A new report from Greenwich Associates suggests that U.S. bond markets will benefit from the elimination of Canada’s foreign property rule, as more than 40% of Canadian institutional investors say they expect to increase their holdings of U.S. Treasuries and investment-grade corporate bonds as a result of the change.

Greenwich says that the removal of limits on foreign investments for Canadian institutions will, “commence a period of transformation in Canada’s fixed-income markets as institutional investors add these and other foreign bonds to their asset mixes, domestic dealers build out their cross-border capabilities, and global dealers re-build Canadian businesses.”

“While the impact will be smaller in fixed income than in equities, Greenwich Associates latest research does suggest that the removal of the rule will have a meaningful impact on Canadian institutions’ relationships with fixed-income dealers,” says Greenwich Associates’ consultant Lea Hansen. “In all likelihood, after the rule revision, there will be a brief period of rapid evolution as domestic dealers augment or develop their global capabilities — be it independently or through partnerships with non-Canadian firms — and foreign dealers reconstitute their sales capabilities after virtually withdrawing from the Canadian market over the past several years.”

The new report also finds that: Canadian institutions plan to increase their holdings of foreign bonds from the current 3% of total assets under management to 5% once the FPR is removed; currently just 10% of Canadian managers invest in foreign fixed income, that’s expected to exceed 20% once the FPR is gone; more than 25% of Canadian institutions expect to add to their foreign investments within six months of the proposed elimination of the FPR, and another 30% said they would do so within a year of the change; and, a quarter of all Canadian plan sponsors and 45% of plan sponsors with more than $1 billion in assets under management tell Greenwich Associates they intend to increase their allocations to foreign investments.

U.S. bonds will likely be the biggest beneficiaries of the shift, Greenwich says. U.S. Treasuries and investment-grade corporates already are far and away the most popular foreign fixed-income products among Canadian institutions, and more than 40% of Canadian institutions say they expect to increase their use of U.S. Treasuries and high-grade corporates if the change takes effect. Almost 40% say they plan to increase their use of European investment-grade corporate bonds, while more than 30% plan to use more U.S. Agencies and more than a quarter expect to use more European government debt.

While Canadian institutions are preparing for a relatively quick move into foreign fixed income, Greenwich’s Woody Canaday cautions that the magnitude of the shift should not be overstated, “As mentioned previously, international equities will provide much of the new foreign exposure taken on by Canadian institutions after the removal of the 30% Foreign Property Rule,” he says. “In particular, one potential factor that seems to be mitigating a substantial build-up of foreign fixed-income assets: Canadian pension plan liabilities are in Canadian dollars while foreign bonds are denominated in foreign currencies.”

Nevertheless, the introduction or expansion of foreign bond holdings in Canadian institutional portfolios could shake up the country’s fixed-income markets for an extended period of time. “The Canadian market is dominated by five domestic dealers,” says Hansen. “We can assume that as institutions pick up the pace of their activity in foreign bonds over the next several years, they will look to those dealers with significant expertise in international markets, which in at least some cases will be foreign or global dealers.”

The study also reports that: over the 12-month period ending in March 2005, cash bond trading volume declined 15% while fixed-income assets under management at Canadian institutions increased 17%; and, while the proportion of Canadian institutions trading fixed income electronically was stable year-to-year at about 30%, the proportion of investors planning to start e-trading is on the decline.