October 17, 1996
Robert Grandy Chairman, Merrill Lynch Canada
WHOSE MARKET IS THIS ANYWAY?
Philip Olsson, Vice Chairman, RBC Dominion Securities
GLOBAL FINANCE: ARE CANADIANS UP TO IT?
Chairman: Julie Hannaford, President, The Empire Club of Canada
Head Table Guests
Alex Squires, Security Analyst, Brenark Securities Ltd. and a Director, The Empire Club of Canada; Stacey Arjoonlal, OAC Student, West Toronto Collegiate; The Rev. Canon John Erb, Rector, St. Michael and All Angels Church; Gerald Segal, Vice-President, Investment Banking, Merrill Lynch Canada; Joseph Oliver, President, Investment Dealers Association of Canada; Kiki Delaney, President, Delaney Capital Investment Management; Anne Libby, Co-owner, Libby's of Toronto Art Gallery and a Director, The Empire Club of Canada; Gerry Phillips, MPP, Scarboro/Agincourt and Liberal Finance Critic; and James Kinnear, President, Pengrowth Gas.
Introduction by Julie Hannaford
Last week, John Hunkin from CIBC Wood Gundy and Rob Gemmell from Salomon Brothers addressed the question of whether Canadian banks will survive in a global arena, and thus opened The Empire Club of Canada's mini-series which is titled "Banking on Change." In doing so, Messrs. Hunkin and Gemmell joined the distinguished list of speakers who have addressed The Empire Club of Canada over the last 93 years. As each new season of The Empire Club begins, we plan our speaking agenda around those issues which profoundly affect and change the lives of most Canadians. If there is one theme that has united the speakers from this season (beginning in May, 1996), it is that none of us operate in anything but a global marketplace. Beginning with Chancellor Helmut Schmidt, who addressed the issue of Germany at the millennium and did so from the perspective of a larger economic union that would deeply change the way in which we understand and interact with Europe to Bill Gates, who graphically (and I mean that literally) illustrated how we must become educated consumers of the Internet and micro-technology, or end up being consumed by it, our speakers have served to insist that we look outward beyond our national borders, not as a matter of competition but rather as a question of survival.
By international standards, our domestic banks are small, and until recently, lived in a world protected from the global marketplace.
It was particularly telling, then, that John Hunkin re-focussed the question of whether Canadian banks would survive in a global arena to how many of our Canadian banks will equip themselves adequately to compete in the global marketplace.
Rob Gemmell, from Salomon Brothers, effectively told us that we had no choice but to do so, and by and large, the investment dealer community and primarily Canadian investment dealers are not yet there.
From 1990 to 1995, M and A activity involving Canadians grew from $10 billion to $16 billion, and new equity issues completed in the United States by Canadian companies increased from $54 million in total proceeds to $2 billion in 1995.
If there is a moral that came from the October 10 addresses, (and this is not a segue into jokes about investment bankers, money, and morality), that moral might well be that if we as Canadians do not equip ourselves to compete in the global marketplace, we shall not just end up as its servants, but shall sit back and watch as our clients choose to be served in a market where the Canadian banker and dealer is simply no longer relevant.
Having now been provided with the background, 1 am particularly grateful to our speakers today for addressing the difficult questions that arise from the background we have been given. In particular, I am grateful to our speaker Philip Olsson, who suggested that the questions we need to address are fundamentally, with respect to the issue of global banking, "Whose market is this anyway?" and on the issue of global finance, "Are Canadians really up to it?"
I am also grateful that Robert Grandy agreed that those questions were the critical ones and both of our speakers have undertaken to answer those questions directly.
Robert Grandy was educated in law at the University of Toronto and in business at Harvard. He began his business career at Wood Gundy, and became Senior Vice-President and Director of Merrill Lynch Canada in Calgary in 1985. In 1988, Mr. Grandy became head of Investment Banking in Toronto, and in 1990, became Chairman of Merrill Lynch Canada.
Philip Olsson, became the Vice-Chairman of RBC Dominion Securities in 1995, and prior to that he was responsible for the worldwide investment banking operations of RBC Dominion Securities. Mr. Olsson received his MBA from Vanderbilt University and engaged in post-graduate research at the London School of Economics. He began his investment banking career in 1979, when he joined the Toronto Corporate Finance Department of RBC Dominion Securities' predecessor, Pitfield MacKay Ross Limited.
Both Mr. Grandy and Mr. Olsson promised to continue the provocative and important issues raised by our speakers last week.
The most important capital markets development of the 1990s is the trend for Canadian issuers to raise more and more of their financing outside Canada, particularly in the U.S.
This is of great significance for the major Canadian investment banks and their bank owners because it will necessitate the making of important structural changes in the way they do business if they are to remain successful in the face of this trend.
Before discussing the type of structural change that will be required, it would be appropriate to review, in some detail, the changes which have been taking place in the Canadian market and the reasons behind them.
Perhaps the most interesting way to review the changes is to consider the following list of the top 10 investment banks responsible for raising financing for Canadian issuers during the 1990s until August 31, 1996.
RBC DS $58.6
Merrill Lynch $54.8
Goldman Sachs $47.5
CIBC Wood Gundy $46.3
Salomon Brothers $23.7
CS First Boston $23.5
Nesbitt Burns $13.8
Burns Fry $9.5
Note that five of the top 10 are foreign investment banks with two of the top four being from the U.S.
The trend towards greater use of U.S. and other international investment banks has increased over time. In 1995, six of the top 10 were foreign with Merrill Lynch holding the top spot, Goldman Sachs number two, CS First Boston number seven, Deutsche Morgan Grenfell number eight, Yamaichi number nine and Lehman Brothers number 10. So far in 1996, six of the top 10 are foreign.
In total, by 1995, less than 50 per cent of all capital-market needs for Canadians was raised in Canada. In that year, 46 per cent was raised in Canada, 39 per cent in the U.S. and 15 per cent elsewhere. This can be contrasted with 1990, when 67 per cent was raised in Canada, 23 per cent in the U.S. and 10 per cent elsewhere.
Most of this change has come in the debt markets, with Canadian government entities raising the preponderance of their financing outside Canada.
In corporate debt markets as well, there has been a massive shift with Canadian corporations now raising 60 per cent more of their debt needs in the U.S. than in Canada. In 1995, Canadian corporations raised 52 per cent of their total needs in the U.S. and only 32 per cent in Canada, with 16 per cent being raised elsewhere. In 1990, 76 per cent was raised in Canada, 20 per cent in the U.S. and four per cent elsewhere.
The shift into the U.S. market for common-stock financing has been slower, primarily because of the marked preference of Canadian issuers for utilising the bought-deal format. However, now that Canadian companies have reduced the high degree of leverage that they put in place in the 1980s, there is a growing trend toward using a traditional marketed deal, instead of the more costly bought deal. Arguably, the principal reason for this is that Canadian issuers are seeking an approach which will enable them to obtain access to the large universe of potential shareholders in the U.S. market.
In 1996, year-to-date, 48 per cent of all common stock issues for Canadians was done by way of marketed deals with 15 per cent of total financing being raised in the U.S. In 1990, only two per cent was raised in the U.S. Clearly, there has been an increasing shift towards the U.S. market. The key question then is whether this shift will continue. The answer lies in the reasons behind the shift which can be put forward as follows.
The establishment of the multi-jurisdictional disclosure system in 1990 made it just as easy for most Canadian issuers to use the U.S. market as the Canadian market. In fact, strangely enough, most Canadians have easier access to U.S. markets than U.S. issuers because MJDS issuers do not face the possibility of SEC review of their prospectus.
Price and demand for securities can be maximised by tapping the large universe of potential U.S. buyers. It is difficult to argue against the premise that share and bond prices will be better supported by having greater, rather than fewer, numbers of buyers.
A number of product markets have, for all intents and purposes, not been available in Canada. The most notable of these has been the high-yield debt or junk market for credits rated BB or less by the credit-rating agencies.
There is a growing natural requirement for non-Canadian dollar financing by Canadian institutions. This has been fostered by a number of developments such as free trade, increased cross border mergers and acquisitions activity and the growth of Canada's exports business that has come with a lower Canadian dollar.
In many industries, in Canada, there is an insufficient number of issuers to warrant the maintenance of industry research analysts at either the investment banks or the institutional buyers. To attract industry-specific expertise of this type it often becomes a necessity to go to the U.S. market.
The depth of the U.S. market is such that it can support a breadth of products for which there would simply be too little liquidity in the Canadian market. Some recent examples of these types of products are TOPrS (debt instruments with certain preferred share characteristics); LYONS (zero coupon convertibles); PRIDES (mandatory convertibles); and step-up convertible debentures.
This list of reasons is compelling and it is difficult to see any factor within this list that would indicate any diminution in the trend towards even greater use of the U.S. markets.
The question then is whether Canadians will use Canadian investment banks or U.S. investment banks to obtain access to the U.S. market. Arguably, the answer to this question is very simple. Canadian issuers will use the Canadian investment banks to complete financing in the Canadian market because those investment banks know the market best and have the best distribution capability in it. By the same token, Canadian issuers will use the U.S. investment banks to complete financing in the U.S. market because those banks know that market best and have the best distribution capability in it. After all, you don't call a plumber when you need an electrician.
In the end, if Canadian issuers are going to continue to increase their use of the U.S. market, and if they are going to use the U.S. investment banks to lead their issues in that market, there seems to be only one legitimate approach for the Canadian investment banks to obtain future growth. They are going to have to combine their operations with those of the large U.S. investment banks by way of joint venture or merger. Only in this way can they protect their position in the home market and grow as major players in the global market.
Philip J. Olsson
Today's question is: "Global Finance--Are Canadians Up to It?" My answer is, "Yes!" We are up to it. We excel at it. In fact, Canada's financial sector is one of the new economy's great success stories.
Today I will tell you about Canada's competitive advantages in global finance. I will tell you how we exploit those advantages. Finally, I will ask you to join with me in seeking public policies that will allow us to create even more jobs and economic opportunity for Canadians.
Living as close to Wall Street as we do--and having people like Rob Grandy around to remind us--sometimes means that we Canadians underestimate our own strength. So let's start with a review of our competitive advantages in global finance.
The first is so obvious that we in this room usually overlook it: Canada has joined the hard-money club. Our low inflation, our skyrocketing exports and our governments' work to restore fiscal health have made our dollar welcome once again in world capital markets. We at RBC Dominion Securities believe that in 1997 Canada will begin to outgrow all other G7 economies. Investors abroad increasingly agree. In turn, the soundness of our dollar and our image of fiscal rectitude greatly enhance the reputation of our financial institutions. This is of great value as we compete internationally in what may be the most competitive industry in the world. If you ever doubt that a sound dollar is important to our financial industry's success, think about Switzerland. Think about the enormous prestige and competitive power that has accrued to the Swiss banks because of that small, landlocked country's refusal to degrade its currency.
Our dollar is sound, and our financial institutions are sound. This is our second great competitive advantage: investors everywhere know they can deal with Canada's banks in confidence, because Canada has simply not tolerated any weakening of its financial institutions. Moody's Investor Services recently introduced its Bank Financial Strength Ratings and reports that Canada's average BFSR ratings are exceeded by only two countries. The high credit ratings of the Canadian banks make them very popular counter-parties. This puts us at the centre of the enormous global trade in foreign exchange, swaps and other credit-related instruments. We use this competitive advantage to create jobs and growth in Canada.
A third competitive strength of Canada's financial sector is the global scale and presence of many Canadian companies. This is most apparent in the resource industries--especially mining and oil and gas, in telecommunications and the technologies which support it and in energy transmission and distribution--and, I almost forgot, Canada's financial institutions. Around the globe, but especially in the emerging economies of Asia and Latin America, globalising Canadian companies such as NOVA, Barrick, ATCO, TransCanada PipeLines, Newbridge and Northern Telecom enjoy name recognition that would astonish many of you. The presence of these companies in Canada and their importance to investors here and abroad has allowed our investment and commercial banks to build a research, trading and financing infrastructure far beyond what one might expect to find in a country of our size.
A fourth competitive strength we enjoy is found on main street as well as Bay Street. We are a multicultural society with a global outlook. We Canadians have a strong sense of whom we are, yet we are woven from strands drawn from many places and traditions--and in most of those traditions the value of enterprise and trade is a core belief. This is an enormous competitive advantage in an industry such as finance which spans all time zones and cultures. Day by day the barriers to free trade in finance are lowered, and the rewards go to those who are the fastest, the most creative, the most industrious and the most able to communicate across cultures. Every day the global financial marketplace tilts somewhat more in Canada's favour, because of whom we are as people.
A fifth competitive advantage flows out of the Canadian propensity to save. Our prudence has created enormous pools of capital in this country. This has created large, liquid markets for both debt and equity securities. This builds a base of expertise and capital strength which allows us to compete very effectively internationally. A particularly striking illustration of this is our willingness to assume bought-deal liabilities in equity transactions at commissions typically lower than those charged in other markets for pre-marketed transactions.
There are five competitive advantages we can use to compete in global capital markets:
• a sound dollar;
• a sound financial system;
• world-scale industries;
• a multicultural, outward-looking society; and
• large, liquid security markets.
So what are we doing with these advantages? Let me tell you three Canadian success stories, two of them drawn shamelessly from my own organisation.
Let's start with life insurance. What could be more Canadian than our life insurers, built on the bedrock Canadian virtues of savings and trust? Sir John A. Macdonald was probably thinking something like that when he founded Manulife Financial in 1887. But the success of Manulife and other Canadian life insurers extends far beyond our borders. In particular, they have been very successful in meeting the needs of the growing middle class in the high-growth economies of East Asia. Manulife's Asia Pacific operations extend throughout the region and accounted for 13 per cent of the company's total premium income in 1995. The company reports that the total number of its policies in Hong Kong, for example, has increased 80 per cent in the past four years. The success of Canada's life insurers in Asia seems almost inevitable when you think of some of the competitive advantages I listed earlier: a reputation for sound money and sound institutions, a multicultural and globally-thinking talent pool, and large pools of domestic savings which have allowed us to build a world-scale industry.
Now let's take a look at the ultimate global market, the world of foreign exchange. This business dwarfs all other capital flows. Global foreign exchange turnover averages $1.7 trillion per day. The Canada-U.S. dollar trade is the largest bilateral flow in this market, and some of the Canadian banks have used this base of business to build very large global businesses.
I'll use the Royal Bank as an example, because on November 1 we consolidate all of the trading businesses of the Royal Bank Financial Group into RBC DS Global Markets, a unit of RBC Dominion Securities. Our foreign exchange trading operation accounts for 1.7 per cent of global foreign exchange turnover, a large part of it generated in our trading room 500 feet away from here in Royal Bank Plaza. Our foreign exchange business has ranked in the top 20 worldwide in each of the past 15 years. Third-party surveys rank us number one in Canada and number five in the United States.
Again, we draw on the competitive advantages of operating from a Canadian base: a sound dollar, very creditworthy banks and a talent pool drawn from many cultural and linguistic traditions.
Thirdly, an example from my own firm, RBC Dominion Securities. For many years we and several of our predecessor firms have worked to keep up with the financing and advisory needs of our clients in the mining industry. As our Canadian clients have grown to dominate many aspects of the global mining industry, especially gold mining, we and other Canadian investment banking firms have turned the Canadian stock exchanges into the financial centre of the mining businesses worldwide. By far the largest volume of mining-share trading in the world takes place on the Toronto Stock Exchange and we believe that over half of the mining equity analysts in the world reside in Toronto. Mining firms whose principal operations are in Africa, Australia, South America and Europe seek to domicile themselves in Canada to take advantage of these highly liquid markets.
A current example is Philex Gold, a Philippine gold mining company which is in the process of being privatised through a global offering. I can't say a lot more because the issue is in registration. I can tell you that we, a Canadian investment dealer, are leading this offering because we have built a global mining business using the competitive advantages we find in Canada. In Toronto we have four gold analysts focused on North America, Australia and Africa. To add to this capability we acquired a mining team in London, which brought 10 dedicated sales, trading and research professionals. This in turn led us to acquire an interest in SMK Securities of Johannesburg, which further broadened our African and South-East Asian sales and trading capability.
So we are another example of a financial enterprise which competes globally from Toronto. The vigour and global scale of our mining companies have drawn the world to Canada.
That's the story. Canada has unique competitive advantages in the global financial arena, and our financial institutions are using them to bring highly skilled jobs and capital to Canada.
Are there some things we should be doing to keep our advantages? Here are three suggestions:
First, we should encourage our government to keep on doing the right things. We have made much progress toward full fiscal health, but we're not finished. The appreciation of Canada as a hard-currency country has greatly enhanced our ability to compete in the global financial industry. We must maintain this edge.
Second, we must preserve the soundness of our financial system. Canadians love to criticise their banks. They're big and sometimes seem a bit impersonal like all large organisations. But never forget that in 100 years we have built a financial system that is sounder than just about anyone else's. Let us judge all proposals first by their effect on the creditworthiness of our institutions, and only secondarily by their social or political utility. Our international competitiveness and the jobs of thousands of Canadians depends on maintaining this balance.
Thirdly, we really need a national securities commission. It is true that our industry has adapted to our province-by-province system, but the cost has been that no one speaks for Canada. In a globalising economy, this means we are at serious risk from competitors in other nations which are able to identify and advance their national interests. Unfortunately, the effort to establish a national securities commission has been sidetracked by issues that, frankly, have little to do with securities regulation or the national interest. In particular, I hope you will join me in urging our elected officials to maintain their focus on this very important matter.
In conclusion, to the question, "Global Finance--Are Canadians Up To It?" I answer "Yes!"
The appreciation of the meeting was expressed by Alex Squires, Security Analyst, Brenark Securities Ltd. and a Director, The Empire Club of Canada.