In November, Ontario Finance Minister Peter Bethlenfalvy directed the Ontario Securities Commission (OSC) to investigate allegations that the big banks and their investment dealer subsidiaries are engaging in tied selling to corporate clients and curbing the availability of third-party investment funds to retail customers.
The OSC is expected to report its findings by the end of February. In the meantime, the regulator’s consultation on the tied-selling allegations was met with blanket denials from the banks and forceful pushback on reforms recommended by the provincial government’s Capital Markets Modernization Taskforce.
The taskforce’s recommendations included proposals to “level the playing field” and stoke competition between large and small players in the capital markets, including enhanced restrictions on tied selling and requiring issuers to include independent dealers in certain transactions.
In responses to the OSC, the Big Five banks all denied tying provision of credit to a promise that a company would, in turn, provide its investment dealer with lucrative investment banking business. The banks also pushed back on the taskforce’s assertions that lack of competition is undermining financing activity and economic growth.
“We understood from the taskforce that its proposals sought to address a perceived decline in capital raising activities for venture issuers and smaller independent dealers. We do not believe that there has been such a decline,” said BMO Financial Group in its submission to the OSC.
In fact, BMO argued that the share of deal value for the bank-owned dealers in the investment banking business has fallen by about 38% since 2005, with both foreign firms and domestic independents gaining share during that time.
“This data shows that the current regulatory regime is not impairing competition in the Canadian market for independent broker dealers,” BMO said.
Indeed, some independent dealers are thriving. In its submission, TD Bank Group pointed out that an independent firm, Canaccord Genuity Group Inc., beat most of the bank-owned dealers in the equity underwriting league tables for 2021 (Canaccord ranked second only to RBC Capital Markets in Refinitiv’s year-end data).
“We believe this demonstrates that the Canadian capital market is healthy and independent dealers are viable,” TD said.
The banks maintained that their business practices are not to blame if venture issuers and independent dealers’ capital-raising activities have declined. Instead, the banks pointed to an array of other factors.
BMO suggested a fundamental shift from public to private markets for raising equity, declining appetites for higher-risk venture issuers, and the increased use of global markets to source capital could be affecting independent dealers. BMO also indicated that “less competitive pricing” by smaller firms plays a role.
CIBC Capital Markets’ submission to the consultation suggested that reduced capital-raising activity in the niches where independent dealers have typically thrived — such as small-cap mining, energy and tech sectors — could also explain some smaller dealers’ struggles. In the 2018–2020 period, these sectors accounted for 21% of equity issuance, down from 30% for 2012–2017, CIBC stated.
CIBC also echoed the suggestion that declines in initial public offerings (IPOs) are largely due to issuers’ growing preference for private markets. Global assets under management in private capital have grown by 950% since 2010, while public market capitalization has risen by only 300% over the same period, CIBC reported.
The bank suggested this shift is being driven by the higher cost of being a public company, not the banks’ sales practices.
“The competition from private capital can only be addressed by thoughtfully lowering the compliance burden of being a public company in a manner that does not sacrifice transparency and investor protection,” CIBC said. “By contrast, it is difficult to see how limiting clients’ choices in how to construct an underwriting syndicate will make public markets more compelling for issuers.”
The banks argued reforms designed to prop up independent dealers — such as requiring a share of certain underwriting mandates go to independents — were not the solution.
For example, Bank of Nova Scotia said many of the recommendations in the taskforce final report “will restrict issuer choice and therefore negatively impact capital raising and/or simply benefit foreign banks/dealers at the expense of all Canadian dealers.”
This could have “broader implications for the Canadian economy and economic strategy objectives toward diversification and supporting the ‘new economy,’” Scotia cautioned.
Independent dealers aren’t buying the banks’ protests. Notwithstanding its recent success, Canaccord blamed anti-competitive actions by the banks for the demise of many independent dealers, stating in its submission that more than 50 firms have either folded or been acquired in the past 10 years.
“The primary cause of the exit from the market by smaller independent dealers is that they are no longer included in [bank-owned] dealer equity syndicates,” Canaccord said. “These syndicates are now explicitly or implicitly tied to the provision of credit, leaving no room or economics for independent dealers.”
While Canaccord said it cannot prove improper tied selling is occurring, the dealer suggested that regulators could.
“The OSC should seek from banks internal documentation relating to corporate loans, including full lending syndicate packages, internal communications, revenue splits among divisions, and other documentation relating to determination of lending revenue that includes equity and ancillary fees,” Canaccord said. “If loans are meant as a bridge to an equity transaction, we believe banks’ internal documentation will often explicitly reference agreed-upon economics on future equity capital raising.”
Legislation already prohibits tied selling, but enforcing those provisions would fail to address the structural imbalances that have emerged in the Canadian equity market, Canaccord argued.
As for the charge that regulatory action to preserve the role of independent dealers could boost the cost of capital, Canaccord said that while the cost of debt may rise due to regulatory action on tied selling, the cost of equity would probably fall.
“Bundling of fees benefits the banks as issuers cannot adequately evaluate the cost of services,” the dealer said. “If tied selling is adequately addressed, equity and debt capital will be priced appropriately.”