Canada’s securities sector has long been dominated by a handful of large firms balanced by a healthy crop of small boutiques, with not much in between. However, the market environment over the past couple of years has the boutique end of the business increasingly looking to be in poor health.

The securities sector, on the face of it, has weathered the period of exceptional market volatility relatively well. According to the latest data from the Toronto-based Investment Industry Association of Canada (IIAC), overall investment dealers’ profits actually rose slightly in 2012. After a rough third quarter, combined profits ticked up to almost $600 million in the fourth quarter (Q4), topping $2.1 billion for the year overall, which is up by almost 6% year-over-year.

However, this seemingly buoyant bottom line is masking a good deal of weakness. Although combined net profits did rise last year, operating profits actually were down by about 11% from the previous year, as revenue slid by about 5%.

Many of the sector’s basic business lines suffered revenue declines last year. Commission revenue was down by 12%, investment banking was off by more than 10% and net interest revenue dropped by almost 18%.

Trading revenue did grow year-over-year; but even so, it is hardly anything to brag about. Fixed-income trading revenue posted a 10.5% gain year-over-year, but this still is about 45% below 2009 levels. And although equities trading revenue returned to positive territory in 2012 (after recording $1 million in negative net revenue in 2011), it’s still down by about 75% from 2009.

The only revenue line that has grown consistently over the past several years is fees. Fee revenue topped $3.2 billion in 2012, up by 3.6% from 2011. That follows double-digit growth in each of the previous two years – making fees the only true bright spot on the revenue side in the latest data.

Moreover, although revenue has declined broadly, expenses generally have not. Overall industry operating expenses were trimmed by 1.4% year-over-year in 2012, but this follows a couple of years of rising costs. In 2012, operating expenses were up by about 10.5% compared with 2009. As a result, since 2009, operating profits are down by 36% and net profits are down by about 25%.

The persistent growth in expenses in a time of weaker revenue is partly due to the growing regulatory burden, says Ian Russell, the IIAC’s president and CEO, in his latest letter to the investment dealers: “The rise in operating costs over the post-crisis period illustrates the impact of the regulatory burden on the bottom line.”

Although direct regulatory costs are on the rise (in the form of fees from regulators), it’s the costs of compliance with new rules that typically is the bigger bill. And, technology spending, both to facilitate compliance with changing rules and to fuel firms’ operations, is helping to keep upward pressure on costs.

The effects are being felt widely throughout the securities sector, with both the large, integrated dealers’ and the smaller, boutique firms’ profits under pressure. But it’s the small firms that are taking a harder hit, particularly on the retail side.

Indeed, the sector overall managed a modest quarter-over-quarter gain in profits at the close of 2012, but the retail boutiques actually suffered a doubling of their losses. According to the IIAC’s statistics, there was a $26-million net loss in Q4 for the retail segment, compared with a $13-million loss in the previous quarter.

In fact, the retail side of the sector collectively lost money in every quarter in 2012, finishing the year with a full-year net loss of $99 million, down from a $22-million profit in 2011. This segment also recorded an operating loss of $18 million for 2012, down from a $221-million profit the previous year, which was already well below the $550 million-$600 million this segment was earning before the financial crisis.

Indeed, while margins are being squeezed throughout the sector, it’s evident that retail firms are feeling the effects more acutely. As Russell points out, the larger firms have both the scale to absorb rising expenses more efficiently and diverse revenue sources to help offset these cost increases.

By contrast, the revenue of the retail boutique firms is under siege from all sides. Overall, retail revenue for this segment dropped by 22% in 2012, with every single revenue line showing a decrease from the previous year. For these firms, commissions revenue is down by 20%, investment banking revenue is off by almost 40%, and both equities and fixed-income trading revenue is down as well. Even fee revenue dropped by 15.7% last year.

The bottom line is that the sector behemoths – the large, integrated dealers – are growing stronger as a result. In 2012, they accounted for about 75% of the securities sector’s overall operating revenue, and an even larger share of profits (about 85%).

In contrast, the diminishing position of the retail boutique firms is starting to claim some casualties. Over the past couple of years, there already has been some attrition: there were 11 fewer firms and about 700 fewer employees who make their living in the retail segment in 2012 compared with 2009. And, given the latest data, the ranks of the retail boutiques look likely to thin further in the years ahead.

The IIAC warns that this could be significant for the market overall, not just for the affected firms.

“The financial squeeze faced by small boutique firms does not just threaten them,” Russell says. “Ultimately, it threatens investors and small- and mid-cap issuers, posing a hazard to competitive and liquid markets for efficient securities trading and financing.”

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