Canada Debt Markets Undergo Structural Change

Terry Flanagan

Canadian fixed income markets are on a path toward electronic trading, led by regulatory initiatives in the United States and Canada.

The Investment Industry Regulatory Organization of Canada (IIROC) has re-issued for comment its revised Debt Transaction Reporting rule proposal for more timely surveillance and enhanced oversight of Canadian debt market activity.

“IIROC’s proposed reporting requirements will bring greater regulatory transparency to the Canadian debt markets. The changes will enable more effective oversight of debt trading, resulting in enhanced market integrity and investor protection,” said Wendy Rudd, IIROC senior vice president, market regulation and policy.

The proposed reporting requirements would be implemented in two phases. At the completion of Phase 1, which is targeted for April 2015, more than 90% of Dealer Member debt trading activity will be subject to regulatory oversight.

The Volcker Rule, which is part of the Dodd-Frank Act, will reduce capital commitment in the fixed income space, particularly for corporate issues, according to ITG analyst Doug Clark.

“Market observers have been predicting the evolution of the fixed income and FX markets for years, and been wrong every time,” said Clark in a report. “We feel strongly that the winds of change are finally gaining critical strength. We are forecasting the first significant changes in fixed income and FX markets, in Canada, will start to develop in 2014.”

In Canada, “changes below the Governor level at the Bank of Canada, have led us to a place where the Bank of Canada is more supportive of electronic markets in fixed income,” Clark said.

Beyond these structural changes, the continued growth and adoption of fixed income-based ETFs is allowing retail investors to gain fixed income exposure at a fraction of the frictional cost they have traditionally paid, said Clark. The legacy fixed income market will be forced to innovate in order to avoid losing their retail market to the ETF providers.

“These various drivers should create an ecosystem that is not only hospitable for fixed income TCA, but also for more electronic trading and even fixed income commission sharing agreements,” said Clark. “We suspect all of these will become common industry products by the time 2014 bids us adieu.”

Electronic trading volume growth has outpaced total volume growth, raising the proportion of total volume executed electronically, according to Greenwich Associates’ 2013 Canadian Fixed Income Investors Study. “After lagging U.S. and European institutions in use of electronic venues for years, Canadian fixed-income investors seem to have reached a tipping point and have significantly increased their use of electronic trading,” said Greenwich Associates.

The increased volume executed electronically by asset managers is noteworthy as Greenwich Associates data shows this segment’s total trading volume down slightly (4%) on a matched sample. The upshot: Asset managers are executing significantly more of their trading volume electronically.

Through CanDeal, an electronic marketplace for Canadian dollar fixed income securities and derivatives, Institutional investors gain direct access to a network of dealers, including all of Canada’s Primary Dealers.

CanDeal also offers Canadian institutional investors and investment dealer’s electronic access to liquidity in additional debt and derivative marketplaces operated by Tradeweb Markets in the United States and Europe.

“The folks at firms like CanDeal may argue that steps towards electronic fixed income markets have already taken place, but with no disrespect intended we believe the change in asset manager thinking and process that will happen in 2014 will far eclipse what has been seen in the past decade,” Clark said.

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