by Derek Wood
The financial services business has undergone major changes over the last 30 years. Probably the biggest change began in 1987 when banks were granted permission to own brokerage firms.
Today it is estimated that between 80% and 90% of Canadian retail investment assets are under bank administration.
Other changes to the investment industry that have occurred include:
• The amalgamation of Canada’s various exchanges in 2000, followed by an IPO of the TSX Group in 2003 (which was taken over by the Maple Group, a consortium of Canadian banks, pension funds and investment firms)
• Increases in automation expense
• Growth in the discount brokerage sector
• Escalation in regulatory compliance costs
• Increases in exchange trading fees
• Acceleration of automated algorithmic trading platforms
• The emergence of exchange traded funds (ETF’s)
• Changes to trading rules including the ability to short stock on a down tick
• The emergence of ‘Dark Pools’ and alternative order matching exchanges
The list is extensive and each point is probably worthy of an article unto itself. The smaller boutique-style firms have faced great adversity in the wake of all this change. Added expenses and shrinking margins, as well as a prolonged bear market in both the energy and mining have taken a toll on smaller Canadian brokerage firms. These firms have spread the rising costs and decreasing revenues over a much smaller asset base. Approximately 30% of IIROC licenced firms have ceased to exist over the last four years. Some of these firms have gone bankrupt; some have simply resigned their membership in IIROC; while other have been sold to, or amalgamated with competitors at low valuations.
Also affected by all this change are the listed venture companies themselves. Early stage, retail-based public venture financings have become increasingly difficult to complete. Canada’s public markets were never designed as place where wealth was to be managed, but rather a place where substantial wealth could be created if investments in early stage ventures proved successful.
As the involvement of the retail boutique brokerages has diminished and the secondary market place has been made more complex, even opportunities that have been successfully derisked don’t often have the benefit seeing that derisking accurately reflected in their market priced valuations. This has been largely due to a decreasing amount of retail participation in the secondary market.
Some of the reasons for decreasing retail participation in the secondary market include:
• Retail brokers, still left in the business, have seen the profitability on market trans-actions diminish substantially.
• The likelihood of a substantial price increase is diminished due to increased complexity in how the secondary market operates.
• A large percentage of retail assets are being managed by firms who limit or ban participation on venture stocks at the retail level.
• Retail firms that once provided after-market support in the form of capital markets-driven research are no longer in business.
When somewhat derisked assets are trading at poor valuations, larger institutions do often provide necessary funding, but because the financing is usually completed in the context of the market, the financing is often so dilutive that it doesn’t provide the early investor with a return that is commensurate with the assumed risk.
Recently, there has been some positive regulatory change for the boutique firms left in business. Last year securities regulators in five Canadian provinces adopted new rules governing a new prospectus exemption. If certain conditions are met, non-accredited investors can now participate in private placements with listed issuers. The main condition is that they receive suitability advice from an IRROC licenced broker. Until this new policy was adopted, smaller investors were shut out of private placement offerings. Sometimes the terms of this type of financing can be extremely attractive and often include a warrant on a unit offering.
By requiring the suitability advice, boutique brokers will likely see an increased demand for their services.
Many of the smaller firms that are still in business have been able to grow through acquisition. These firms are now able to spread costs over a larger asset base. Some firms are starting to invest by hiring capital markets professionals to complement their over-all service offering. Hopefully this leads to increases in secondary market retail participation.
Over the last year there has also been a slight recovery in the junior resources space, particularly mining. Statistics through the end of April, released on May 5 by the TMX Group, indicate that so far 2017 has been a better year than the same period a year ago as evidenced by a 366% increase in IPO financings raised and a 446.6% increase in secondary financing raised on the TSX Venture Exchange.
Perhaps regulators are starting to act on concerns that have been voiced about the state of the venture market over the last few years. There are a great number of issues which need to be addressed to attract necessary capital and for successful ventures to provide returns commensurate with the risks taken.
Derek Wood is the President of Conduit Investor Relations Ltd. and a licenced Exempt Market Advisor.
Re-published with permission from Resource World Magazine.