‘Collapsing industry’ needs help from regulators: IIAC

Russell says that industry consolidation remains a worrying trend, after domestic institutional boutiques had their second-worst quarter ever in the first quarter of 2013 due to “moribund equity investment banking and trading businesses.” And, while retail boutiques enjoyed a rebound in operating revenue and profit in the quarter, he suggests that these gains “were likely short-lived as retail investors retrenched” in the second quarter.

“The steady erosion of needed capital at institutional firms to fund continued operating losses, and continued weak earnings at retail firms, are forcing small firms to focus more intently on strategic reorganization,” he says. Indeed, he reports that 11 firms left the industry in the first four months of the year, which is a “much faster pace of resignation than in the past several years”. And, he says that the IIAC expects this trend will continue.

“One should take this accelerating pace of dealer consolidation seriously,” Russell warns, predicting that this is not part of the normal, cyclical ebb and flow of the business. New firms won’t easily spring up in their place when markets rebound, he says, “The massive structural changes in equity markets, changing investor demographics, and extensive new regulatory demands have required significant investment that has created barriers to entry for new retail and institutional dealers.”

The infrastructure required to operate a competitive firm these days, suggests that, “when equity markets embark on significant recovery, new start-up entrants in the securities industry will be few and far between,” he says. Additionally, factors such as regulatory and tax-reporting requirements, the high cost of keeping quality investment advisors, the loss of net interest income, and the tighter margins in the trading business will discourage new firms from entering the business.

If small dealers continue to fold, Russell warns, “Canadian capital markets will suffer serious consequences, both in terms of reduced competitive stimulus in retail and institutional markets, and less financing opportunities for small Canadian businesses. The loss of small firms will be a particular blow to regional economies and to the viability of the venture markets.”

On that basis, he argues that regulators should be looking to help the industry, and the IIAC has a series of proposals for them to consider.

First, it calls on them to slow down new rule making, and to ensure that all new regulations are justified on a cost-benefit basis.

Second, it says that investment dealer firms should be allowed to employ reps that are only registered to sell mutual funds, which “would give small IIROC- registered retail boutiques more options to build scale in their retail businesses.”

It also recommends that, instead of allowing crowdfunding, regulators should provide an exemption from suitability requirements for a portion of individual investment portfolios, in order to facilitate more speculative investing.

Additionally, it suggests that regulators consider reducing holding periods on private placements to improve liquidity; that they eliminate any unjustified fees; and that they should ensure a level playing field between foreign and domestic firms in the derivatives business.

“Regulators cannot stand by while the industry faces its toughest challenge in decades,” he concludes. “Fortunately, there are steps that can be taken – steps that would benefit the industry, the markets, and investors.”