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Canada still has one major stock market, the TSX, and you might think that's where the real trading action is for premier Canadian stocks like Research In Motion (RIM) and Saskatchewan's PotashCorp. You'd be wrong, actually. According to a study produced by the company I work for, almost every good Canadian stock trades far more actively in the U.S. these days. In Potash's case, on an average trading day, more than 80% of its shares change hands in U.S. markets. For RIM, the average is more than 90%. For the 10 largest stocks by market capitalization that are interlisted in Canada and the U.S., the average is about 70%, and that includes shares of the big banks.
Those totals will likely become even more lopsided in the Americans' favour very soon. Former TSX stalwarts like Inco, Falconbridge and Alcan are already gone, and BCE may join them. U.S. money managers who want some northern exposure will be loading up on those remaining big Canadian names, yet there are few compelling reasons for them—or anyone else—to buy and sell those shares in Canada.
Why should they if they can trade in the U.S. much faster and cheaper? One reason for the huge gains in efficiency is more competition between exchanges. In 1990, the New York Stock Exchange accounted for 70% of the value of all stock trading south of the border. In the first quarter of this year, that was down to 52%. Nasdaq was second at 22%, and much of the rest was split among young alternative electronic markets such as Kansas City-based BATS and New Jersey-based DirectEdge.
Spreads between the prices buyers and sellers of stock offer to one another in the U.S. have narrowed sharply. That means that exchanges, brokers and other middlemen collect less of that spread in fees and commissions per trade. But total trading volumes are way up. So both sides, along with the old and new exchanges in the middle, are the better for it. The clincher is that U.S. money managers buying and selling Canadian stocks in U.S. dollars at home also sidestep the still-substantial foreign exchange markups that they might have to pay to trade in Canada.
Another factor pushing orders south is that we have just four miniscule new electronic trading systems competing with the TSX here in Canada, with a total market share of about 2%. I have a bias, however, because the company I work for has an interest in one of them: Omega. If these systems grow and price competition heats up, some trading will return from the U.S. But the TSX has to let some competitors thrive before total volumes will climb sharply for everyone.
Even trading of shares of so-called restricted heavyweight Canadian companies is slipping away. Those include the banks and telcos, which have foreign ownership limits and other regulatory restrictions. The big bank-owned Canadian dealers still dominate trading in their shares. Even so, trading in restricted companies' shares on U.S. exchanges has climbed by more than 240% since December, 2006, but only by 65% in Canada. In fact, U.S. markets and foreign dealers operating here in Canada now trade the majority of shares in TD Bank and Manulife Financial.
The foreign dealers have accelerated the shift south. They are forgoing any foreign exchange spread on trades, and will only do a trade here if it's better for the client. According to our study, Credit Suisse is now the fastest-growing dealer in the country. Word on the Street is that TD and Royal Bank will be introducing currency-neutral trading for both Canadian and U.S. clients by the end of this year. Will they execute those orders here or in the U.S.? I bet they'll go wherever the trade is cheapest. Right now, that's definitely south of the border.
Time is running out for the TSX and the big Canadian dealers to act on all of this. On a typical trading day, the total volume of all stocks traded in Canada is roughly equal to that of the five biggest U.S. issues trading there.
The exchange and the dealers should accept the fact that more competition is inevitable, and they should invest in better technology for their trading clients, as their American competitors have done. There is some hope, particularly if the savings stemming from the concentration of trading among a few large dealers could be passed on to investors. But it has to happen soon—say, within the next 18 months—or else our market centres might want to start looking to beaver pelts, maple syrup and other uniquely Canadian novelties to sell from our quaint northern trading outpost.
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