Humans naturally take risks in the hope of profit and those profits are the source of the immense wealth of modern society. Animals too, looking for food, take risks. But the human version is refined, and divided into legal categories like investment, gambling, insurance, and trading. Regulation of these risk-taking activities is almost as ancient as business itself. In Hammurabi's Code from 4000 years ago:
If a businessperson entrusts money to a broker for an investment, and the broker suffers a loss in his journey then he shall make good on the capital to the businessperson.
This is Part 1 of a multipart article series.
The Hidden Law of Speculation
Law of Speculation is the regulation of risk. It's commonly thought of as distinct areas of law by lawyers who don't see any connection between gambling and investment, or between all of the areas of risk that create opportunities for entertainment, profit, risk management, or innovation.
Without knowing the law, people have a great understanding of which uses of their money are likely to fluctuate in value and maybe increase (or decrease). Gambling is risky. Buying a house in a property market increasing by 20% a year is risky. The stock market is risky. Insurance (selling risk to a well-capitalized company) reduces risk for the insured but increases the risk of the insurance company. At the core of all of these is risk, and its regulation can be dramatically improved by recognizing risk as the shared concept.
A unified Law of Speculation in Canada that pushes out historic laws made for a different century (pre-Internet, pre-globalization, pre-computer) would improve investments, boost incomes, address social problems like addiction, and enable Canada to build a new multi-billion export market.
The remainder of this article sets out the goals of the current system of regulation, problems with today's system, economic axioms, and why a new approach is urgently needed. Part 2 will explain parts of the solution that should be considered for legislation.
Goals Of The Current System
Canada's disparate laws regulating risk usually have as their goals:
1. Stopping people from taking on large risks that are too much for them to bear
2. Stopping companies from defrauding their customers
3. Stopping companies from charging customers prices that aren't fair
4. Stopping unapproved companies from gaining market access
5. Stopping companies from creating hard to understand risks that might affect the system
6. Creating government agencies with supervisory capacity
Example laws include the Ontario Securities Act, Quebec's Derivatives Act, the Criminal Code of Canada prohibitions on gambling, the Insurance Act in Ontario, the Ontario Real Estate and Business Brokers Act, and delegated authority rules like IIROC's Universal Market Integrity Rules. There are likely many hundreds of statutes and regulations in Canada that regulate speculation, and they're all made separately, with no connecting framework. The public experiences these are various kinds of risk regulation, but the regulators never view themselves as being in the wider sea of risk management.
What's Wrong With The Current Approach?
Below are seven examples of what's wrong with the current approach to risk. The problems can also be seen by looking at the huge number of rules that exist and how often they change.
A. Real Estate Consuming Investment Dollars
The percentage of Canada's GDP that is devoted to residential real estate has doubled over the last twenty years, as part of a global pattern that has led to ever more money being devoted to real estate instead of productive business activities. The same house at twice the price isn't twice as useful.
Real estate investment crowds out other kinds of investment because investors have to choose where to put their money. Canada's rapidly increasing prices have pushed some people out of the housing market and led to an increasing percentage of incomes devoted to real estate amidst only marginal increases in wages. Perhaps most importantly, purchasing housing is largely done using credit, partially backed by the federal government, and is sometimes entirely exempt from taxation. In short, housing is now an investment for many and the profits from that investment come largely from improvements in society that aren't attributable to land owners.
B. Gambling Addiction And Money Laundering
Casinos in Canada make 25-50% of their revenue from a small number of gambling addicts. The Ontario Lottery and Gambling Corporation ("OLG", owned by the provincial government) publishes annual plans that show profit increasing and revenue increasing amidst a decline in the percentage of Ontarians who gamble but doesn't mention "addiction". They do mention "problems with gambling", a euphemism for significant social harms. OLG has been sued by many people who signed themselves up for an "exclusion list" and then weren't excluded from their casinos. The increasing revenues are enabled by the poor pricing offered to gamblers, who would prefer to have a near zero cost of gambling instead of a highly profitable OLG.
Money laundering is also rampant and associated with violent criminals in some places. An inquiry in British Columbia found that casinos are a significant source of money laundering (but not as significant as real estate).
C. Lack Of Risk Management Products
Heavy regulation of the derivatives and insurance industry results in very few products being available to everyday Canadians. Rules that stop "non-accredited investors" (i.e. everyone except the top ~1% of income/wealth in Canada) from participating in most investments reduces possibilities for picking investments that meet risk goals. Insurance regulations keep out competitors and prevent innovative products from being launched that might offer insurance against the risks that Canadians care about like a downturn in the housing market, government lockdowns related to Covid, or extreme currency fluctuations.
D. High Costs of Investing
Canada's finance industry is incredibly profitable and has taken up an increasingly large percentage of GDP over time. It's not a secret that Bay St. makes a lot of money, but what's usually less recognized is that these profits are at the expense of customers (rather than due to a high level of technology or some other cause). Most Canadians buy shares through a small number of banks who control banking, investing, insurance, and other financial services. Stock trades cost pennies, or in some cases nothing, and although Robinhood in the US offers free trading, most Canadians are paying $10 or more per stock trade.
Finance should not be able to take up a larger percentage of the economy over time but it has, in Canada and abroad. Regulations prevent new competitors and stop innovative models from gaining market share. Canada's top deposit-taking financial institutions (e.g. banks) made approximately $1300 in annual profit per Canadian adult in 2019/2020 according to the federal Canada Deposit Insurance Corporation (annual report, page 5).
E. High Cost of Foreign Currency
Banks and credit card companies in Canada have lost many lawsuits for misleading or incorrect pricing of foreign exchange because it's difficult for customers to understand that they're being ripped off on USD<>CAD or CAD<>EUR. Foreign currency exchange is a regulated business with many participants but due to legal rules, the low prices that are easily possible are rarely achieved by consumers. Is there a rule that says that foreign exchange must be a ripoff? Of course not. But the rules that are set, and the reality of the market leads to prices that wouldn't exist if foreign exchange was like buying groceries (which can also be a ripoff). This is just one example of a regulated product being unusually expensive but it's the norm rather than an exception when compared to what a properly functioning market would deliver. Some foreign exchange has commissions that are 90% less than typical retail prices.
F. Government-Granted Monopolies
Provincially-licensed monopolies are usually immune from challenge under Canada's competition laws. If the government grants a monopoly to a company, or licenses a small number of companies to operate an industry, there's nothing the public can do legally. It's the right of the government to restrict market participation, and often a core part of regulatory schemes. But monopolies and oligopolies are widely known to offer bad pricing, poor service, and generally behave in ways that customers don't like. Most children know that if the other players in Monopoly all have hotels and properties then they're probably going to lose soon.
G. Investment Frauds
Too many people in Canada fall victim to investment frauds. In this type of fraud a person invests money with a fraudulent company and the main source of profit for the fraudster is the investment money itself. Although many of these are based offshore, some of this activity is domestic and the victims rarely have a remedy. The police will tell the victim that it's a "civil matter" and lawyers will tell them they'll have a hard time getting back their money through the legal system, and regulators offer little help in seeking the return of funds. The public assumes that the government is there to protect them but when they need that protection the most they find out that they never had it.
But what's wrong with high profits, addiction, or overpriced homes? The wrong is that people are paying too much of the money they go to work to earn, and they're not able to get the products that they want. A lack of dynamism in a market is also a problem in itself as Canada faces increasing competition from the United States, Europe, China, India, and elsewhere. If businesses here aren't competitive, eventually the captive market will be upset by foreign competitors. But even if there's never a reckoning consumers are still paying an enormous price for the current system. And they're not taking advantage of the profits available to liberalizing and rationalizing the Law of Speculation.
In the next article in this series I'll explain the elements of a better Law of Speculation, but the solutions rely on accepting certain axioms that are almost universally recognized by economists:
Risk ∝ Reward
Competition ↑ Price ↓
Time ↑ Reward ↑
Risk ↑ Insurance Cost ↓
Asset ↑ Utility →
Rules ↑ Price ↑
And most importantly: consumers prefer low prices. People love Amazon and they love Walmart because they offer low prices. Given a choice between identical options, consumers will usually pick the cheaper option. Legal terms are almost never valued by users who don't read the agreements they're given, and even if they did read them, there's almost no chance they would be able to realize on any of their rights because of the high cost of court. But they can easily realize a price advantage.
Amazon and Walmart are a testament to what people really want, rather than what they say they want. The government doesn't try to tell Walmart how to better ensure low prices and if they did it would, without any doubt, be considerably worse than what Walmart comes up with. The next competitor to Walmart isn't going to emerge in Cuba.
Improving Risk Markets
The solution to the problems in Canada's risk markets is to regulate them as a single concept: the Law of Speculation. Unifying disparate laws about risk would better align the law with how consumers understand their actions, be much easier to understand, dramatically increase competition and thereby lower prices, and prevent harms like problem gambling through a modern, digital-first approach. Because right now, millions of people are building the financial services of the future around the world and almost none of them are considering Canada's regulatory regimes so very little of that innovation will make its way into the hands of consumers. Part 2 will say more about this.