Small, entrepreneurial investment dealers are facing tough times, and both the industry and regulators have a role to play in preventing their extinction, suggests Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC).
In a letter to IIAC members, Russell notes that small firms are under increasing pressure, as markets are undergoing an unprecedented slump; and, at the same time, firms’ fixed costs have “escalated dramatically”, both in terms of the systems needed to service clients, and to comply with regulation.
This is particularly tough on small dealers, he says, as their fixed costs represent a higher proportion of overall expenses, and their margins are tighter to begin with due to their smaller scale. And, as a result, half of the boutique firms in the industry were losing money on a net basis in mid-2012, he reports.
“If these conditions continue much longer, we will undoubtedly see an acceleration of firm closures, amalgamations and acquisitions,” he says, noting that 30-odd small- and mid-sized dealers have disappeared over the four years since the onset of the financial crisis, most due to acquisition. And, the current environment presents a higher barrier to entry, with only about 10 new dealers launching in that time (excluding proprietary and other specialized trading firms).
The erosion of small firms doesn’t just dilute competition, it can also have negative consequences for the markets and the economy, Russell warns. He notes that these boutiques often target under-served segments of the market, such as less affluent retail investors, or small businesses. “The demise of the small dealer will limit consumer choice for wealth management services, aggravate the already difficult financing problem for small and mid-sized companies and erode the liquidity of venture and TSX listed shares,” he warns.
Preventing that will require efforts from both the small firms themselves, and regulators, Russell suggests.
“Executives at small firms must continue to make the needed business adjustments to manage the industry’s higher cost burdens,” he says. “Some business models are just not compatible with these new realities, and managers must recognize the need for critical mass. Remedial measures should include building sufficient business scale through incremental hiring or strategic acquisition, and achieving targeted cost savings.”
And, regulators must also try to minimize the compliance burden, he suggests. “The rule-making process must be subject to rigorous cost-benefit analysis, both to prioritize the rule agenda and avoid unintended consequences,” he says. Moreover, he suggests that, “regulators need to work closely with the industry to streamline required compliance procedures and provide the needed flexibility to accommodate different business models, often with limited business scale.”