09.19.2013
By Terry Flanagan

Trade Importer

CIBC works to draw trades from outside Canada, boosting the greater national good as well as its own book

With only 4% of the world’s equity-market capitalization, Canada won’t attract many foreign investors on liquidity alone.

But the nation’s financial markets are said to punch above their weight, partly due to the advocacy of its market participants and operators, including the highly regarded Canadian Imperial Bank of Commerce.

“Promoting Canada among all the alternatives for foreign participants to trade in is a top priority at CIBC,” said Thomas Kalafatis, managing director and head of execution and prime services at CIBC.

Thomas Kalafatis, CIBC

Thomas Kalafatis, CIBC

In the financial space, Canada is best-known for its natural resources sector, which can anchor or diversify an equity portfolio. It’s the job of Canadian market operators and trade handlers to tell the story of the other sectors and asset classes that are liquid, and how Canada’s market professionals, infrastructure, and technology enable efficient trading and investing.

The current initiative to lure order flow from outside Canada began about a half-decade ago, when the Canadian financial system and economy drew attention by weathering the global financial crisis comparatively well. Also around that time, new trading venues were emerging to compete with the incumbent TMX, boosting efficiencies and lowering costs.

“We saw the opportunity early to deliver that message to our clients, both within Canada and outside of Canada, to bring them to the Canadian equity marketplace,” Kalafatis told Markets Media in a Sept. 11 telephone interview. “From that time we have specialized in helping businesses and our clients grow by trading and investing in Canada.”

Capital Flow

The single best proxy for the robustness of Canadian capital markets is perhaps TMX Group, which owns the Toronto Stock Exchange and the TSX Venture Exchange. By this measure, Canada’s stature is rising — TMX had the most new listings among exchange operators globally in each of the last four years, and it ranked third in equity financing raised in 2012 and sixth in 2011, according to the World Federation of Exchanges. TMX drew a buyout bid from London Stock Exchange Group in 2011 before selling itself to Maple Group last year.

The capital flow “reflects the global business development and marketing activities undertaken over the last several years,” TMX Chief Executive Tom Kloet said in the company’s 2012 annual report.

Toronto-based CIBC was created in 1961 by the merger of the Canadian Bank of Commerce and the Imperial Bank of Canada, which were founded in 1867 and 1875, respectively. CIBC has 42,000 employees worldwide and is Canada’s fifth-largest bank by deposits; in May 2013, Bloomberg Markets ranked CIBC as the third-strongest bank in the world for the second consecutive year.

CIBC World Markets, the institutional business of CIBC, spans capital markets, corporate banking, and investment banking. Within equity markets, electronic execution services include algorithmic trading, smart order routing, co-location, broker services and market-structure analytics.

Kalafatis joined CIBC in 2008 from the Toronto Stock Exchange, and two years later helped consolidate the prime services group. “Historically, equity prime brokerage, the electronic trading desk, and the securities lending operation were independently managed,” he said. “In 2010, we integrated those teams. We’ve got a fantastic group of people that came from within CIBC, from other leading-class electronic trading firms, from the buy side, from (alternative trading systems), and from regulators.”

When establishing relationships in a new marketplace, we look for a strong counterparty that can provide us with market insight and technical expertise. – Chris Concannon, Virtu Financial

“We see ourselves as partners with our clients in assisting them with their needs, whether it be related to their technology, operations, balance sheet, or access to the marketplace,” Kalafatis said. “To deliver on this, we have over the last five years fully integrated our prime services operation within a full-service equity markets franchise. Our partners are looking for exposure to Canada, and we help facilitate that through any combination of those products or customization that suits their business model.”

At least one proprietary trader indicated CIBC does just that. “When establishing relationships in a new marketplace, we look for a strong counterparty that can provide us with market insight and technical expertise,” said Chris Concannon, executive vice president and partner at New York-based Virtu Financial. “Our experience in Canada has been extremely positive and that reflects well on CIBC.“

CIBC’s competitors in the Canadian sell-side space include RBC Capital Markets, TD Securities, BMO Capital Markets, and Scotiabank. There are also global heavies such as Goldman Sachs, Bank of America Merrill Lynch, Credit Suisse, and Morgan Stanley, who have generally expanded their presence in recent years.

“We have a very robust sell-side community in Canada,” Kalafatis said. “There are nuances to every brokerage firms’ offering and risk appetite, as well as their balance sheet, technology, service, people, advisory, and research. Having that robust sell-side community promotes Canada as a good place to trade and invest.”

Being a leader in that regard, year after year, can be challenging because industry knowledge is diffused and best practices spread quickly. – Thomas Kalafatis, CIBC

“One thing that’s very unique about the Canadian marketplace, that has allowed Canada to over-achieve relative to marketplaces of a similar size, is that domestic firms successfully compete with global broker-dealers,” Kalafatis continued. “I believe we’re the only G7 or G8 country where global broker-dealers don’t dominate the marketplace. That speaks to the quality of Canadian sell-side firms.”

Canadian sell-side players face many of the same challenges as their counterparts in the U.S. and Europe, including tepid overall trading volume and tighter regulation. Firms must do more with less to stay ahead of the competition and meet the needs of buy-side customers, who themselves are squeezed and need every last basis point of return.

“The sell-side community needs to deliver alpha-generating opportunities for clients,” Kalafatis said. “However, being a leader in that regard, year after year, can be challenging because industry knowledge is diffused and best practices spread quickly. As the industry continues to get more competitive, the market becomes more and more efficient, raising the performance bar.”

Under One Roof

CIBC cites its one-stop-shop offering as a key component of its value proposition. “Equity trading has historically operated in a siloed fashion, but CIBC operates the business in an integrated way,” Kalafatis said. “Our view is that the best way to respond to our clients’ needs is by providing alpha across multiple product suites, and integrating that product offering.”

Whereas just generating alpha on a trade execution was enough to make clients happy in the 1990s, Kalafatis said today’s clients demand more value-adds, such as tie-ins with investor calls and other research offerings. “Another thing that’s unique about CIBC is our execution and trading operation,” Kalafatis said. “We view execution as being across our entire equities platform — we don’t distinguish between an execution done on the cash side versus the prime brokerage side. We’ve integrated our trading desks and we manage our execution based on the nature of the order flow, as opposed to its source.”

Among hedge funds, one of the major trends since the financial crisis has been a winnowing of the weaker, newer and smaller end of the market, and a strengthening of the stronger, ‘brand’ names.

“The Canadian hedge fund community is still evolving and growing, and you’re seeing more assets go to the more established players and those that demonstrate longer-term track records,” Kalafatis said. “The track records in Canada aren’t necessarily as long as you see overseas. Adding the last year to a track record to funds that are in the $100 million to $200 million dollar range has been very useful for them. We’re seeing more assets gathered by funds that are starting to demonstrate a track record, rather than emerging funds.”

To better align with end-user demand for a safe investing experience above all, more hedge funds will adopt institutional processes going forward, a dynamic Kalafatis called an ‘industrialization’ of the sector.

“There will likely be some consolidation around hedge funds that demonstrate an investment process and an investment thesis that is auditable or reviewable, so investors don’t feel like they’re simply trusting someone who knows how to trade stocks,” Kalafatis said. “Firms that continue to show that, and very strong risk management and due diligence, are going to continue to gather assets.”

CIBC’s prime brokerage offering helps hedge funds with day-to-day investment operations for existing accounts, including trade execution, reporting, and research. But the lifeblood of hedge funds is new money, which often comes via third-party capital introduction.

“Allocators are looking for a track record, scale, investment process, investment thesis, auditable due diligence, and financials,” Kalafatis explained. “A large part of our business is providing consulting services to hedge-fund clients, around everything from their marketing docs, to how they present their story, to their financials, to allow them to have a better chance of succeeding with the allocators.”

Still, it has been tough sledding for hedge funds, as boom years before the financial crisis have given way to a more muted era of higher costs, lower returns, and lower fees. That has had a knock-on effect on hedge-fund service providers.

“Prime brokerage units have been experiencing a lull of late,” said Brad Smith, a financial-services analyst for Stonecap Securities in Toronto. “Banks’ consolidated securities brokerage commissions have been contracting for years.”

Regulatory Regime

Regulation continues to be a headwind for market participants and operators in North America and Europe, as rulemakers in Washington, Brussels, and Montreal seek to make markets fairer and more transparent. Kalafatis said in Canada, the most significant developments have been (1) rules addressing electronic trading, and (2) how regulators collect fees.

In July, the Investment Industry Regulatory Organization of Canada adopted rules pertaining to electronic-trading arrangements between dealers and third parties. Kalafatis said these so-called ETR rules and its parallel in the U.S. “have had very positive outcomes.”

“As technology evolves, there needs to be safeguards and appropriate checks on marketplace participants, and the interests of participants need to be kept balanced,” he said. “We benefit by having a very open marketplace…The key is that a marketplace is not just an opportunity for people to invest or to trade; participants also have an obligation to the marketplace itself and to other participants.”

Regarding regulatory funding, Canada has deployed “a powerful approach…which recognizes the cost of regulation and tries to tie it with the revenue-collection model without necessarily discouraging participation in the marketplace,” Kalafatis said.

Still on the regulatory docket is the order-protection rule, which “effectively requires participants to direct orders to the marketplace that provides better quotes,” Kalafatis said. “In Canada, that trade-through rule applies to the very first trade or the very first order on that new market — discussion on the topic focuses on whether that is too strong a protection afforded to new marketplaces.”

In a sense, the regulatory process affords market participants and operators the best opportunity to advocate on behalf of their own markets. It’s one thing for a firm to pitch its own offerings to attract business, but playing a part in shaping effective regulation can have a much broader effect.

“From a tangible, practical perspective, look at the adaptation of the ETR rules, which are similar to the U.S. 15(c)3 rules around electronic trading,” Kalafatis said. “We were at the forefront of advocating on behalf of the community with the regulators and in public comment, that we needed strong safeguards for credit-risk checks and buying-power checks for order flow. We’ve invested significantly on those safeguards.”

“This ties in to our role as executors of our clients’ stock, as gatekeepers to the marketplace, and as participants in their community,” Kalafatis continued. “We want to make sure we’re having a dialog with regulators well in advance of change, and providing a balanced yet thoughtful approach that keeps Canada viewed as a very fair and transparent marketplace. Those are the core tenets of a strong market structure and a marketplace that is safe for investors.”

It’s important to not always compare ourselves to our American cousins whose capital market is 12 times the size.- Thomas Kalafatis, CIBC

Canada can’t compete with the U.S. on liquidity and the sheer number of trading and investing opportunities, but it has its own unique strengths. “Canada has a very clear model around dark pools, the order protection rule, and price improvement,” Kalafatis said. “It’s viewed as a fair and equitable place to trade and invest, and it does quite well in attracting capital from overseas.”

“It’s important to not always compare ourselves to our American cousins whose capital market is 12 times the size,” he added. “Because our largest issuers will always consider listing on New York Stock Exchange or Nasdaq from a dual-listing perspective, we created our business models and our market-structure models to compete with that reality. The need to compete with a larger capital market is what forces us to do well.”

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