The Exempt Market in Canada: Empirics, Observations and Recommendations

There is a massive and vital capital market at work in Canada — possibly bigger than rough estimates have so far suggested — and it is one for which several market regulators are preparing new rules. Yet the remarkable thing is how little we know about it. Data about the so-called exempt market are so lacking that were regulators in Ontario and the other provinces contemplating new exempt-market regulations to proceed, they would be creating policies based on anecdotal, incomplete and, potentially, incorrect evidence. Even estimating the size of the Canadian exempt market has been an inexact science, given the incomplete data, but we can estimate that it provides in excess of $100 billion in gross capital flow every year, and that amount continues to grow. While it may be natural to assume that the exempt market is used primarily by small and medium-sized enterprises, it seems it is primarily used by the financial services industry. These institutions appear to rely on the exempt market to raise potentially short-term debt capital relatively free of particularly burdensome information-disclosure requirements. Unfortunately, we are forced to rely here again on deductions based on limited evidence: So incomplete are the data about the exempt market that we lack even complete information on the type of issuers, investors and securities, or the volume and duration of the securities and the level of redemptions. The exempt market exists for important reasons: it is a way out of the regulatory conundrum, wherein the regulator’s mandate to protect investors, through significant requirements for information disclosure, can put too large a burden on certain issuers. That is why it is essential that any new regulations are developed using a thorough understanding of how it operates. Yet the reality is that it is impossible to evaluate how individual investors and small firms are using the exempt market, or their experience in it. This is disconcerting, given that the very logic behind regulating this market is to allow the cost-effective and efficient matchmaking of sophisticated, higher-risk capital to firms unable to access capital through other means. If minimal or no data are available for analysis (as is currently the case), there is no way to tell whether this is in fact happening. This should be rectified before new regulations are imposed. Provincial jurisdictions and major market participants should co-operate to form an “exempt market data repository” to collect structured data, funded through a small fee, based on the size and type of issue. This repository should allow for segmentation by industry, size of issuer, and by whether it is a reporting issuer or not, and it should provide detail on the size of each issue, the types of security, the intended use of the capital, and the liquidity and duration of the security, as well as requiring notification of redemptions. Reporting the costs of intermediation should be mandatory and the accumulated data should indicate the type of investor (segmented by categories such as “accredited” or “eligible”) as well as the investment size and type. Of course, none of this should become so costly as to render the exempt market prohibitive to the issuers who rely on it. Nor should it necessarily lead to more onerous regulations. Indeed, another important priority must be a broader debate over the very role of a securities regulator when it comes to regulating capital flows between investors and issuers. But at a very minimum, regulators should be able to make available to investors useful information about how a market operates. Unfortunately, when it comes to the exempt market, that responsibility is the very area where Canadian regulators have so far proved to be remiss.