7th ACSDA Seminar - Trends in the Capital Markets

7th ACSDA Seminar - Trends in the Capital Markets

November 9, 2006 - Sao Paulo, Brazil

2

Trends in Capital Markets

1. Demographic Influences

- Demands of Retail Investors

- Pensions Reform

2. Buy-Side Requirements

3. Regulatory Pressures

4. Market Structure Changes

5. Implications for CSDs

3

Demands of Retail Investors

Largest transfer of wealth as boomers inherit wealth– Households 55 years+ hold 58% 68% in 10 years

Greater demand for above-market returns, professional advice, tailored products

More complex investments for income generation, principal growth/protection, tax minimization – Structured products (e.g. principal protected notes) – Hedge funds– Income trusts (until last week)

More global diversification as result of removal of foreign content restrictions on registered plans

4

Income Trusts

Corporate structure that avoids corporate taxation by paying all taxable income and net capital gains to unitholders

Very popular investment because of high yields– 39% held by pension plans and tax-deferred registered

retirement plans– 22% held by foreign investors

Risks:– Limits ability to reinvest in the business– Lack of standards for calculation of cash distributions,

disclosure– More complex corporate action processing, tax reporting

5

Income Trusts Listed on the TSX

Image source: Your Key to Capital Income Trusts on Toronto Stock Exchange

October 2006: $210 billion in market value, 11% of TSX by value and 16% of number of listings

6

Income Trusts

Originally used in sectors with modest but steady growth and reliable cash flows: – real estate, resource companies, utilities

Base has broadened to include manufacturers, investment/asset management firms, service companies– Two largest phone companies - Telus Corp and BCE

Inc. - recently announced conversion plans Government concerns about lost tax revenues resulted in

taxation on income trusts converting after October 30 and taxation on current trusts in 2011

7

Pensions Reform

Aging populations an increasing burden on private and public pensions as they are drawn for income

States will need to implement reforms to improve sustainability of public pensions – Hard choices: increasing contributions, reducing

benefits, achieving higher returns Private pensions increasingly relying on more

sophisticated asset management to meet obligations Impact on markets as public and private sectors seek

improved returns

8

Canada Pension Plan

To keep the Canada Pension Plan (CPP) viable, Canadian government implemented two reforms in late 1990s:– increased contribution rate (split equally between employer

and employee):

– 5.6% in 1996

– 9.9% in 2006

– 11.3% expected by 2050

– created CPP Investment Board (CCPIB) to improve returns

9

CPP Investment Board

CPPIB’s portfolio of $99 billion: – $58 billion invested in equity of 2,600 publicly-traded

companies– 600 Canadian companies – 2,000 foreign companies

Expected to grow to $147 billion by 2010 Sustainable for at least 75 years Becoming a more active manager

– $14 billion committed for investment in private equity, including infrastructure assets, with $5 billion already invested

10

Canada Pension Plan Assets

11

Buy-Side Impacts

Size of institutional trades can affect pricing – Buy-side wants more control and faster, less costly and anonymous

executions Direct market access

– Enables buy-side traders to access liquidity pools and execution venues directly without intervention from a broker’s trading desk

– Use the broker’s infrastructure and clear through the broker but buy-side controls the order

Algorithmic trading optimizes timing for placing orders in order to minimize impact on pricing

Dark liquidity pools that allow order crossing without displaying quotes to the market

12

Regulatory Initiatives - Canada

Regulators are adopting initiatives to reduce costs and increase efficiency and transparency of trading and settlement

In Canada, CSA proposed institutional trade matching and settlement rule (National Instrument 24-101):– Promote more efficient and timely settlement processing of

trades, especially institutional trades, per STP– Registered dealers and advisers must have procedures to match

institutional trades no later than prescribed times and to facilitate settlement by standard settlement time

– Transition to achieve 98% matching of trades executed before 4:30 pm by 7:30 pm on T by July 1, 2008

13

Regulatory Initiatives - U.S.

Elliott Spitzer obtained changes in market practices in the investment banking, mutual fund and insurance brokerage industries

Burden of SOX has led to increased privatizations and initial offerings in foreign markets with less onerous disclosure requirements

SEC Regulation NMS (National Market System): – market centres to prevent “trade-throughs” (i.e. execution of order at a

price inferior to best displayed bid or offer)– uniform market access rule to assure non-discriminatory access to best

prices displayed by market centres– sub-penny quoting banned, unless security priced <$1– changes to dissemination of market data to public

14

Regulatory Initiatives - EU

MiFID - Markets in Financial Instruments Directive to create a single market in financial services:– Establishes common conduct of business practices– Firms to obtain best execution for clients, taking into account

not only price but cost, speed and likelihood of execution and settlement

– Improved operation of passport approach to better enable firms to open branches in other member states and offer broader range of cross-border services

– New minimum standards for regulated markets and multilateral trading facilities

– Minimum standards for pre-trade and post-trade transparency

15

Regulatory Initiatives - EU

TARGET2-Securities (T2S) – Proposal issued by the European Central Bank for

consultation to develop a more efficient, cross-border integrated model for securities settlement

– New service of the Eurosystem for settlement of securities in central bank money on one technical platform

– To only cover settlement function; CSDs to continue providing safekeeping, custody, administration, corporate actions

16

Market Responses - Investment Firms

In U.S., firms countered disintermediation threat by direct market access by buying DMA providers

Prime brokerage provides centralized trade processing, reporting, financing and servicing for hedge funds

Technology now gives traders a centralized way of seeking out liquidity and intelligently routing orders among markets– Opportunity to create partnerships among firms and

exchanges, provide transparency and offer institutional traders a single point of entry

17

Market Responses - Investment Firms

Proliferation of investments in alternative trading systems (ATSs) and regional exchanges as alternatives to NYSE and NASDAQ – E.g. Block Interest Discovery Service (Bids) - Citigroup,

Lehman Brothers, Merrill Lynch, Goldman Sachs, Morgan Stanley, UBS

– Level ATS - Citigroup, Credit Suisse, Fidelity Brokerage, Lehman Brothers, Merrill Lynch

With an estimated 33 crossing systems in the U.S.,

shake-out is inevitable

18

Exchange Trade Volume Growth

Total Exchange Equity Trades Processed

-

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

90,000,000

100,000,000

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Equity Exchange Trade Volumes

Fiscal Year

19

Market Responses - Exchanges

As public companies, exchanges expected to continue growing earnings

Increase prices for transactions and market data or change pricing model– Contributor to proliferation of ATSs and firms internalizing their

crossing systems Reduce costs and counter electronic competition by replacing

floor trading with electronic trading Diversification of revenue sources by expanding asset classes:

– Derivatives – Fixed income trading– Gas and electricity contracts

20

Market Responses - Exchanges

Increase alliances between markets for interlistings

– E.g. MOU between TSX, TSX Venture Exchange and BOVESPA to promote broader co-operation and exchange of information to facilitate interlisting of issuers

Compete for interlistings– E.g., AIM market is marketing its less onerous disclosure

requirements, deep pool of liquidity and international institutional investor base to attract U.S. and Canadian issuers

– Canadian listings account for 20% of foreign firms listed on AIM

Vertical integration with CSDs, clearing houses

21

Horizontal Consolidation

22

Implications for CSDs

Ongoing pressure to reduce costs Enhance systems and operational capabilities and risk

controls to:– Process higher trade volumes and accept trades from

multiple sources– Accept and process new asset classes– Process increased and more complex corporate actions

Opportunities to broaden services, market data Establish global links to support exchange linkages,

interlistings Continued consolidation - vertical and horizontal