Slowing global economic growth, softening commodities and the retreat of the loonie all suggest that a slowdown in trading activity could be in store

The Canadian fixed income business is booming, and sell-side firms are beefing up operations in this area, but the surge may not prove sustainable.

According to new research from Greenwich Associates, institutional fixed income trading volume has been soaring in Canada — volume increased 42% from 2009 to 2010, including a 60% increase in cash bond trading volumes — at a time when it is slowing in the United States.

The firm reports that this spike in Canadian fixed-income trading volume was driven by a surge in the trading of government bonds. Among a sample of 80 of Canada’s largest institutions, trading volume in government bonds increased 93% from 2009 to 2010 and trading volumes in provincial bonds increased 50%, it notes.

Also, Canadian mortgage bond trading saw big growth, Greenwich says. It notes that while these products only account for a small part of the overall Canadian fixed-income market, institutional trading volume in mortgage bonds quadrupled from 2009 to 2010.

“One of the biggest stories in the Canadian bond markets throughout the global crisis was the success of mid-sized firms in expanding their fixed-income trading market share among Canadian institutions,” Greenwich says. “The rapid gains achieved by firms such as Desjardins Securities, Casgrain and Laurentian Bank Securities from 2008 to 2009 were enabled by the retreat of many large U.S. and global fixed-income dealers forced by internal balance sheet pressures to scale back their Canadian operations.”

However, it reports that foreign dealers returned to Canadian markets last year, driven by renewed balance sheet strength, the attractiveness of the Canadian markets, and a growing demand among Canadian institutions for foreign government bonds, especially U.S. Treasuries. Foreign firms that gained market share over the past 12 months include HSBC, Deutsche Bank, Morgan Stanley, and Barclays Capital.

Nevertheless, a couple of domestic heavyweights continue to lead the business. BMO Capital Markets and RBC Capital Markets remain the market share leaders in Canadian fixed-income trading Greenwich says. And, it reports that RBC is the 2010 Greenwich Quality Leader in Canadian Fixed-Income Overall, Fixed-Income Sales and Fixed-Income Trading, “meaning that the firm received client ratings in each of these categories that topped those of competitors by a statistically significant margin”. BMO Capital Markets is the 2010 Greenwich Quality Leader in Canadian Fixed-Income Research.

Looking ahead, the firm suggests that the primary challenge facing Canada’s major dealers and mid-sized firms in the coming year is not foreign competition, but the potential for a slowdown in the domestic fixed-income market. “The past year was truly an extraordinary period that was driven by the confluence of several extraordinary factors. But some of the factors that contributed to this boom now appear in doubt,” says Greenwich consultant, Peter Kane. “A loss of strength in the Canadian dollar, declining commodity prices or a sputtering in the global recovery all seem real possibilities at the present moment, and any one of those developments could mean an end to the party.”

Yet firms have been building up their capabilities in the fixed-income area. Greenwich says that, over the past 12 months, Canada’s leading dealers have been expanding in the US and Europe, and several mid-sized firms, “have made major investments in their fixed-income franchises, including physical build-outs involving new or expanded offices and trading floors in Toronto.”

“The sell side is increasing capacity,” says Kane, “but a variety of indicators ranging from slowing global economic growth, subsequent softening in commodities market and the gradual retreat of the Canadian dollar relative to the U.S. currency all suggest that a slowdown in trading activity could be in store.”

IE