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Strength in the retail brokerage business drove Canada’s investment industry revenues and earnings higher last year, but with turmoil in other parts of the business, continued consolidation is on the horizon, says the Investment Industry Association of Canada (IIAC) in a new report.

In his latest letter to the industry, Ian Russell, IIAC president and CEO, predicts industry consolidation will continue, amid tepid economic growth, subdued commodity prices and rising costs.

“The industry will continue to consolidate around the firms that have stayed profitable through the period—a tribute to strategic vision and focus, sound management practices and cost control,” Russell says. “It will be a lean and resilient industry that eventually emerges, but one that will be smaller.”

Looking back to 2017, retail investment business was the industry’s main source of strength, offsetting weakness in investment banking and fixed-income trading. Retail revenues rose by 14% at the large integrated firms last year, according to the IIAC letter, and by 19% at the retail boutiques. Along with this top line growth, retail earnings rose by 12%, it notes.

Within the retail sector, self-clearing firms outpaced introducing firms. “The 29 self-clearing retail firms recorded the highest earnings in three years, with operating profit nearly doubling to $327 million in 2017 compared to 2014,” the letter says. “Revenue gains outstripped operating costs by a wide margin.”

At the industry’s 62 introducer firms, operating profit dropped by more than 50% to $68 million, the lowest level in five years, due to rising cost pressure.

“The difference in performance, in relation to cost increases, between the self-clearers and the introducers, has a lot to do with the timing of cost increases,” the letter adds. The self-clearing firms had already invested in systems to comply with recent changes in regulatory, tax, and anti-money laundering requirements, whereas these costs started hitting the introducers last year in the form of fee increases by their clearing firms.

“On balance, the steady and broad-based growth in wealth management revenues over the past three years 2014-17, from rising portfolio valuations, client asset inflows and new services such as financial and estate planning, have outstripped the steady above-inflation rate increase in operating costs. Profits have nonetheless been volatile in the period and not shared evenly across firms in the retail business,” the letter continues.

While the overall number of firms in the retail business has remained more or less steady over the period, there have been changes in the boutique end of the sector.

“The composition of the small firm grouping has altered, with many small and mid-sized vibrant firms taken out by acquisitions and largely replaced by startup firms and specialized fintech players,” the letter says.

The institutional side of the business has been under greater pressure in the last several years, and the IIAC expects this to persist in the future. “The continued business pressures on small institutional firms suggest consolidation of the grouping will accelerate over the next several years,” the letter continues.

“The wealth management business at large and small firms will continue as the driving force in the industry, but handicapped by continued increases in operating costs,” the letter says.

Consolidation and other structural shifts will likely continue as a result, “change will be sweeping — both macro-change from continued amalgamations and IIROC resignations among firms in the industry, and joint ventures and partnerships with online platforms, and the firm-level internal need to adapt financial technology to broaden products and services, improve cost-effectiveness and deliver convenience through digitalization,” the letter adds.