Bay street companies often tend to see regulators as adversaries, but in a region where almost no capital market exists, regulators must be nurturers as well. Such is the challenge facing the New Brunswick Securities Commission as it embarks on a mission to build its capital markets.

The NBSC was established in July 2004 with a dual mandate of investor protection and fostering capital markets. Other securities regulators are expected to provide both investor protection and fair, efficient markets, but a market already exists to make efficient. That’s not really the case in New Brunswick.

Late last year, the NBSC took the first step in the building process when it brought the TSX Venture Exchange’s capital pool company program to the province. It has also signed on to the passport model with the other provinces (excluding Ontario). This allows it to act as a principal regulator and provides easier access to markets in the rest of the country. If the province hopes to develop a vibrant capital market, however, much more remains to be done.

To that end, the commission started a series of round tables on Jan. 18, in which it will canvass for ideas on how to expand its markets. The regulator will host 10 sessions around the province in the coming months, with the intention of coming up with concrete solutions.

“The objective is not just to have a discussion of the issues, but also to develop ideas and ultimately shape an effective action plan that can be implemented within the commission’s mandate,” the NBSC says. It will host a forum toward the end of 2006 in order to publish its proposals to advance the cause of the province’s capital markets.

In the past six months, the NBSC has been doing some research into the state of its markets and possible initiatives for improvement. The results of part of that research are contained in a discussion paper that is the starting point for the round table discussions. A draft of the paper, which was provided to Investment Executive, sets out the rather uninspiring state of New Brunswick’s capital markets.

New Brunswick is home to just six publicly listed companies, ranking last among the provinces that have at least one listing (P.E.I. has no listed companies). The number isn’t related to the province’s size, either, as it also ranks last when number of listings are considered in proportion to both population and provincial GDP. British Columbia and Alberta rank first and second, respectively, owing to the large number of junior companies that call those provinces home. Ontario ranks third and Quebec fourth.

Looking at the size of the market on the basis of total equity market capitalization to GDP, New Brunswick ranks eighth among the nine provinces that have at least one public issuer, just edging out Newfoundland. With a market cap that amounts to only 17.6% of GDP, the NBSC says, this puts the province on a par with Turkey in terms of its relative market size.

For Canada overall, the total equity market cap is 123.9% of GDP. Alberta leads the country by far, at 241.4%. Ontario is a distant second, at 129.1%; and Manitoba ranks third, at 108.6%. New Brunswick’s result is skewed to the upside by the presence of one company, which represents about 85% of the province’s market cap. Without it, the province would be much further behind.

Clearly, New Brunswick has a lot of work to do if it hopes to build a viable capital market from its current position. The NBSC’s research indicates the province suffers from a host of issues that are inhibiting the growth of a homegrown equity market. The list includes everything from the absence of an equity culture to a shortage of venture funds to a lack of expertise — entrepreneurs, mentors and advisors, such as lawyers and accountants, with equity market experience — not to mention things such as taxes and regulatory costs.

The NBSC paper states that the province suffers from a problem that’s common to many jurisdictions: a dearth of funding in the $100,000-$1.5 million range. Bridging that gap between start-up (when companies can reasonably raise funds from family and friends and government support programs) and commercialization (when venture-capital investors start getting interested) presents a real obstacle. Even for companies that do leap the gap, there’s a shortage of venture capital and “angel” investors in the province.

@page_break@More fundamentally, the province doesn’t have a history of entrepreneurial equity capitalism. Debt financing has typically been the way local companies fund themselves. Traditionally, public equity hasn’t been a force; the province’s biggest companies have been family-dominated, privately owned firms, such as Irving Oil Ltd. and McCain Foods Ltd.

Breaking out of the tradition is likely to require a range of initiatives. The discussion paper lists dozens of ideas, including lowering dividend taxes and providing other incentives to utilize equity, and softer notions for nurturing local sources of funding and knowledge, such as facilitating more interaction and co-operation among government, academia and industry, and attracting funds and expertise from outside the province.

One source of both inspiration and aspiration is the Boston area — which has its own well-known venture industry focused around Route 128 — as a possible source of knowledge and capital. But it’s more likely that such benefits will have to be cultivated locally.

A study for the wise person’s committee in 2003 found that 84.4% of private equity investments in Canada are situations in which the investor and entrepreneur are located in the same province. This is hardly surprising because venture investors tend to prefer providing more than money to their investments; they also provide advice. And it’s easier to do that when investee companies are nearby.

To attract out-of-province money, in which case a venture-capital investor wouldn’t have much of a say, companies generally have to be very advanced in their development, and possibly already publicly listed. The importance of proximity and the existence of social networks for fostering venture-capital formation is evident in the sort of industry clustering that has taken place in locations such as Boston and Silicon Valley.

The same effect is evident in the public markets. Another WPC study found that Canada has developed a variety of localized capital-raising infrastructures. They include energy companies in Alberta, micro-caps in B.C., financial services firms in Ontario, miners in B.C. and Ontario, life sciences in Ontario and Quebec, and media firms in Ontario, Quebec and B.C.

Initiatives such as the capital pool program in Western Canada have clearly been successful is nurturing such clusters for public equity funding. So the program’s introduction in New Brunswick should be encouraging to the province’s capital market cheerleaders.

The NBSC paper also raises the question of what the appropriate regulatory regime for a fledgling market should be. B.C. has been touting a move to a less burdensome, principles-based approach to regulation, in contrast to the more prescriptive model that prevails in more developed markets such as the U.S. and Ontario. Although B.C. has actually yet to implement its new securities act, the vibrancy of its market suggests that a lighter touch is certainly conducive to capital formation among small issuers. If the goal is to create a vibrant junior market in Atlantic Canada, it may make sense to follow B.C.’s lead rather than adopting the rules-heavy approach — particularly in a region in which navigating the equity game is already considered daunting.

The challenge of developing an entrepreneurial culture is a tough one. Consider the example of Scotland. It faces similar challenges to New Brunswick in that it’s an underdeveloped region living in the shadow of a modern capital market. As such, it has none of the problems that emerging markets in China, Latin America or Africa may face. It boasts modern, well-developed institutions, property rights, the rule of law and little political risk. Yet, despite its first-world institutions, it is a regional laggard.

Recognizing the problem in 1999, Scotland established an economic development agency, Scottish Enterprise, with many of the same goals as the NBSC has: fostering new businesses and supporting development of growing businesses.

According to its latest annual report, however, the country still ranks in the third quartile in an international index that measures new start-ups. Within Britain, it has fallen to 11th place from 10th in a ranking of 12 regions in terms of new businesses. It has had much more success in other metrics, such as improving the quality and quantity of skills and training, and the proportion of businesses that are online. But for getting new businesses going, Scottish Enterprise has had little impact.

The reality is that capital markets have many moving parts, and it is incredibly tough to command one into existence. Perhaps the best a regulator can do is create an environment in which success is possible. It can provide few barriers to entry, efficient and cost-effective rules, and then stand back and hope for the best. IE