More than a year and a half ago, a couple of heavyweight players in the Canadian wealth-management business made a striking move: Sun Life Financial Inc. sold its 37% stake in CI Financial Corp. to Bank of Nova Scotia (all based in Toronto.) It seems the deal isn’t quite working out as expected.

When Sun Life sold its position in CI to Scotiabank in October 2008, it was viewed as a potentially transformational step by a bank that was seen as a bit of a laggard in the wealth-management business. Since then, analysts have been anticipating a move by the bank to, at some point, take control of CI (and, possibly, its other minority holding, Toronto-based DundeeWealth Inc. ) in an effort to realize synergies and catalyze growth in the wealth-management space.

However, the firms have yet to turn the deal into anything more than an investment relationship. And, at least for now, it doesn’t appear likely that they are ready to take their relationship to the next level.

CI’s CEO Bill Holland, speaking on his company’s latest quarterly conference call in early May, indicated that talks aimed at a deeper partnership between the firms have gone nowhere thus far; and he doesn’t expect anything to happen anytime soon.

Holland said the two firms have talked constantly over the past year and a half about ways to create a partnership that could work for both sides. “If, after 20 months, we haven’t been able to find a place to land that both sides thought was the basis of a good partnership, I’ve got to conclude that there probably isn’t the basis of a good partnership.”

The problem, as Holland sees it, is that Scotiabank wants control, but isn’t willing to pay for it: “It wants effective control, meaning it wants to have considerably more ownership. It wants board seats, it wants dilution protection, but it still wants to be able to compete with us with its fund company. And its position is that it doesn’t want to pay a premium to increase its stake to something resembling effective control.”

Holland added: “I’d like to be seven feet tall and play centre for the Toronto Raptors, but it’s not happening. Our view is that [Scotiabank] can control or compete, but it can’t do both. And, if it wants to get effective control it has to pay the appropriate takeover premium. I think what we have here is almost a perfect Mexican standoff.”

Following the conference call, Stephen Boland, analyst with Toronto-based GMP Securities LP, said in a research note: “We believe that CI has attempted to establish a relationship through different structures, though no progress has been made. The lack of progress is unfortunate in our view.”

For its part, Scotiabank indicates that it is “satisfied with our level of investment in both CI and DundeeWealth”, according to Jane Shannon, senior manager, public affairs, with the bank.

Although Scotiabank may be content to remain a passive investor in these businesses for now, this stance doesn’t do much to improve its strategic position in the wealth-management business.

Moreover, proposed changes to the Basel II capital rules may make these sorts of minority holdings less attractive. The details of those changes have yet to be finalized; and once they are, they aren’t expected to take effect until the end of 2012. But, under the initial proposals, banks wouldn’t be able to count their minority interests in other firms as part of their Tier I capital anymore, meaning they would likely have to put up more capital to maintain their existing ratios.

@page_break@This sort of change wouldn’t represent a huge impact on the big banks’ capital positions (Scotiabank and Toronto-Dominion Bank would likely be most affected), but if this sort of minority stake strategy becomes less efficient because of changes to the capital rules, it may then push banks to deal with these sorts of positions conclusively — either by divesting these businesses or taking outright control of them.

In the meantime, Holland said, he’s content to have Scotiabank as a passive shareholder, but that it is looking in other directions for strategic growth. He indicated that this could include institutional business; that it is also interested in the high net-worth and alternative products businesses; but that CI doesn’t have a great deal of interest in a traditional mutual fund business.

“I think a pure mutual fund acquisition would have to have some interesting component to it, otherwise that’s not our first choice right now,” he said, adding that retail brokerage and capital-markets businesses hold no appeal.

The fact that CI is now more open to acquisitions marks a shift, and possibly an indication that deal activity may resurface in the sector. For a firm that has been a player in much of the mergers and acquisition activity that has gone on in the industry over the years, even CI wasn’t open to deals in the midst of the financial crisis. But now, Holland suggests that viable opportunities may start to emerge.

“I think we’re probably a little bit more open-minded,” he said. “As we get bigger and bigger, and the mutual fund industry is essentially getting smaller and smaller, I think we’ve got to diversify a little bit more. And I think there’s still room to take advantage of scale and synergies with smaller businesses. But there have to be something other than mutual funds.”

Long-time industry analyst, Dan Hallett, director of asset management, with Oakville, Ont.-based HighView Financial Group, says that he doesn’t foresee a load of M&A activity in the fund business just yet: “But there will always be an appetite for good deals, and there is nothing like turmoil to drive down prices and create opportunity where there previously was none.”

Ironically, the one company that is now looking to grow in the mutual fund business is Sun Life. On May 13, it announced it’s establishing its own mutual fund company and will be launching a new family of funds in Canada in the autumn, which will be offered alongside the funds it currently distributes as part of an ongoing partnership with CI — a holdover from its days as CI’s large minority shareholder. (See story on page 16.)

Boland’s report said that the new company likely won’t affect CI’s sales for several years, and even then, it likely won’t have a material impact (he estimates that about 15% of CI’s gross sales take place through the Sun Life channel).

Nevertheless, in hindsight, it’s hard not to wonder if Sun Life and CI would both be happier now if they’d managed to stay together in the first place. IE