This article appears in the June 2021 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
The Canadian investment industry is enjoying astounding results, with retail investing taking flight like never before. However, online investors are creating new regulatory worries.
Investment dealers’ revenue, profit and productivity all rose sharply in the first quarter of 2021 on the heels of a record-setting year for the wealth-management business. According to the latest data from the Investment Industry Association of Canada (IIAC), overall industry operating revenue topped $8.1 billion in Q1, up by 14.9% from the prior quarter and by 38.7% year over year.
Fees, the single largest component of industry revenue, rose to $2.7 billion, up by 5.8% from the prior quarter and by 14.2% year over year. Overall commission revenue jumped to more than $2 billion, up by 26.1% from the previous quarter.
The industry’s latest gains came amid a surge in retail trading driven by strong markets, rising income and the emergence of the so-called “meme stock” phenomenon, with novice investors piling into equities that are catching social media buzz.
This flood of trading action has caught regulators’ attention. The Investment Industry Regulatory Organization of Canada (IIROC) warned the retail surge has created “stress across the system,” prompting IIROC to undertake a review of reported service disruptions at online brokers.
IIROC is considering whether service disruptions could represent “fair access issues that … rise to the level of investor protection issues,” said Sean Hamilton, director of public affairs and member education services with IIROC. The regulator has completed a survey of dealers and is deciding whether further action is warranted, Hamilton said.
The Ontario Securities Commission (OSC) has voiced similar concerns about the rise of retail trading and the accompanying surge in client complaints regarding service interruptions and delays — particularly at the major discount brokers, which are grappling with large numbers of new clients and high trading volumes.
In a speech on May 19, OSC chairman and CEO Grant Vingoe suggested firms should be prohibited from opening new accounts if they don’t have the capacity to serve those clients.
Vingoe flagged other concerns, such as whether firms’ efforts to make trading easy for clients has encouraged reckless trading. He also said the OSC is looking at potential conflicts of interest in connection with the foreign exchange (FX) fees that firms charge retail clients for cross-border trading.
In the U.S., online brokers finance commission-free trading by generating revenue through payment for order flow. That practice is prohibited in Canada, but, Vingoe said, brokers here generate revenue from FX fees instead. The OSC declined to elaborate on its concerns with FX fees.
Using the IIAC’s data to determine the impact that the surge in retail trading has had on firms’ revenue is difficult. Online discount brokers don’t fall neatly into any of the dealer categories analyzed by the IIAC.
According to Jack Rando, managing director at the IIAC, the results for the bank-owned discount brokers are lumped into the “integrated dealers” category and reported alongside their full-service counterparts, whereas independent online dealers are generally classified in the “full-service retail” category.
It’s also not entirely clear where firms are reporting rev- enue from the FX fees that the OSC flagged. Rando said dealers’ FX gains generally are reported as “other” revenue, whereas most account servicing fees are classified as “fee” revenue — so, online brokers’ FX revenue could fall into different categories, depending on the broker.
What’s clear is that the brokerage business is thriving amid the growth in retail trading. Commission-based revenue in Q1 was strongest at the full-service retail firms (which include independent online brokers): up by 45.6% from the prior quarter and by 69.4% year over year.
In total, full-service retail dealers accounted for almost $400 million of the overall industry quarterly commission revenue of slightly more than $2 billion. (Retail introducers accounted for another $208 million.)
Combined, retail firms (including full-service and introducing brokers) produced about 30% of the industry’s total commission revenue in Q1, despite generating only about 21% of overall operating revenue (up from 19% in 2020). As well, for the first time since mid-2017, retail firms’ quarterly commission revenue was higher than their fee revenue.
Commission-based revenue was up significantly at the integrated firms too, although not by as much. At the bank-owned firms, commission revenue rose by 23.4% from the prior quarter, totalling $1.3 billion.
In investment banking, overall industry revenue from equity and debt underwriting, along with M&A and other advisory fees, topped $1.5 billion in the quarter — up by 44.7% from the previous quarter and almost double the total in Q1 2020.
Trading revenue was the only blemish on a standout quarter. Equities trading in particular took a beating (negative $2 billion) and fixed-income trading was also down (negative $20 million). All of the equities trading losses came at the large, bank-owned dealers, which collectively suffered $2.7 billion in negative revenue for the quarter, well off the $3.9 billion in revenue generated in the first quarter of 2020.
Despite weak trading and net interest revenue, overall industry profit soared in the first quarter. Total operating profit was $3.3 billion, up by 22% from the previous quarter and more than double the amount reported in Q1 2020. Net profit reached $1.9 billion, up from less than $900 million in the first quarter of 2020.
Industry employment totalled 44,700 in Q1 2021, up by 2.7% year over year, but the strong rise in revenue meant productivity (measured as revenue per employee) rose by 35.1% from Q1 2020.
Whether the rise in retail trading continues is uncertain, but it is fuelling a booming bottom line for the investment business.