In 1989, the Canadian financial services sector was in the early days of a seismic shift that was to remake the financial landscape. Fast-forward 25 years, and a bank-dominated retail investment business has emerged from that initial upheaval.
The late 1980s marked a new era for the financial services sector in Canada. The so-called “four pillars,” which had kept the banking, investment, insurance and trust businesses in legally separate “silos,” were toppled by reforms to federal and provincial legislation that, for the first time, gave financial services firms the opportunity to stray out of their traditional silos and into each other’s business segments. What wasn’t known at the time was that these reforms would lead to domination of the Canadian financial services sector by the big banks.
Back then, recalls longtime sector analyst, Dan Hallett, vice president and principal with HighView Financial Group in Oakville, Ont., “[The] idea of shopping à la carte for financial services was kind of in vogue.” But with the toppling of the four pillars, he adds, the banks have been able to assemble financial services supermarkets: “So, now, the idea of one-stop shopping is more appealing than it used to be. And banks are bigger and smarter about it – partly because they used their deep pockets and strong stock prices to grow into financial services firms that could offer most of the services people need and want.”
Yet, at the time, one of the central motivations for this wave of deregulation was weakness within the banking segment, which had witnessed the collapse of a couple of institutions in the mid-1980s. Policy-makers were persuaded that allowing the banks to diversify and improve their access to funding would bolster their stability, too. One of the first consequences of this legislative shift was the big banks hurrying to buy into the brokerage business.
In 1987, Bank of Montreal (BMO) picked up Nesbitt Thomson and Co., and Bank of Nova Scotia bought McLeod Young Weir Ltd. The following year, Canadian Imperial Bank of Commerce (CIBC) acquired Wood Gundy & Co., Royal Bank of Canada (RBC) took a majority stake in Dominion Securities Inc., and National Bank of Canada snapped up Lévesque Beaubien Geoffrion Inc. Toronto-Dominion Bank (TD) took a different route, first establishing itself as the dominant player in discount brokerage with the creation of its Green Line service, then building its own full-service firm, TD Evergreen, from the ground up.
Since then, these bank-owned brokerages have come to dominate the retail investment landscape in Canada, although, in the early days, that was far from a sure thing. The banking and brokerage businesses of the day were from wildly different worlds. The inevitable culture clash could have seen the buttoned-down bankers stifle the entrepreneurial brokers and kill the latter’s competitiveness in the process. But that didn’t happen. In fact, in many ways, it’s been the opposite: the more aggressive broker culture has shaken up the staid, clubby world of banking. Indeed, each of the Big Six banks have named CEOs in recent years who got their start in the brokerage business.
Rather than suffocating the investment business, the banks have built upon it. Some of that has come through more consolidation. After the initial flurry of brokerage buyouts in the late 1980s, BMO acquired Burns Fry Ltd. to create BMO Nesbitt Burns Inc., and RBC added Pemberton Willoughby Investment Corp. and Richardson Greenshields of Canada Ltd. to its brokerage arm.
In the 1990s, CIBC famously took advantage of U.S.-based brokerage giant Merrill Lynch & Co. Inc.’s on-again, off-again flirtation with Canada. CIBC Wood Gundy bought Merrill’s retail brokerage business when the latter decided to abandon Canada in 1990. By 1999, Merrill had returned to Canada by taking out Midland Walwyn Capital Inc., then the largest independent firm on the Street. But, two years later, Merrill was in retreat once again – and, again, it sold its retail brokerage business to CIBC, along with its asset-management division and other lines of business.
Merrill’s follies in Canada highlight one of the central fears about the initial move to deregulate the financial services sector that never materialized: the risk that foreign banks would take over Bay Street once the pillars were toppled.
Although various foreign-based firms have made forays into Canada, they have either ultimately abandoned the effort and sold the business back to a Canadian firm (as in the cases of Merrill and, more recently, Australia’s Macquarie Group Ltd., which sold its Canadian wealth-management arm to Richardson GMP Ltd. in 2013) or largely stuck to the wholesale business.
At the same time, the manufacturing side of the investment business also has fallen increasingly under bank control over the past 25 years – although, in the early days, it seemed doubtful that the banks would succeed in the asset-management business. As with the brokerage channel, fund portfolio managers tend to be fiercely independent and entrepreneurial, and they didn’t seem to be a good fit with banks.
When the mutual fund segment of the investment industry began taking off in Canada in the early 1990s, the banks’ funds were generally poorly regarded – apart from TD, which had a respected niche in index funds. The banks didn’t seem to pose much of a competitive threat to either the fund companies or the mutual fund dealer business, the latter of which was highly local and independent at the time.
In those days, Hallett recalls, “taking business from the banks – even for a rookie like me – was very easy.”
The mutual fund segment’s growth in that period was explosive. In the early 1980s, total mutual fund assets under management (AUM) was only about $4 billion; today, $4 billion is an average month’s worth of net sales. Mutual fund sales really took off in the early 1990s and, despite a few bumps along the way, that segment has thrived over the past 25 years. According to data from the Investment Funds Institute of Canada, total mutual fund AUM was less than $25 billion at the start of the 1990s. By the turn of the millennium, that total was up to $440 billion. By the end of the 2000s, AUM had almost doubled yet again to $780 billion. This year, AUM broke through the $1-trillion barrier.
The mutual fund segment’s rise has been fuelled by a couple of major demand-side factors, including the shift away from defined-benefit pensions (which increases the pressure on households to save for retirement) and weak fixed-income returns (which has investors eager to participate in the seemingly indefatigable bull market for equities). But supply-side factors have played a part, too, as industry ingenuity in product development and marketing flourishes amid fierce competition to meet the rising demand for portfolio returns.
These trends effectively have transferred the retail investment market’s focus from traditional stocks and bonds and onto packaged investment products. In 1989, Ermanno Pascutto was executive director of the Ontario Securities Commission. At the time, he says, retail investors were primarily shareholders in listed companies: “Mutual funds and structured products were a small part of the market.” However, these days, he adds, the investment industry’s clients “are really ‘consumers’ of financial products and services rather than more traditional investors.”
The mutual fund segment’s independents led this transformation. Yet, the glory days of the independents didn’t last. Eventually, the banks managed to exploit their overwhelming distribution advantages to climb in the mutual fund AUM rankings.
“Banks started requiring front-line salespeople to obtain certified financial planner designations, started ramping up on financial planning tools and started more proactive marketing of investment fund products,” says Hallett. “As banks already had the biggest and broadest distribution channels, this kind of concerted effort was all that was needed to become a dominant player in the investment fund [segment].”
Thus, the mutual fund distribution landscape has changed dramatically over the years. The highly fragmented, independent dealer channel came under pressure to consolidate in the late 1990s, as the demands of mounting regulatory costs and increasing technology expenses forced dealers to seek the scale required to absorb those rising costs. At the same time, the banks’ efforts to build out their sales capacity within their existing branch networks assured them of unparalleled access to distribution, whereas the independent fund companies found themselves in an increasingly bitter battle for shelf space as the independent dealers consolidated.
The end of the bull stock market and the global financial crisis in 2008 also played into the banks’ hands, Hallett suggests, as both “caused many retail investors to perceive banks as ‘safe’ places to invest their money.”
But the banks haven’t completely had their way with the retail investment business. The one thing that the razing of the four pillars didn’t do was give the banks control of the insurance business. Although the banks would surely love a bigger stake in the insurance business, policy-makers have resisted repeatedly. Instead, the insurers underwent their own seismic event in the late 1990s, when all of the major life insurers decided to demutualize and become publicly traded companies.
Although the banks have largely triumphed as a result of the toppling of the four pillars, the investment industry, in general, has flourished over the past 25 years despite recent concerns about weak profits. According to data from the Investment Industry Association of Canada (IIAC), there were 119 firms operating in the brokerage business in 1990, with slightly more than 20,000 employees. Now, there are about 190 firms employing almost 40,000 people. And those job gains haven’t come at the expense of productivity. In fact, amid rapid advances in technology over that time, employee productivity has jumped enormously, too. The IIAC’s data indicate that revenue generated per employee has almost quadrupled since 1990.
So, although Canada’s Big Six banks have grown to dominate the investment business over the past 25 years, it’s hard to argue that this has been a bad thing for the industry – or for the economy.
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