FIN 2061 Canadian Investments I

FIN 2061

Canadian Investments IApril 13, 2020

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Section 1: The Canadian Investment Marketplace

Chapter 1: The Canadian Securities Industry

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The Canadian Securities Industry

1.3 Overview of the Canadian Securities Industry

• The Canadian securities industry is a regulated industry.

Provinces have the power to create and to enforce their own

laws and regulations through securities commissions (also

called securities administrators in some provinces).

• Securities commissions delegate some of their powers to self-

regulatory organizations (SROs), which establish and

enforce industry regulations to protect investors and to

maintain fair, equitable, and ethical practices.

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1.3 Structure of the Canadian Securities Industry

1.5 The Role of Financial Intermediaries

Intermediaries are a key component of the financial system. The

term “intermediary” is used to describe any organization that

facilitates the trading or movement of the financial instruments

that transfer capital between suppliers and users.

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1.5 The Role of Financial Intermediaries

Investment dealers serve a number of functions, sometimes acting on their clients’ behalf as agents in the transfer of instruments between different investors, at other times acting as principals.

Investment dealers sometimes are known by other names, such as brokerage firms or securities houses.

Investment dealers play a significant role in the securities industry’s two main functions.

• First, investment dealers help to transfer capital from savers to users through the underwriting and distribution of new securities. This takes place in the primary market in the form of a primary distribution.

• Second, investment dealers maintain secondary markets in which previously issued or outstanding securities can be traded.

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1.5 Types of Investment Dealers

Three categories of firms make up the Canadian securities

industry:

1. integrated firms,

2. institutional firms and

3. retail firms.

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1.5 Types of Investment Dealers

Three categories of firms make up the Canadian securities industry:

1. Retail firms include full-service investment dealers and self-directed brokers (also known as discount brokers). Full-service retail firms offer a wide variety of products and services for the retail investor.

2. Institutional firms are investment dealers that serve exclusively institutional clients, organizations that trade large volumes of securities. Institutional clients include pension funds and mutual funds, and may be domestic or foreign institutional firms.

3. Integrated firms offer products and services across the industry and participate fully in both the retail and institutional markets. Most integrated firms underwrite all types of federal, provincial, and municipal debt, as well as corporate debt and equity issues.

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1.6 Organization within Firms

There is a three level organization structure:

1. Front office,

➢ Front office performs all staff functions pertaining directly to portfolio management activities. Functions include: Portfolio management, Trading, Sales, Marketing

2. Middle office, and

➢ Middle office performs functions critical to the efficient operation of the firm. Functions include: Compliance, Accounting, Audits, Legal

3. Back office

➢ Back office settles the firm’s security transactions. Functions include Trade settlement

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1.6 Organization within Firms: Trading Department

Traders work in close co-operation with a firm’s underwriting and sales departments. The trading department is often divided into bond, stock and specialized product divisions:

Bond: Typically traded in and out of a fi rm’s own inventory or from the inventories at

other fi rms specializing in particular issues. Traders tend to specialize in government and

corporate money market instruments, medium and long-term Government of Canada

bonds, provincial bonds and guarantees, municipal debentures, and corporate bonds and

debentures.

Stocks: Common and preferred shares trade on stock exchanges rather than from a firm’s

own inventory.

Specialized instruments: Some firms employ mutual fund specialists and many also have

trading specialists.

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1.7 Principal and Agency Functions

When acting as a principal, the securities firm owns securities as

part of its own inventory at some stage in its buying and selling

transactions with investors. The difference between buying and

selling prices is the dealer’s gross profit or loss.

When acting as an agent, the broker acts for or on behalf of a

buyer or a seller but does not itself own title to the securities at

any time during the transactions. The broker’s profit is the

agent’s commission charged for each transaction.

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1.8 The Clearing System

In Canada securities are cleared through CDS Clearing and Depository Services Inc. (CDS). Marketplaces (exchanges such as the TSX and TSX Venture) and alternative trading systems (ATSs) report trades to CDS’s clearing and settlement system, CDSX.

Over-the-counter trades are also reported to CDS by participants in the system. Participants with access to the clearing and settlement system primarily include banks, investment dealers and trust companies.

By using a central clearing system, the number of securities and the amount of cash that has to change hands among the various members each day is substantially reduced through a process called netting.

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Practice Question

Identify the process by which the number of securities and the

amount of cash that has to change hands among the various

exchange members each day is substantially reduced.

A. Balancing.

B. Clearing.

C. Netting.

D. Settling.

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Practice Question - Solution

Identify the process by which the number of securities and the

amount of cash that has to change hands among the various

exchange members each day is substantially reduced.

A. Balancing.

B. Clearing.

C. Netting.

D. Settling.

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C. Netting.

The number of securities and the amount of cash that has to change

hands among the various members each day is substantially reduced

through a process called netting where the clearing system establishes

and confirms a credit or debit cash or security position balance for each

member firm, compiles their clearing settlement sheets and informs each

member of the securities or funds it must deliver to balance its account.

Clearing refers to the process of confirming and matching security trade

details. Settlement refers to the moment of irrevocable exchange of cash

and securities. Balancing simply refers to balancing a firm’s account,

where they receive what they are owed and pay what they owe.

1.9 Banks as Financial Intermediaries

Banks operate under the Bank Act, which specifies what they can

and cannot do. Banks are the most important player in the

Canadian Securities Industry and each Bank is designated as

either Schedule I, Schedule II or Schedule III.

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1.9 Schedule I Chartered Banks

1. Schedule I Banks: most Canadian owned banks are

designated Schedule I. There are ownership rules – voting

shares must be widely held and subject to no more than 20%

ownership by any individual or group. There are 30 Schedule

I Banks altogether – including Royal Bank, CIBC, TD, Bank

of Nova Scotia, Bank of Montreal and National Bank

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1.9 Schedule II & Schedule III Banks

2. Schedule II Banks: incorporated and operate in Canada, but

are owned by a foreign parent – examples include Citibank

Canada, AMEX Bank of Canada and BNP Paribas (Canada).

By law, may engage in all types of business permitted to a

Schedule I Bank; however most derive their greatest share of

revenue from retail banking and electronic financial services

3. Schedule III Banks: foreign bank branches of foreign

institutions. Schedule III banks tend to focus on corporate and

institutional finance and investment banking18


1.9 Trends in the Role of Banks: 2010

➢ Bank-owned investment dealers are an important part of the

securities industry. More recently, they have begun to acquire

U.S. investment dealers, primarily discount brokers, as well as

investments in international banks.

➢ Another significant development is the expansion of powers given to the

banks under revisions to the Bank Act. Banks now may hold a range of

other types of corporations, including information services, e-commerce,

real property holding and brokerage, and specialized financing

corporations. Banks may also offer investment counselling and portfolio

management services “in-house” rather than only through a subsidiary.19


1.10 Credit Unions and Caisses Populaires

➢ Early in the 1900s, many individual savers and borrowers felt

that chartered banks were too profit oriented. This led to the

establishment of many co-operative, member-owned credit

unions in English-speaking communities in Canada.

➢ Credit unions offer diverse services such as business and

consumer deposit taking and lending, mortgages, mutual

funds, insurance, trust services, investment dealer services,

and debit and credit cards.

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1.11 Trust Companies and Loan Companies

➢ Federally and provincially incorporated trust companies offer a

broad range of financial services, which in many cases overlap

services provided by the chartered banks.

➢ Trust companies accept savings, issue term deposits, make

personal and mortgage loans, and sell RRSPs and other tax-

deferred plans.

➢ They also offer estate planning and asset management.

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1.11 Insurance Companies

➢ The insurance industry has two main businesses: life insurance and property and casualty insurance.

➢ Life insurance and related products include insurance against loss of life, livelihood or health, such as health and disability insurance, term and whole life insurance, pension plans, registered retirement savings plans and annuities.

➢ Property and casualty insurance encompasses protection against loss of property, including home, auto and commercial business insurance. The largest aggregate premiums are generated by automobile insurance, followed by property insurance and liability insurance.

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1.11 Trends in Insurance: 2010

➢ Insurance companies in Canada are organized either as mutual

companies, owned by policyholders, or as joint stock

companies, owned by shareholders.

➢ Demutualization is a process by which insurance companies,

owned by policyholders, reorganize into companies owned by

shareholders. Policyholders, in effect, become shareholders in

an insurance corporation. The significance of demutualization

is that it provides insurance companies with access to capital

markets.23


1.12 Other Financial Intermediaries: Investment Funds

➢ Investment funds are companies or trusts that sell their shares to the public and invest the proceeds in a diverse securities portfolio.

➢ There are two types of investment funds:

➢ Closed-End Funds: normally issue shares only at start-up or at other infrequent periods and reinvest the proceeds and borrowings in a portfolio of securities to produce income and capital gain.

➢ Open-End Funds (or mutual funds): continually issue shares to investors and redeem these shares on demand at their net asset or “break-up” value per share of the fund’s investment portfolio. Mutual funds range from those primarily seeking safety of principal and income through the purchase of mortgages, bonds and blue-chip preferred and common shares, to much more aggressive funds primarily seeking capital gain through trading common shares in growth industries.

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1.12 Savings Banks

➢ The Alberta Treasury Branches were formed in 1938 when

chartered banks pulled out their branches from many smaller

towns. Funds on deposit are 100% guaranteed by the

respective province. In some places, they are the only financial

service provider in town.

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1.12 Pension Plans

➢ There has been a remarkable growth in the institutionalization of savings through pension plans during the past 55 years. This growth is partly the result of longer life expectancy, earlier retirement and the desire for financial independence during the now-longer period of retirement.

➢ One or other of these plans is compulsory for virtually all employed persons and, in addition to minimum retirement benefits, both plans provide certain disability, death, widows’ and orphans’ benefits. Based on employee earnings with set maximums, both employee and employer contribute and both have cost-of-living adjustments on contributions and payouts.

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1.12 Sales Finance and Consumer Loan Companies

➢ Such companies make direct cash loans to consumers who

usually repay principal and interest in instalments. They also

purchase, at a discount, instalment sales contracts from

retailers and dealers when such items as new automobiles,

appliances or home improvements are bought on instalment

plans.

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1.12 Financial Market Trends 2010

➢ Continued mergers and alliances between Canadian and global brokerage houses to improve access to capital and global trading.

➢ Continued debate over the harmonization of securities laws across Canada and the call for a national securities regulator.

➢ A continuation of the trend away from commission-based accounts to fee-based accounts. Over the last 20 years, retail investors in Canada moved from individual ownership of securities to an increase in the purchase of managed products, particularly mutual funds.

➢ The creation of an ever-expanding array of innovative financial products to meet market demand and investor needs. 28


1.12 Financial Market Trends: 2010

➢ There have been many changes to global capital markets over

the last several years.

➢ Physical marketplaces (the trading floors) are becoming

obsolete, while virtual marketplaces or electronic trading

systems are reducing the need for human participants in the

market mechanism.

➢ Exchanges are merging to meet the challenge of globalization.

Ten years ago, there were over 200 exchanges in the world;

today there are fewer than 100.

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The Capital Market

1.12 Financial Market Trends 2020

➢ 1 • 13 Financial Technology

➢ 1 • 13 Robo-advisors

➢ 1 • 13 Shifting Demographics

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Summary

➢ Canadian capital markets are among the most sophisticated and efficient in the world, as indicated by the variety and size of new issues brought to the markets and the depth and liquidity of secondary market trading.

➢ The three categories of investment dealer firms are: integrated, institutional, and retail. Integrated firms offer products and services that cover all aspects of the industry. Institutional firms primarily handle the trading activity of large clients such as pension funds and mutual funds. At the retail level, full-service firms offer a wide variety of products and services, and self-directed brokers offer reduced trading rates but do not provide advice.

➢ One main role of investment dealers is to bring new issues of securities to the primary markets. They also facilitate trading in the secondary markets. These firms can act as principals or agents in either market.

➢ The Canadian chartered banks are the largest financial intermediaries in the country. They are designated as Schedule I, Schedule II, or Schedule III banks. Each designation has different rules and regulations regarding ownership levels and the types of services they are allowed to offer.

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The Capital Market

Summary

➢ Financial intermediaries offer a broad range of financial services that, in many cases, overlap with the services provided by chartered banks. Services include deposit taking and lending, debit and credit cards, mortgages, and mutual funds.

➢ Investment funds sell their shares to the public, most often in the form of closed-end or open-end funds, and invest the proceeds in diverse portfolios of securities. Loan companies make direct cash loans to consumers, who typically repay principal and interest in instalments. Pension plans represent a type of institutionalized savings. These plans are offered to the employees of many companies, institutions, and other organizations.

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The Capital Market

Documents

FIN 2061 Canadian Investments I