investors appropriately. However, costs associated with access to and use of that data have escalated due to the increased number of marketplaces charging for data, the variety of data fees charged and the lack of an oversight mechanism to bring the cost of real-time consolidated market data to a reasonable level.

This has led nearly all Canadian dealers to only provide real-time market data of the listing exchange to their investment advisors and self-directed retail investors. Proprietary traders and institutional investors, on the other hand typically have access to real-time consolidated market data. In addition, proprietary traders with multiple trading systems are often charged multiple times for access to the same exchange data.

Many stakeholders have raised concerns fact that a large number of Canadian investors have no access to real-time consolidated equities market data, including fairness (i.e., is real-time market data available to all on a fair and consistent basis), quality of execution (i.e., many dealers post limit orders on the listing exchange so that their clients are able to see them — which hinders exchange competition), and transparency of volume traded (i.e., the ability for investors to see the full liquidity and activity of a security or ETF).

Most market participants argue that the consolidated fees charged by marketplaces for data are too high, while a few take the position that the value of the data has increased because of changes to the business models of intermediary firms, such that the fees charged are warranted.

In the U.S., the Securities and Exchange Commission enforces display requirements whereby all investors have access to real-time consolidated equities market data and works with equities marketplaces on appropriate pricing and revenue allocation models. Other global regulators (such as the European securities regulators and the International Organization of Securities Commissions) are examining issues regarding access to market data, including fairness, value and fees.

Stakeholders noted other impediments to an efficient and competitive Canadian marketplace, including issues around market close auctions and national indices being calculated using only listing market data.

Recommendation:

The CSA’s approach is to examine the issues relating to equities market data by:

  • Assessing the changes in market data use and costs since the introduction of marketplace competition;
  • Assessing whether the current regulatory requirements that contribute to the need to use market data continue to be appropriate; and
  • Assessing whether the current model for consolidated market data in Canada, including the role of the information processor continues to be appropriate.

The Taskforce notes that the CSA through the OSC has already commenced a review of these issues, including through informal consultation with industry stakeholders.

The Taskforce recommends that the CSA complete its review and undertake a formal public consultation on the regulatory framework concerning the model for the distribution of and access to equities market data, with a particular focus on:

  • A model of market data availability that promotes fair, cost-effective access to individual marketplace and consolidated information;
  • The availability of timely consolidated data at a reasonable cost, especially for investment advisors and retail investors; and
  • Access that promotes fair competition among marketplaces and users and looks to reduce barriers to competition among exchanges.

The Taskforce acknowledges that the issues associated with access to market data and the possible resolutions are dependent on local regulatory requirements, including models of consolidation, and the business models of the market data users. However, addressing these issues is key to instilling confidence in Ontario’s capital markets. Further consultation of stakeholders that would inform potential changes to the regulatory framework will ensure a fairer and more efficient model for the provision of market data. An increased availability of consolidated market data at the right cost may enhance investor protection and reduce costs for all intermediaries. The recommendation is critical to leveling the playing field between retail and professional investors.

54. OSC to conduct a review of the impacts of marketplace outages

There have been a number of issues highlighted in recent years relating to marketplace outages. One key issue relates to the ability of trading to migrate to other marketplaces. This trading network redundancy is important for a variety of reasons, including facilitating ongoing price discovery and ensuring that all market participants, including retail investors, can continue to have uninterrupted access to Canadian capital markets.footnote 54

However, in the event of a marketplace outage, this migration of trading does not always occur as anticipated and the option to execute orders elsewhere may not always be available for all market participants. This issue may be particularly acute for retail investors and retail investment advisors. There may be a variety of reasons why trading does not efficiently migrate to other marketplaces including, but not limited to, access to market data from all marketplaces, lack of cancel messages from the affected exchange, availability of certain order types only on some marketplaces, and operational and risk management issues.

Another issue relates to the impact on the closing price of a security where there is an outage of the listing marketplace. This is particularly important where the market-on-close facility does not operate at the end of the day and the closing price of a security is not determined. In the past, the alternative used has been the last sale price of the security on the listing marketplace. However, as there are multiple marketplaces, this is not an optimal solution.

Recommendation:

In light of these concerns, the Taskforce recommends that the OSC undertake a review of the impacts of marketplace outages, including the impediments that challenge the immediate movement of trading between marketplaces and the effect of the outages on the closing price for securities. The Taskforce recommends significant focus be placed on the impact to retail investors resulting from marketplace outages and resolving the impediments to retail orders being migrated to other exchanges.

Footnotes