It’s become almost a cliché to comment on the globalization of financial markets. Yet, many aspects of these otherwise international markets remain resolutely local. Take the initial public offerings trade, which reached record heights in the rest of the world but faced made-in-Canada problems at home.

According to Investment Exec-utive ’s annual survey of IPOs, the Canadian IPO market suffered a notable downturn in 2007, with issuance on the Toronto Stock Exchange dropping to $6.2 billion in 2007 from $10.5 billion in 2006. At the same time, Thomson Financial reports, the global IPO market reached a record US$308.7 billion in issuance for 2007, up about 15% from the prior year.

The market for Canadian IPOs has always been a delicate flower, but in 2007 it wilted, not surprisingly, as a result of the dearth of income trust deals. For the past few years, the Canadian IPO market has thrived on the strength of income trusts coming to market. The federal government’s decision to remove the tax incentives that were driving the primary part of that market — the business and resources trusts — effectively knocked away one of the central pillars of support for the domestic new-issue business.

Clearly, the types of companies that were launched as income trusts in the past are not now doing ordinary common-share offerings. The main reason the government found it necessary to kill the income trust vehicle is that it boasts significant tax advantages over traditional equity. Without that edge, companies may be deciding that it’s not worth it for them to be public.

While that may come as music to the ears of the policy-makers whose goal it was to eliminate the trusts’ tax advantages over old-fashioned corporate structures, the dearth of new income trusts coming to market presents a problem for inves-tors. Namely, what will replace income trusts? The answer has yet to emerge in the IPO market.

Certainly, companies don’t appear to be reverting to traditional common-stock corporations at the same rate as they converted to income trusts. About half of the issues that are coming to market as IPOs are still non-traditional deals. Indeed, many are merely investment vehicles that recycle their capital into the same old crop of large public companies.

For example, there remains a proliferation of split-share instruments that invest in existing companies such as the big banks. Other offerings that are counted as IPOs more closely resemble investment funds. As a result, they, too, often invest in existing companies and don’t represent capital injections into new, growing companies, which is the ostensible purpose of IPO capital.

At the same time, existing publicly traded companies are being snapped up by both private-equity buyers and foreign firms, further draining the supply of genuine domestic investment opportunities for Canadian investors. And there appears to be more of that same activity on tap for the years ahead, particularly as existing income trusts continue to be consolidated or taken private in response to the new tax regime they are facing.

With some of Canada’s more venerable companies disappearing, income trusts being phased out and as well, not much of a high-yield bond market to speak of — a niche that trusts were supposed to fill, in part — there appears to be the risk of investors’ needs going unmet. The income trust phenomenon may have irritated policy-makers and exasperated corporate executives, but the trusts served a purpose for yield-hungry inves-tors. The expectation is that investment bankers will dream up something to take the place of income trusts in the hearts and minds of IPO investors, but, so far, nothing has filled the gap.

In the meantime, Canadian investors are being fed more of the same. In 2007, there was a notable gain in equity issuance generally, notwithstanding the weakness in IPOs, led by a spike in secondary common-share offerings. On this count, the Canadian market was in line with the global trend.

According to data from Thomson Financial, the issuance of equity and equity-related securities in Canada jumped by more than 40% from 2006 to 2007, to a total of almost $45 billion. Data from the Investment Industry Association of Canada highlights the fact that a significant jump in secondary common-share offerings is the primary driver of that increase in overall equity issuance. The total value of secondary offerings jumped to $34.2 billion in 2007 from $21.8 billion in 2006. This puts follow-on common-share issuance at slightly more than double what it was two years ago.

@page_break@Also offsetting the decline in trust issuance were modest year-over-year gains in preferred share and limited partnership issuance, the IIAC reveals.

DISTINCTLY DIFFERENT LOOK

But the big jump was in secondary offerings of common shares. As a result of these divergent trends in the two main components of the new-issue business in Canada (initial vs. secondary offerings), the Canadian market is taking on a distinctly different look from the rest of the global capital markets.

On the global stage, the IPO and the secondary markets are fairly close to being equal contributors to deal volume. This mix between initial and secondary offering volume stands in stark contrast to the situation in Canada, where the secondary market dwarfs the IPO activity by a factor of several times. In Canada, secondary deals accounted for 77% of equity new issuance in 2007. That’s in contrast to 44% for the rest of the world.

This apparent divergence comes at a time when equity issuance volumes are up worldwide. Thomson Financial reports that global equity and equity-related underwriting reached record levels in 2007, rising 21.8% to US$876.3 billion. Not only did the global IPO market reach new heights in 2007, but secondary offerings also enjoyed strong growth. The value of follow-on offerings rose about 19% from 2006 levels to finish 2007 with US$389.2 billion issued during the year.

It remains to be seen if Canadian investment dealers can come up with anything to get the domestic market on track with the rest of the world, or if Canadian markets will continue to count on secondary issuance to supply fresh equity. Nabil Melhem, senior analyst, capital markets, with the IIAC in Toronto, hasn’t heard of any new equity vehicles in the works.

Although, on the fixed-income side, Melhem points out that covered bonds, a type of asset-backed security that stays on the issuer’s balance sheet, were issued by two of the big banks for the first time this past year, and more of these types of issues are in the pipeline. Also, Melhem notes, shares in special-purpose acquisition companies are becoming increasingly popular in the U.S. It remains to be seen if that trend emerges here, too.

Of course, 2007, which brought about the onset of the global credit-market disruption, was probably not the time to be floating exotic new securities. In the last five months of the year, at least, inves-tors were largely gun-shy when it came to the markets. And they were particularly chastened about dabbling in exotic investments, given that the problems that emerged were the work of financial engineers who specialized in dreaming up new methods of packaging and repackaging securities so that they could be sold to investors.

It has since become apparent that these efforts at financial engineering had obscured some of the risks involved, and the ensuing fallout has highlighted the lack of transparency that can accompany complex securities. Given that investors are now acutely aware of these sorts of problems, it seems unlikely that they will be willing to stray too far from plain-vanilla offerings for the foreseeable future.

But, if Canada wants to join in the global IPO boom in the years ahead, it must hope that its financial wizards can come up with something that comes close to replicating the success of income trusts. IE