It’s odd that Canada and the US enjoy free trade in goods but not in the trade of stock. Yet as the combined El Nino of communications and information technology blows through existing regulation, that barrier too will soon disappear. North American capital markets swirl at the cusp of convergence; and issuers, investors, intermediaries and regulators are bracing for impact and wondering how to survive the new world order.
For Gerald Lacoste, president and CEO of the Montreal Exchange, the coming North American market realignment is a logical development in the new world of convergence. As he puts it, convergence implies something inclusive rather than exclusive. ‘A bigger pie means more for everyone,’ notes Lacoste. ‘Fragmentation reduces the pie. Getting a greater share of a smaller pie is not my objective. It’s to get a piece of the big action.’
That sort of attitude could go far in helping Canadian capital markets adjust to a world of mobile cross-border flows, institutionalized investment and alternative trading systems – a competitive world where traditional regulation is impotent, irrelevant or in the way.
In the eye of the storm remains the US Securities and Exchange Commission, the world’s most powerful financial regulator. It aims to boost US securities markets’ global pre-eminence but at the same time lose no turf over its mandate to protect US investors. Last May, it began the broadest attempt at regulatory reform since 1933, gathering comment on how to regulate securities markets in the light of alternative trading systems and increasing levels of foreign market activity in the US. It received plenty of comments, each with a unique appraisal of what constitutes a ‘level playing field’.
Before consensus is reached on both technological and philosophical issues, the SEC can expect some of the most intense lobbying since the North American Free Trade Agreement (Nafta). Like a sumo wrestler, the commission will cautiously adopt any definitive stance, but an air of urgency pervades as regulation chases technology.
Meanwhile, Canadians are seeking answers too, with the Toronto Stock Exchange and Ontario Securities Commission pondering market fragmentation and off-exchange electronic networks. The search to devise a rational scheme regulating cross-border electronic equities trading is on. In the future, many more North Americans will be chasing stocks, domestic and foreign. But the markets they trade on won’t be like today’s. And IROs will have to respond.
Bill Rowe, IR chief at Calgary-based Nova Corp and president of the Canadian Investor Relations Institute, is hawkish on breaking down barriers to trade and competition. ‘Three quarters of our trade in goods and services is with the US,’ notes Rowe. ‘While the Nafta is far from perfect, the structure of the capital market is hugely imperfect. Canadian companies have done an outstanding job, but we must break down more regulatory barriers to fully succeed on the capital markets side.’
Very interlisting
A commodity price slump and the Bre-X bombshell helped vaporize volume and performance in Canada, but markets largely shrugged off their fraudulent odor. Last year saw record Canadian trading volumes, IPOs and M&As which fueled boffo Bay Street bonuses.
Yet, cloaked in comforting news, the Canadian stock exchanges’ grip on the ‘Canadian’ capital market is under siege. Some 14 percent of Toronto Stock Exchange issuers are listed on US exchanges with companies like Northern Telecom trading more in US markets than at home. Meanwhile, small cap companies such as software maker Discreet Logic have been lured directly to New York’s seductive embrace. All the Canadian companies which have a sole US listing have a combined capitalization of almost US$5 bn.
What drives these companies to trade on US markets? While the adage ‘follow the money’ certainly applies, ‘follow the analytical skills’ might be a more appropriate maxim for CFOs of Canadian high-tech companies.
‘Many junior high-tech companies find it easier to raise money in the US,’ comments Fred Ketchen, managing director of equity trading at ScotiaMcLeod and a former TSE chairman. ‘US investors are more risk oriented and more informed. That results in issuers getting a better price,’ he explains.
Still, data gathered by the TSE indicates a Nasdaq listing doesn’t guarantee an automatic US analyst following. The intense competition for coverage means small foreign companies have to shout pretty loud to get noticed.
Rowland Fleming, president of the TSE, is less despondent than many Canadians about interlisted trading, noting that there has not been any shrinkage of the TSE as a result. ‘While we may end up with a certain market percentage, markets on both exchanges grow,’ he says. ‘That companies interlist doesn’t mean Canada’s capital pool is shrinking.’
The problem is that interlistings without ready cross-border access results in the market in a company’s stock being fragmented. Fleming envisions an electronically integrated North American market – one featuring easy access to the TSE for buy-side players across the continent. ‘Companies interlist largely because the investors who access one capital pool can’t easily access the other,’ he says. ‘If we can provide easy electronic access to our markets from the US buy-side, then we have both liquidity pools competing for investors. That would let investors access the pool of capital as opposed to issuers going to investors.’
It’s not an entirely novel paradigm. Fleming points to Europe where, for a time, London’s Seaq International drew a large interlisted crowd. As technology progresses, the move toward interlisting is declining. ‘That’s the future for North American capital markets,’ he says.
But to retain business, Canada’s securities industry must provide better regional and global research. With notable exceptions, their US cousins remain far better versed in knowledge-based issues.
One former broker was stunned upon walking into a Chicago buy-side analysts’ office. ‘A Canadian biotech was my stock of the day,’ he explains. ‘I thought I knew the story. I soon discovered not only did the guy know my company, he understood the science inside out. US analysts are highly specialized. In Canada, biotech is a subsector for most firms if it’s covered at all.’
Canada’s response
Even were convergence not inevitable, Canadian exchanges are encouraging it on purpose, with the SEC’s impending changes seen as a window of opportunity. The major Canadian exchanges and the Investment Dealers Association want a North American solution. More specifically, they want an integrated North American stock market ‘framework’.
Pointing to the many similarities in legislation and regulation, the Canadians say US investors trading into Canadian markets are well protected. Mutual reliance on home country regulation and a simple agreement between securities regulators could govern cross-border electronic trading between the exchanges.
‘Without amending the Nafta or securities laws, we could effect a more liberalized international market,’ says Lacoste at the Montreal Exchange (ME). ‘The question is whether the SEC would rely on the job done by Canadian regulators and exchanges.’
Free trade in stock probably means some form of home country jurisdiction. But convincing the SEC won’t be easy. The tone of its concept release suggests the SEC is not thrilled about a home country app-roach, labeling it as ‘extreme’.
Yet the Canadian scheme could work. Precedents for cross-border understandings between regulators include the Montreal Exchange’s one-way link with the Boston Stock Exchange and the multi-jurisdictional disclosure system, which allows cross-border offerings based on home country disclosure rules.
While waiting for reliance on home country regulation, Lacoste suggests traditional exchanges should spearhead the charge by forming cross-border alliances, effectively broadening the US national market system on a North American scale. Lacoste says this would help consolidate market fragmentation while leveling the playing field with alternative trading systems.
Coping with convergence
In carving out its role as a regional exchange, the ME has mapped a strategy of integration with larger capital pools. By providing the network to the big market, Lacoste reasons companies will be satisfied with a single regional listing for longer. ‘Once they are ready to go global, they will do so,’ shrugs Lacoste. ‘We won’t necessarily lose the listing. North American markets may be linked, but regional specialties will remain. Our people know those stocks and can compete with the big guys in the US.’
But ScotiaMcLeod’s Ketchen believes electronic links will only go so far. He says Canadian exchanges must intensify their marketing programs aimed at US institutions, noting certain advantages to trading on Canadian markets. ‘A US-based investor trading a Canadian-based interlisted issue can minimize price impact by looking at both markets and determining which one provides best execution,’ states Ketchen.
For their part, Canadian exchanges and their members have been concentrating on improvement, notably the TSE floor’s electronic replacement. The TSE is also contemplating an electronic call market integrated into its central auction system – satisfying big investors’ craving for anonymity. Canada led North America’s move to decimal pricing, reducing spreads and encouraging US investors to trade interlisted stocks in Canada, while other steps include the new electronic filing system Sedar and a messaging protocol called Stamp which will let brokers use one device to direct orders to any Canadian exchange.
‘Efficiency of access is mission critical to our success,’ says the TSE’s Fleming. For him, the struggle to keep the Toronto exchange relevant is more art than science. ‘We must find balance between an undisciplined trading environment and one that is well-regulated yet not so onerous that it prevents efficient transactions,’ he assents.
Fleming believes the TSE has done just that. ‘We are now positioned to have all the attributes and benefits of an off-exchange system with all the qualities of a well-regulated market,’ he says.
With a modern trading environment in hand, Fleming is impatient to exploit it. How and when he can do so will depend largely on the SEC. But Fleming remains skeptical that the commission’s wheels can spin fast enough. ‘The reality is that global electronic commerce is here today,’ states Fleming. ‘The SEC will have a difficult time impeding that over the long haul.’
Should it attempt to do so, Fleming will resist. ‘If the SEC chooses a direction making it hard for the TSE to facilitate direct access from US buy-side institutions, it won’t be hard for us to encourage electronic access indirectly,’ he says. ‘Ultimately, we must move to a well-regulated market as opposed to one the SEC dominates.’
Afta Nafta
The Nafta did little to open trade in financial services between Canada and the US. However, negotiators agreed to review the issue by the year 2000. Given the pace of change, Canadians want to speed things up.
‘It’s appropriate to look at this discussion sooner rather than later,’ says Frank Swedlove, director of the financial sector at the federal Ministry of Finance. ‘Regulators must ask whether the present rules meet the needs of an environment where financial services are increasingly traded cross-border.’
Events are overtaking bureaucratic processes. No matter how the pieces fall into place, regional specialties will remain. The new world of convergence, it seems, will have more the flavor of a fusion food buffet than a single meal menu.
Competition, technology, regulation. At their apex balances the corporation. No-one wants any of these factors to put them out of business. Besides, North American capital markets have worked pretty well so far. And the task is nothing if not clear – assure a capital markets convergence rather than a collision.
IR tomorrow
Most Canadians treat IR less seriously than Americans, with paltry pay scales and a spot further down the corporate ladder than their US counterparts. Yet, as capital markets converge, Canadian IROs must deal with an increasingly international and demanding ownership base. The result is that Canadian corporations are being tugged into ‘convergence’ with US standards.
Canadian companies can’t be blamed for their thirst for the world’s largest capital pool. Yet for those ready to make the leap, the sheer range and depth of potential shareholders make research and planning vital.
‘A Canadian company that goes to the US and just looks for funds that invest in Canada is selling itself short,’ observes Paul de la Plante, vice president of financial communications at National Public Relations. Moreover, says de la Plante, companies that don’t even consider a Canadian listing, may also be doing themselves a disservice.
‘American fund managers pay more but are far more ruthless in terms of performance,’ warns de la Plante. ‘With Canadians, the peaks may not be as high, but the valleys aren’t as low. There’s far more loyalty.’
Asian flu hit Canada along with the US on Grey Monday, October 27. As the Dow sank 554 points (7.2 percent) only to gain 337 points the following day, Canadian moves were less dramatic, certainly in the rebound: the TSE fell 434 points (6.2 percent) on Monday but only rallied 137 points on Tuesday.
‘If you go to the US, make sure you are well positioned in Canada first,’ de la Plante counsels. ‘The guy willing to race your stock up just to get his position will be the same one who races it down just to get out. Why not have a variety of shareholders prepared to help you through all that?’
Even so, while momentum investing has never been much of an issue in Canada, as more Canadian fund managers compete with their US counterparts for returns, they will have to learn this American tune.
Ultimately, company management must carefully weigh the pros and cons of different markets when deciding where to list. Misapprehensions can be fatal. ‘If it’s an inappropriate market, companies will end up spending lots of money and providing none of the intended shareholder value,’ notes Anne Lachance, vice president at Fleishman-Hillard Canada. ‘Going south is not for every company. It’s easy to get lost.’
