A combination of weaker revenues and rising regulatory costs has the boutique side of the securities industry under tremendous pressure, reports the Investment Industry Association of Canada (IIAC). Without a convincing market revival, many of these firms may be in trouble.
The IIAC Tuesday released both its year end industry statistics, and the latest letter from its president and CEO, Ian Russell, which examines the current state of the securities industry.
The report indicates that overall industry net profits rose about 6% during the past year to finish at $2.1 billion for 2012. Moreover, it points out that industry revenues, at $15.3 billion in aggregate, are only down slightly from before the financial crisis took hold.
However, the composition of industry revenues and profits has shifted notably over the past few years, with the large integrated dealer firms holding up much better than the industry’s smaller boutique operations.
In his letter, Russell notes that the seemingly stable overall industry revenue picture, “masks the deep stress on the industry and individual firms, stemming from rising industry-wide cost pressures – especially due to the impact of increased regulation – and a dramatic fall-off in financial business at the boutique firms.”
The IIAC reports that revenues for the large firms have actually risen over the past few years, as gains in debt and derivatives markets business has helped overcome a falloff in equity trading and underwriting. They’ve also seen their fee revenue rise over the past few years.
The same cannot be said for the boutique dealers, who are more reliant on the equity business, and have been less able to offset weaknesses there with new revenues from other business lines. “The viability of the smaller boutique firms is threatened, unless a market turnaround occurs in the near term,” Russell says in his letter.
Moreover, it notes that, while revenues are falling for these firms, operating costs are rising, which is squeezing margins even further. Russell puts much of the blame for rising costs squarely on the shoulders of regulators. “The rise in operating costs over the post-crisis period illustrates the impact of the regulatory burden on the bottom line,” he notes, pointing to “The steady increase in regulatory compliance costs, in terms of resources and technology spending, is the major factor responsible for this escalation of operating costs at the boutique firms.”
And yet, Russell doesn’t see any end in sight to ongoing regulatory reforms. When combined with continued market weakness and new tax reporting obligations (both foreign and domestic), promises continued pressure on industry margins. The IIAC reports that about half of the institutional and retail boutiques have been losing money fairly steadily over the past two years, “leaving them in a precarious position.”
This isn’t just bad for the dealers themselves, but also for investors and markets, Russell suggests. “The financial squeeze faced by small boutique firms does not just threaten them. Ultimately, it threatens investors, and small and mid-cap issuers, posing a hazard to competitive and liquid markets for efficient securities trading and financing,” he says.
To avoid that, the IIAC argues that regulators must work harder to limit the regulatory burden and avoid negative unintended consequences.