Just as the Canadian economy was recovering, with an interest rate hike expected in September, the country’s neighbour had a sclerotic political debt fit and global markets took a dive over sovereign debt concerns in Europe.
Just as the Canadian economy was recovering, with an interest rate hike expected in September, the country’s neighbour had a sclerotic political debt fit and global markets took a dive over sovereign debt concerns in Europe.
This, after Canada’s economy had registered a surprising contraction in May, by 0.3 per cent, leading to disappointing GDP figures in the second quarter this year. The Spring decline was largely attributed to a “confluence of negative factors”, according to RBC economists, such as natural disasters like forest fires and flooding, and disruptions in industrial production.
In turn, economic growth has been revised downwards across the board. RBC has pegged growth this year at 2.7 per cent compared to a previous forecast of 3.2 per cent.
“Although we expect to see stronger growth in the quarters ahead, the financial market instability and persistent uncertainty surrounding the pace of global growth will keep the [Bank of Canada] side-lined,” wrote RBC in a recent report. Most analysts now predict that interest rates will remain on hold until 2012.
Notwithstanding, Canada remains a top safety investment destination. Pimco founder, managing director and co-CIO, Bill Gross, recently advised investors to look at countries with “cleaner dirty shirts” such as Canada.
The labour market is also recovering from the financial crisis with growing strength. A recent survey by PayScale found that wages in Canada in Q2 2011 are up more than 1.5 per cent since the bottom in 2009.
Before the recession hit in late 2008, wages were growing in Canada at a healthy rate of three to four per cent year-over-year in 2007 and 2008. When wages finally tumbled in 2009, they did so for a brief three quarters. As the recession began to ease up, earnings for Canadian workers recovered swiftly. Incomes for Canadians showed significant improvement starting in Q2 of 2010.
In terms of Canada’s competitive position internationally, the World Economic Forum’s 2010/11 Global Competitiveness Index ranks the country 10th of 139 economies overall and 12th for financial market development. Notably, the country is the top ranking for soundness of banks, second for availability of financial services and eighth for financing through the local equity market.
Regulatory environment
It’s certainly no secret that the country is internationally recognised for prudent regulation in the financial services sector, particularly important in the wake of the financial crisis and while investors continue to recoil over sovereign debt issues plaguing Europe.
The regulatory environment itself is something that is distinctly Canadian. Canada is the only G20 country, for example, without a national securities regulator, instead it remains under the jurisdiction of the 13 provinces and territories. Politicians under a conservative government has been pushing to change this and the Canadian Securities Transition Office (CSTO) was established to implement and develop a plan in anticipation.
Some provinces are leading the charge to prevent this transition of power to the federal government; in Alberta and Quebec, courts have already said the Constitution forbids national regulation in that area and Manitoba is also strongly opposed. The Supreme Court of Canada heard arguments in mid-April and a decision is pending. Currently, a passport system between provinces is used to ease the administrative burden of filing in multiple provincial jurisdictions. Some banks, like Toronto-Dominion and major asset managers, like the Ontario Teachers’ Pension Fund, are supportive of federal coordination, which would further simplify the fragmented provincially-based regime, according to the Globe and Mail.
Financial institutions, however, are regulated nationally, by the Office of the Superintendent of Financial Institutions (OSFI), while a host of other industry and regulatory bodies cover multiple jurisdictions with differing requirements – such as the Canadian Depository for Securities or the Investment Funds Institute of Canada.
Custody market
Investors are not expressing any particular concern over any of the jurisdictional challenges and continue to retain confidence in the safety of the Canadian market, while also requiring expert guidance in the regulatory landscape. As a result, custodians find themselves uniquely positioned to meet the needs of institutional investors facing significant pressure from clients, boards and other stakeholders for increased transparency, risk management and performance tracking.
Though Canada’s custody market is growing in absolute terms, in relative terms growth in assets under administration (AUA) may be slowing. At the end of December 2010, the custody market had some CAD$3.5 trillion AUA at the end of last year (pension funds accounting for almost 40 per cent) compared to CAD$3.2 trillion at the end of 2009 and CAD$2.9 trillion at the end June 2009, according to data from Investor Economics.
Looking at these figures over the three half-year periods from June 2009 to December 2010 indicates some volatility, says Juhaina Kabir, an analyst at Investor Economics. “In terms of annual growth in relative terms, it looks like there is a slowdown in that time, but the June 2011 figures are not complete yet,” she says.
In other words, it is difficult to identify which way any trend is going until more data becomes available in the coming months, although any wild swings are unlikely.
There are a relatively small number of players in the custody market with four major national providers – CIBC Mellon, Northern Trust , RBC Dexia and State Street - and a small number of regional operations, such as National Bank and Desjardins in Quebec.
CIBC Mellon is the only asset servicing provider (ASP) to focus exclusively on the Canadian market, says Claire Johnson, head of marketing and product. “The custody business is about scale – particularly the ability to build global scale, but at the same time tailored to the specific needs of a given client in a given market,
“Clients’ needs are evolving and asset servicing providers are changing to meet these needs by deploying a variety of new solutions...for example, through our parent BNY Mellon’s Derivatives360 solution, clients can obtain an entire derivatives servicing solution – including trade execution, lifecycle management, collateral management, valuations, accounting and more. Or, clients can pick and choose to outsource individual components of their derivatives needs,” Johnson says.
The driver of clients’ changing needs has much to do with anticipated global and national regulatory changes. Canada’s regulatory environment is evolving at a rapid pace, notes Johnson, and the onus is on ASPs to provide detailed, accurate information to support clients as they prepare to comply.
In other words, investors want more services, safely, at the lowest price. That might be nothing new, but certainly the competition for clients keeps heating up in a risk averse economic climate.
In turn, custodians are pushed further into the asset servicing space. Whereas institutional investors used to identify the custodian role as back-office, today that perception is changing and custodians are expanding capabilities to include “middle-office” services, which CIBC Mellon defines as including post-trade-execution support, trade matching, trade settlement and reconciliation, performance and risk analytics, as well as various other reporting capabilities..
“The market is demanding this change,” Johnson says. “As clients are focusing on their core investment strategies and the market is pushing for more transparent and sophisticated reporting, clients are looking for both expert support and value-added services...asset servicing providers are expected to deliver on a wide range of client needs – from quickly opening new markets, to delivering detailed accounting for investments, to safeguarding client assets.”
Moreover, the very notion of “value” changes over time. “What was emerging last year becomes more and more of a commodity this year,” Johnson notes. “I can say that CIBC Mellon’s move into this space has helped us grow significantly – we surpassed CAD$1 trillion in assets under administration in 2011. We are also winning mandates in the alternative investment space, ETFs and in hedge fund servicing.”
Clearing services
Just as investors are demanding more of their services providers, so too are custodians looking to their providers for greater transparency, risk management and efficiency.
Clearing and Depository Services (CDS) - which processes all exchange and alternative platform trades, money market transactions as well as provides entitlement processing for the securities it holds - reports that custodians are focused on the importance of expanded electronic communications.
“What custodians are talking to us about is increased usage of messaging, electronic communication of information on settlement activity, on entitlement activity and tax information,” says Keith Evans, executive director of operations.
“As a result of demand for those services, just recently we implemented SWIFT MT566 messages and that is to complement the MT564 narrative messages which were implemented over the course of the past three or four years,” said Stephen Nagy, managing director of business systems development and support at CDS.
In addition to such electronic offerings, CDS is making headway on its immobilisation and dematerialisation strategy. It has reduced the number of physical certificates in the vault by 170,000 in the last couple of years, bringing the quantity of physical certificates remaining in the vault down to 55,000.
“This is a very significant reduction...we have worked with issuers, lawyers and law firms...to permit electronic holdings and I believe that almost all the issues coming into the market are using and allowing for an electronic or bulk non-certificated position to be held,” says Evans. “We also developed an electronic closing that permits the underwriters, issuers and transfer agents to [close new issues] in electronic form without the need to issue a certificate.”
He points out that there are efficiencies to be gained by the industry going electronic, but the main focus is on risk. Notably, CDS is AA rated with a stable outlook by Thomas Murray in its January report. It is rated AA- for asset servicing risk, with sole exposure identified in payment banks who extend lines of credit to receivers intraday but only receive finality of cash at payment exchange, while operational risk is rated AA+.
When global markets plunged in early August, Canada, like most countries, was hit by record volumes. The exchange trades being recorded into CDS peaked at just over three million trades per day, compared to an average annual daily volume of some 1.2 million year-to-date .
“We had zero problems in handling that volume. All of the volumes, our applications and delivery times have been met without exception and we are stress tested to just under five million trades a day, so three million was not a concern for us.” said Evans, adding that the turmoil presented an opportunity to gather information and evaluate CDS systems. “We certainly took advantage of that.”
On the settlement front, CDS implemented real-time continuous net settlement, replacing four intraday continuous net settlement cycles and enabling participants to manage their settlement activity earlier in the day.
This September in Toronto, Canada’s financial capital, CDS along with the asset servicing community will get a chance to showcase this and other successes.
President and CEO of CDS, Ian Gilhooley will be participating in sessions focused on the Canadian standards landscape as well as reflecting on the potential lessons that can be learned from the experiences of the US and Canada for the world’s securities markets.
US-Canada relations
The US and Canada tend to follow each other in the way in which the back office of the securities industry operates, says Evans, and as such have very similar processes in the clearing settlement and custody business as well as a cross-border relationship with the Depository Trust and Clearing Corporation (DTCC).
“It is primarily a custody, clearing and settlement link that we have with the US and the largest in the world, the most active and the most actively used...somewhere in the neighbourhood of almost 40 million trades per year,” says Evans.
And that close relationship translates into asset servicing as well.
There are more similarities between the US and Canadian markets than differences, says Claire Johnson from CIBC Mellon, but the size of the individual mandates tend to be much larger in the US though Canadian clients are equally sophisticated with the same global investment needs as their US counterparts.
And that is unlikely to change soon. With a population of some 34.5 million, around a tenth that of the US, and GDP at $1.3 trillion compared to the US at $14.7 trillion, the Canadian banking and financial services sector will remain a smaller market as well as a more stable one.
In terms of legal implications for ownership, Canadian banks are incorporated under the Bank Act and there are restrictions as to the percentage of ownership by any one person. Subject to specific statutory exceptions large banks, whose equity exceeds CAD$8 billion, are not permitted to have any shareholder own, either directly or indirectly, more than 20 per cent of any class of voting shares or more than 30 per cent of any class of non-voting shares and no person may control such a bank, according to online information from Canadian law firm Heenan Blaikie.
Any person who wishes to hold more than 10 per cent of any class of shares of a bank must be approved by the Minister of Finance who will apply a “fit and proper” test. The minimum capital required to incorporate a new bank is CAD$5 million.
Is Canada boring?
Arguably, it was such laws and conservative regulation that protected the Canadian banking system from the worst effects of the global financial crisis. And protectionist leanings persist - Canada’s regulators were recently in the spotlight during a failed bid by the London Stock Exchange to merge with the TMX Group. Overall, there is a definite “risk-off” leaning in the current environment. Though that may make the Canadian investment environment boring, at the moment it may just be what institutional investors are looking for after years of “exciting” crises.
