On the Competitiveness of the Canadian Stock Market

Transcription

1 On the Competitiveness of the Canadian Stock Market Cécile Carpentier, Jean-François L Her & Jean-Marc Suret* Even if the competitiveness of the Canadian securities market is a central argument in the ongoing debate related to the proposal of a single securities commission, the exact level of competitiveness and the evolution of this market are largely undocumented. The numerous changes that modified the structure of the securities market during the last twenty years probably explain this lack of evidence. Two dimensions of the market s competitiveness deserve attention. The first one is the proposition that the Canadian market is unable to compete with other markets in attracting and keeping new listings and transactions. The second one is the proposition that a discount penalizes firms that finance in Canada relative to the U.S. We address the first proposition by carefully analysing the evolution of the Canadian market from 1990 to 2007 in terms of market capitalization, number of listed companies and trading volume. We then compare the increase observed in Canada with similar data from other countries. We analyze the discount argument in light of recent studies that explain this phenomenon, and document this discount on other markets. The objective of this article is to provide documented evidence that could ground the debate on the optimal regulatory structure for the Canadian market. Même si la compétitivité du marché canadien des valeurs mobilières est un argument central du débat qui entoure la création d une commission unique des valeurs mobilières, le niveau exact et l évolution de ce marché sont mal connus. Les nombreux changements qui ont touché la structure de ce marché au cours des vingt dernières années expliquent probablement cette lacune. Nous pensons que deux dimensions de cette compétitivité méritent d être analysées. La première est cet argument qui veut que le marché canadien soit mal armé pour faire face à la concurrence des autres marchés. Il ne serait en mesure ni d attirer de nouvelles inscriptions ni de conserver les transactions. Le second argument indique que les émetteurs canadiens souffriraient d un escompte lors de la vente de leurs actions. Nous traitons le premier argument en analysant soigneusement l évolution des principaux indicateurs de développement du marché entre 1990 et * Cecile Carpentier and Jean-Marc Suret are Professors at Laval University Québec, and Fellows of CIRANO (Montreal). Jean-François L Her is from La Caisse de dépôt et placement du Québec. Contact Author: Jean-Marc Suret, [email protected]. The views expressed in this article are those of the authors and do not necessarily reflect the position of the Caisse de dépôt et placement du Québec. The authors thank Jacques Saint-Pierre for his very helpful comments. Any remaining errors are own.

2 288 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] Il s agit de la capitalisation, du nombre de sociétés inscrites et des volumes de transaction. Nous comparons ensuite l évolution canadienne à celle des autres pays. Nous analysons l argument de l escompte en utilisant les travaux récents qui expliquent l origine de cet escompte et qui montrent qu il existe également dans la plupart des pays. L objectif de l article est d alimenter le débat relatif à la structure de la réglementation des valeurs mobilières au Canada à l aide de données rigoureuses. INTRODUCTION Recently, a great deal of attention has been devoted to the health of the Canadian securities market, in conjunction with the proposal of a single securities commission. According to the Wise Person Committee Report, the weaknesses of the Canadian Securities regulation system make Canada less competitive than it should be at a time of increasing global competition. 1 The Committee reports that many capital market participants, large institutional investors and market intermediaries argue that Canada s international competitiveness suffers as a result of the current structure and that it is disadvantaged internationally because of its regulatory system. The Task Force to Modernize Securities Legislation in Canada was commissioned in June 2005 by the Investment Dealers Association of Canada, with the mandate of making recommendations to modernize securities legislation in Canada that would maintain or enhance the competitiveness of Canada s capital markets. The general hypothesis underlying these reports is that the competitiveness of the Canadian securities market is indeed low and that Canada lacks the conditions to attract and keep new listings and trading volume. This concern relative to the competitiveness of the Canadian securities market has been exacerbated by the global situation of intensified competition among exchanges and by an apparent decline in the relative weight of North American Markets. The decrease in the relative share of initial offerings resulting from a shift to London Alternative Investment Market (the AIM), launched in 1995, as well as the Asian markets, has raised serious concerns south of the border, as clearly illustrated in the report commissioned by the mayor of New York and Senator Schumer. 2 This report notes a decline of 4% to 7% in New York s relative 1 Wise Person Committee, It s Time (Ottawa: Report to the Minister of Finance, Government of Canada, 2003) online: [It s Time]. 2 McKinsey & Company, Sustaining New York s and the U.S. Global Financial Services Leadership (New York: Report commissioned by New York s Mayor and Senator Schumer,

3 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 289 share of financings and the loss of a significant number of jobs in the financial sector, and attributes this situation to regulatory causes, among others. In a work entitled The Competitive Position of London as a Global Financial Centre, Yeandle et al., 3 evidence the strong increase in the volume of equity transactions on the London Stock Exchange relative to the New York Stock Exchange. A recent paper by Rousseau 4 evidences that the AIM has been extremely successful in attracting investors and issuers, including a number of Canadian public companies. However, Rousseau concludes that the importation to Canada of the regulatory model used by the AIM would be very difficult. The present article is justified by the observation that, even if the lack of competitiveness of the Canadian securities market is underlined in numerous documents and reports, evidence of the current and past situation of the Canadian stock market relative to the other developed markets is scarce. Harris advocates more empirical analysis to inform the debate on securities regulation in Canada. He contends that the debate in Canada [...] typically has not been informed by robust empirical analysis. 5 Probably because of the lack of empirical evidence, opinions about the strength of the Canadian market diverge considerably. The various reports wrote by the successive task forces in Canada generally evoked the lack of competitiveness of the market. However, for Boisvert and Gaa In Canada, the number of shares traded on the Toronto Stock Exchange (TSE) has doubled in the last five years, while the dollar value of trading has increased three-fold. Some 49 per cent of Canadians now hold equities in some form, twice the level of involvement recorded only 2006) online: schumer/schumerwebsite/pressroom/special reports/2007/ny REPORT%20 FINAL.pdf ; See also L. Zingales, Is the U.S. Capital Market Losing its Competitive Edge?, ECGI Finance Working Paper (2007) 192 online: M. Yeandle, M. Mainelli, & A. Berendt, The Competitive Position of London as a Global Financial Centre, (Corporation of London s Report, 2005) online: 0/BC RS compposition FR.pdf. 4 S. Rousseau, London Calling?: The Experience of the Alternative Investment Market and the Competitiveness of Canadian Stock Exchanges (2007) 23:1 B.F.L.R D. A. Harris, A Symposium on Canadian Securities Regulation: Harmonization or Nationalization? (2002) [unpublished, online: at 3].

4 290 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] 11 years ago. 6 According to Jenkinson and Ljungqvist, Canada ranks ahead of the U.S., Japan and the U.K. in terms of increases in stock exchange listings from 1981 to Freedman and Engert conclude that data do not provide much support for the view that domestic capital markets have been abandoned by Canadian firms or hollowed out in recent years. 8 The discrepancy of opinions regarding trends in the Canadian stock markets can be traced primarily to the lack of clear-cut evidence. Exploiting the historical data pertaining to the Canadian markets is a real challenge, due to several changes in the market and in the reporting methods. Most data available for Canada are provided by the stock exchanges and are characterized by several difficulties: The merger of several exchanges, double counting of several stocks before the merger of the exchanges, the merger and the associated delisting of several securities and the inclusion at the beginning of the 1990s of several large foreign corporations in the estimation of the Canadian stock market capitalization, followed by their exclusion during the 1990s. Moreover, divergent opinions about the health of the Canadian stock market are fostered by the specific situation of this market in terms of cross-listing. According to Karolyi, Canada has the world s largest number of securities listed abroad (211 in 2002); the next country is Israel, with 59 foreign listings. 9 Several Canadian-based corporations post high transaction volumes on American stock markets, specifically corporations listed on the National Association of Securities Dealers Automated Quotations (NASDAQ). When analyzing the health and relative global position of the Canadian stock market, we must take into account this unique factor. Our first objective is to present a clear picture of the changes in the Canadian stock market from 1990 to 2007, a period characterized by a sharp increase in competition among stock ex- 6 S. Boisvert & C. Gaa, Innovation and Competition in Canadian Equity Markets (Summer 2001) Bank of Canada Review T. Jenkinson & A. Ljungqvist, Going Public: The Theory and Evidence on How Companies Raise Equity Finance, 2nd ed. (Oxford: Oxford University Press, 2001). 8 C. Freedman & C. Goodlet, The Financial Services Sector: An Update on Recent Developments (2002) 91 Bank of Canada Technical Reports, online: bca/bocatr/91.html. 9 G. A. Karolyi, The World of Cross-Listings and Cross-Listings of the World: Challenging Conventional Wisdom (2006) 10 Review of Finance 99.

5 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 291 changes. 10 The second objective is to examine the relative position of the Canadian stock market versus the other main developed stock markets. Only this worldwide comparison can provide relevant information about the competitive position of the Canadian stock market. However, this comparison is complicated by the mergers of several markets in Western Europe (Euronext) and in Nordic countries (OMX). The article is divided into four parts. Part 1 presents the key data pertaining to the evolution of the Canadian market from 1990 to 2007, and discusses the adjustments and corrections required to obtain accurate and comparable data. The second section is devoted to an international comparison to assess the relative rank of the Canadian market. The third part presents and discusses the arguments related to the Canadian discount and cost of capital. This article concludes by discussing whether there is strong evidence of a lack of competitiveness of the Canadian securities market. 1. RECENT TRENDS IN THE CANADIAN STOCK MARKET (a) Measurement Tools and Problems The classical indicators used to analyze the development level and growth of a securities market are market capitalization, the number of listed companies and trading volume. These indicators describe different and complementary dimensions of a stock market. Listing a large number of new companies can be a good signal of a market health, but if these companies are very small and thinly traded, these listings generate little economic activity. A market where several large firms are listed exhibits large market capitalization but generates little activity if the 10 In 1991, interlisting of Canadian corporations has been facilitated by the implementation of the Multijurisdictional Disclosure System (MJDS), which allows Canadian issuers to meet their U.S. filing requirements using Canadian disclosure documents. Canadian issuers can use MJDS forms to offer securities publicly in the U.S. based on a Canadian prospectus that is subject to review only by Canadian securities regulators. In addition, MJDS allows eligible Canadian companies to meet their ongoing U.S. public annual reporting requirements by wrapping a Form 40-F around their annual information form filed with the Canadian securities regulators and by filing the Form 40-F with the SEC. During the 1990s, the Canadian and U.S. markets competed using the decimalization decisions, intended to decrease transaction costs. In the U.K., the AIM was implemented in From 1990 to 1998, more than 100 consolidation deals in the exchange industry have been reported and analyzed. See A. Cybo-Ottone, C. DiNoia & M. Murgia Recent Development in the Structure of Securities Markets (2000), Brookings-Wharton Papers on Financial Services 223.

6 292 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] stocks are traded abroad. Indeed, the three dimensions of a market should be analyzed simultaneously. Each measure presents several difficulties, which are particularly acute in the Canadian context. The market capitalization is the sum of the market value of all firms listed in a market. This measure should be corrected when a single firm is listed on several stock exchanges in the same country, a situation that prevailed, for example, for numerous firms listed in Montreal and Toronto before the transfer of stock trades to the latter exchange. A second problem is the treatment of foreign issuers. Large foreign issuers can sharply influence the measure of market capitalization in their host country. Whereas the classic method for resolving this difficulty is domestic capitalization, this method was not used in the estimation of Canadian capitalization in the early 1990s. Several difficulties can also bias the number of listed companies, particularly when the objective is to compare several markets. Generally, stock exchanges define rules and delist companies whose stocks do not meet requirements based on price, capitalization or volume. NASDAQ delists a company if the stock trades under $1 for 30 days, and if the situation is not corrected during the following six months. 11 In Canada, during the main part of the period we analyze, the delisting rules allowed securities to stay listed for a very long time, even if these securities are not traded or if their price is very low. 12 Several of these stocks are used as shell companies during a reverse takeover listing. Before the NEX See J. Macey, M. O Hara & D. Pompilio, Down and Out in the Stock Market: The Law and Finance of the Delisting Process (2005) [unpublished, online: ]. Delisting rules are complex, they vary between exchanges and their application is partially discretionary. In 2001, NASDAQ suspended this Penny Stock Rule for several months because about 15 percent of Nasdaq s listed companies are trading below $1 at this time. See Aliza Earnshaw, Nasdaq s suspends $1 minimum listing requirement (2001) Portland Business Journal, online: last visited January 15, For example, in December 2001, 313 stocks listed on the TSX Venture Exchange had prices equal to 3 cents or less. 13 According to the TSX Venture Exchange, NEX is a new and separate board of TSX Venture Exchange. It provides a new trading forum for listed companies that have fallen below TSX Venture s ongoing listing standards. NEX companies have the opportunity to refinance, reactivate or reinvent themselves in order to re-apply to TSX Venture Exchange provided they can evidence their compliance with TSX Venture Minimum Listing Requirements, online: last visited January 15, 2009.

7 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 293 was created, in 2003, companies that fell below TSX Venture s (TSXV) ongoing listing standards were designated inactive and given 18 months to meet the standards or be delisted. However the delisting is not systematic and the Exchange uses discretion and flexibility in applying the rules. 14 The ongoing standards for Tier 2 listing on the junior market refer to a minimal market capitalization of CAN$100,000 (in 2007), minimal working capital of CAN$50, and significant operating revenues in the previous 12 months; or at least $100,000 on expenditures directly related to the development of assets in the previous 12 months. No conditions apply to the stock price. By comparison, similar limits for the NASDAQ (under standard 1) are US$5 million for market capitalization and US$1 for the stock price. 16 This situation, together with the low initial listing requirements that prevail on the TSXV, can explain why the number of listed companies is high in Canada. Several firms that would have been delisted in other countries are still traded in Canada. Second, the application of stricter rules by the exchange can induce significant variation in the number of listing companies. This was apparently the case during the restructuring of the exchange, and the same situation has prevailed since the creation of the NEX. A part of the decrease in the number of Canadian listed 14 Policy 2.4 relative to Tier Maintenance Requirements (page 3 of the Corporate Finance Manual of the CDNX, as at January 2000), reads as follows: (b) If a Tier 2 Issuer fails to meet more than one Tier 2 TMR, the Exchange will notify the Issuer of the Tier 2 TMR that it does not meet and will allow the Issuer 90 days to meet the requirements. If, after 90 days, the Issuer still does not meet all Tier 2 TMR, the Exchange will designate the Issuer Inactive and apply the restrictions on Inactive Issuers retroactively to the initial Notice date. (c) An Inactive Issuer can continue to trade on Tier 2 of the Exchange, but an I will be added to its trading symbol until it has completed a Reactivation and meets Tier 2 TMR. An Issuer which is designated as Inactive has 18 months to meet all Tier 2 TMR. If an Issuer does not meet all of the applicable Tier 2 TMR within 18 months, its Listed Shares can be suspended from trading. (d) The Exchange uses discretion and flexibility in applying Tier 2 TMR. 15 After the creation of the NEX, the Exchange still uses discretion and flexibility in applying Tier 2 TMR. According to the TSX Manual (2007, policy 2.5, page 3): If an Issuer has a viable business although it does not meet certain elements of the Tier 2 TMR, the Exchange may determine that it is not appropriate to transfer the Issuer to NEX. The Exchange will consider the seasonal or other cycles which affect an Issuer s business. If an Issuer s Working Capital is low because of seasonal or other temporary conditions, the Exchange may delay enforcement of this Policy but will continue to monitor the Issuer. 16 According to the Listing Standard and Fees document, available on the NASDAQ site (last visited January 30, 2009) online: listing req fees.pdf.

8 294 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] companies is linked to these events. Lastly, the trading volume is also a source of difficulty, mainly in Canada. A large part of the trading in the largest Canadian stocks, issued by cross-listed firms, is done abroad. We consequently distinguish the domestic from the foreign trading volume for Canadian firms. (b) Adjustments for Double Counting and Listing of Foreign Stocks Between 1990 and 1998, before the merger of the various exchanges, several companies were listed on more than one market, and the total reported number of Canadian listed stocks was clearly inflated. In 1999, the Alberta and Vancouver Exchanges merged to form the CDNX. In 2001, the Montreal Exchange (ME) opted to specialize in derivatives, and transferred its small capitalization securities to the CDNX, which is now the TSXV. The restructuring had disruptive effects: on November 22, 1999, the trading of certain classes of shares of small-cap corporations was transferred from the ME to the CDNX. On December 6, 1999, 56 large-cap corporations on the ME were transferred to the TSE, and interlisted securities were henceforth traded only on the TSE. The number of corporations listed in Montreal fell from 532 on November 30, 1999 to 129 on December 31, The transfer covered over CAN$1,000 billion of market capitalization. 17 However, because 91 large companies were listed on both the ME and TSE, three of which were also listed in Vancouver, the transfer had little effect on the capitalization of the TSE. This transition was apparently an opportunity to delist roughly 400 securities that probably did not meet the criteria of either of the original two exchanges. 18 In October 2001, all remaining small-cap securities were transferred from the ME to the CDNX. We therefore adjust the number of stocks and market capitalizations for double counting of stocks that are listed on several Canadian exchanges simultaneously. We also adjust the number of stocks and market capitalizations for foreign firms whose stocks are listed but rarely traded 17 This value is based on the difference in stock market capitalization at November 30, 1999 (CAN$1,005 billion) and December 31, 1999 (CAN$0.684 billion), according to the 1999 annual report of the ME. 18 We should observe an increase of 403 securities on the TSE but in fact only 23 new securities were listed from 1998 to 1999.

9 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 295 in Canada (e.g., BP, IBM). 19 Indeed, except for , when the average proportion of trades on foreign stocks concluded in Canada reaches 0.60%, it was lower than 0.10% in each of the other years. These large foreign firms gradually disappeared from the records. Their huge size significantly impacted the reported capitalization of the Canadian market, and we illustrate this effect in our estimations. (c) Changes in the Canadian Market Statistics provided by the international organizations 20 are simply inapplicable to Canada, because they include the TSX only up to the year 2000, and the sum of the TSX and the TSXV thereafter. Accordingly, we report in Table 1 (all Tables can be found at the end of the article) a non-corrected number of listed companies by summing the numbers reported by the various exchanges. 21 Even after the stock exchange restructuring, the international statistics are still biased, as they include firms whose options are traded on the Montreal Exchange, but whose stocks are listed on another exchange in Canada. Table 1 also reports the corrected data for the number of listed companies and for the market capitalization of the Canadian stock market. We estimate that the corrected number of companies listed on the Canadian stock market is 4,182 instead of the reported 4,696 in The total capitalization reported by the Canadian exchanges in 1998 was CAN$2, billion. Following incorporation in the TSE of securities already listed in Montreal and Vancouver, on December 31, 1999 the total capitalization diminished to CAN$1, billion, which illustrates the impact of double counting. In 1990, the reported capitalization of the Canadian stock markets was CAN$1,079 billion, while the cor- 19 IBM disappeared as a listed security in Canada in In its final prospectus (November 5, 2002), the TSX Group Inc. reports a total capitalization of CAN$1,300 billion in 2001, but CAN$264 billion were associated with foreign securities, which are almost never traded on this market. 20 Statistical data are available online at the World Federation of Exchanges website ( ) online: 421&document We do not present the yearly numbers of listed firms and market capitalization reported by each exchange, but this data is available from the authors. 22 We corrected the reported number of listed stocks in 1990: 94 stocks were omitted due to their being listed in several exchanges, 20 due to the listing of foreign companies and 400 due to the adjustment observed during the merger. These approximations have little impact on the rank and the estimated growth rate.

10 296 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] rected Canadian companies amounted to only CAN$328 billion. 23 Using corrected data, we estimate the average annual growth rate of the Canadian market capitalization at 11.21%. The number of companies listed decreases. This can be traced to the delisting of 400 inactive stocks when the exchange was restructured, and to the creation of the NEX, where inactive stocks are now listed. Table 2 presents the changes in trading volume. These numbers are affected only slightly by the previously mentioned problems. The good news is that globally the trading volume on Canadian securities increases from CAN$ billion to CAN$2, billion, at an annual rate of 20.64%. The bad news is that the increase is mainly observed in the U.S. The volume of Canadian securities traded in the U.S. grew from CAN$31.04 billion in 1990 to CAN$1, billion in Since 1990, the annual growth rate of American trading has been 23.04%, which largely exceeds the domestic growth rate of 19.52%. However, since 1998, the gap has widened, as shown by the respective growth rates of 22.41% and 13.57%. Accordingly, the ratio of the U.S. volume to the total volume of transactions on Canadian securities climbs from 26.96% (in 1990) to 37.69% (in 2007) and the trading volume in the U.S. represents 60.48% of the Canadian volume in The proportion of U.S. trading is volatile, and is mainly linked to several hot stocks that are listed on NASDAQ. Nortel largely explains the peak observed in 2000, while Research in Motion with CAN$215.6 billion of trades, equal to 94.5% of the volume in the U.S., explains the surge of American trades in However, there is a steady and significant increase in the proportion of American transactions involving Canadian stocks. This slippage, in spite of the declining advantages of cross-listing for Canadian firms, surely represents a challenge for the Canadian stock market, especially for Canadian growth stocks. 2. THE CANADIAN STOCK MARKET RELATIVE TO THE MAIN DEVELOPED FOREIGN MARKETS In all countries, the stock market has progressed steadily since Below we analyze the number of listed corporations or securities, total 23 To eliminate the effect of double-counting, we have estimated the capitalization of each of the Canadian companies listed on more than one stock exchange in Canada, from 1990 to These amounts have been used to correct the reported capitalization of the various exchanges.

11 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 297 capitalization and trade volume, which are classic indicators of the level of development of a stock market. Since comparisons are possible only when numbers are expressed in the same currency, we express all values in US$. The growth rate for Canada thus differs from previously reported figures, due to the exchange rate variation from 1990 to Moreover, the growth of a market is a combination of two factors. The first one is the issuance of new stocks, net of repurchase by listed companies and the capitalization of newly listed companies. The second one is the growth in the value of stocks, summarized by the variation in the index. These effects should be distinguished, and the first effect should be interpreted only as a measure of the capacity of a market to attract new listings and issues. (a) Number and Characteristics of Public Corporations Table 3 reports the number of listed securities in the main developed foreign stock markets, in 1990 and 2007, and the variation in the number of listed stocks during the whole period. We have adjusted the number of Canadian listed stocks in 1990 as previously indicated. The U.S. and Canada retained first and second position respectively in terms of number of listed securities. However, the number of listed companies decreased by 11.83% in the U.S. and by 9.39% in Canada. Karolyi documents this reduction in the number of listed stocks in North America from 1990 to 2002, and the acceleration of this phenomenon since the burst of the high tech bubble. 24 However, several countries exhibit strong growth in the number of listings: U.K. and Spain have surpassed 3,000 stocks, 25 while the Japan market has reached 2,891. Switzerland posts the lowest variation in the number of listings, which is in fact negative (-19.19%). The decrease in the number of listed stocks in Canada can be seen as problematic in light of the numerous actions that the exchanges, the securities regulators and the governments have implemented to stimulate 24 See Karolyi, supra, n Nonetheless, the case of Spain is unique. Most of the listed companies are closed ended mutual funds (SICAVs) that had to be listed in a stock exchange to qualify as a collective investment scheme and qualify for tax benefits associated therewith. On May 2006 an Alternative Stock Market (Mercado Alternativo Bursátil or MAB) was implemented for closed end funds and stocks with small market capitalization. The statistics on the Website of the Spanish Exchange indicate that 3,288 of these funds were listed in December See the Factbooks, online:

12 298 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] the listing of young companies. These initiatives include low listing requirements, capital pool companies and the introduction of tax incentives like the Quebec Stocks Saving Plan. Carpentier et al., report 2,573 new listings in Canada from 1991 to 2006, for an annual average of Corresponding annual numbers are 47 Initial Public Offerings (IPOs) in France, 80 in the U.K., 43 in Germany and 412 in the U.S. 27 As the total number of listed firms decreased by 504 during the period, the number of delistings can be estimated at 3,077, plus the 400 stocks that vanished during the merger of the exchange. Approximately 3,477 companies disappeared from the Canadian listings in 16 years. This significant death rate may result from mergers, going private transactions and delistings. Clearly, the promotion of early listing warrants reexamination. On average, initial offerings raised US$131 million in Germany, US$74 million in France, US$93 million in the U.K. and US$63.5 million in the U.S. 28 In Canada, the median amount initially raised by an IPO is less than CAN$1 million, excluding privatizations and demutualizations. Only 10% of Canadian IPOs during the period raised proceeds that exceeded the US$20 million threshold, and are thus comparable to issues of SEC-covered securities under the National Securities Market Improvement Act of The Canadian market is characterized by the presence of a large number of new businesses, generally smallcap, along with a significant death rate among listed corporations. It is thus atypical compared with the other developed markets. (b) Market Capitalization Growth Table 4 compares the growth of the Canadian stock market with that of the major developed stock markets. First, the ranking related to market capitalization does not change very much during the 18-year study period: Canada ranks 7th rather than 6th. Canadian market capitalization expressed in US$ grew at an annual rate of 13.09%, compa- 26 C. Carpentier, J.-F. L Her & J.-M. Suret, Stock Exchange Markets for New Ventures (2009) forthcoming in the Journal of Business Venturing. These authors study Initial Public Offerings, qualifying transactions of capital pool companies and listings through reverse takeovers. 27 A. Ljungqvist & W. Wilhelm, IPO Allocations: Discriminatory or Discretionary? (2002) 65:2 Journal of Financial Economics Ibid.

13 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 299 rable with the growth observed in France and Switzerland. Five countries post a lower growth rate than Canada (U.S., Japan, U.K., Germany and Italy). The growth in capitalization is affected by the changes in the value of stocks (the Price Index Return) and by the net creation of capital. To disentangle both effects, we report the average annual growth rate in capitalization and the MSCI 29 Capital Index variation. The differences between these two rates can be interpreted as the rate of creation of capital: this is the portion of the growth in capitalization that cannot be explained by the appreciation of the stock s value. In terms of capital creation, the Canadian annual average growth rate is 2.37%, which is slightly higher than the growth rate of other larger stock markets such as the U.S. and Japan. However, the Canadian capital creation is significantly lower than that of smaller markets such as Hong Kong, Australia, and Spain. The net Canadian capitalization growth is therefore slow, which implies that statements referring to the dynamic growth of the Canadian exchanges should be qualified. (c) Trade Volume Growth Data from Levesque, Beaubien and Geoffrion Inc. show extremely rapid growth in the value of trades on Canadian stock exchanges between 1976 and As growth in trading value is a worldwide phenomenon, we present a comparison with other developed markets in Table 5, for 1990 and For each country, we report the annual growth rate in trade volume, together with the average return of the MSCI Capital Index. The comparison of both rates indicates the annual net variation in volume, which is not explained by the changes in stock value. The relative position of the Canadian market is deteriorating: it dropped to 10th place in 2007, from 8th place 17 years earlier. The Canadian stock market has been surpassed by those of Italy, Spain and Switzerland. In net terms, volume growth of Canadian trades was less than that of the U.S., and only four countries in our sample had poorer performance. 29 Global equity indices provided by MSCI Barra have become the most widely used international equity benchmarks by institutional investors. See MSCI Barra online: R. Shearmur, Financial Flow and Places: The Case of Montreal (2001) 27:2 Canadian Public Policy 219 at 233.

14 300 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] Canada is thus progressively losing strength relative to other markets, particularly the American market. Stock market growth is fuelled by internal factors, but may also be triggered by the issue of securities by corporations or, on the contrary, weakened by the transfer of local securities trading to other markets. The loss of ranking of the Canadian stock market is essentially due to the transfer to the U.S. of a large part of the trades on cross-listed securities. The total (Canadian and U.S.) trade volume on Canadian securities is US$2,676 billion in 2007, 31 corresponding to the sixth highest trading volume among the markets analyzed. 32 The loss of a significant and growing part of trade to the U.S. market is thus the main challenge for the Canadian securities market. Why the U.S. market is capturing a growing part of the trades of Canadian stock is not totally clear. Firms list abroad for several reasons, and it is in the interest of investors to trade in the country where the liquidity is higher and the trading cost are lower. Two arguments are evoked in the debate surrounding the regulatory structure in Canada, which deserve attention. 3. CROSS-LISTING PREMIUM AND COST OF CAPITAL According to several reports, firms that cross-list in the U.S. benefit from a cross-listing premium (CLP) and a decrease in their cost of equity. 33 This can partially explain the movement of Canadian securities activity south of the border. Both arguments, translated by a Canadian discount is often used as evidence of the lack of competitiveness of the local market. For example, in his address to the Economic Club of Toronto, Tom Allen, Chairman of the Task Force to Modernize Securities Legislation in Canada, argues that capital markets in Canada suffer 31 This number is the sum of the Canadian value traded (US$1,634.87) and the U.S. value traded (US$1, that we get by converting in US$ the amount of CAN$1, from Table 2) of Canadian based companies. 32 Trades in the U.S. of Canadian based companies represent only US$330.6 million less than the total value traded in the Australian market (Table 5). A comprehensive analysis of the cross listing phenomena in Canada is provided by C. Carpentier, J-F. L Her & J-M. Suret, Does Cross-Listing Reduce the Cost of Equity? (2008) [unpublished, online: ssrn.com/abstract ]. 33 Both dimensions are linked as follows. A basic principle in finance indicates that a stock price is the sum of the present value of future cash flows. If the rate (the cost of capital) used to actualize the future stream of cash flows decreases, the present value moves in the opposite direction. Accordingly, a premium (in the U.S.) is consistent with a lower cost of capital in this country.

15 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 301 from a made in Canada discount. There is no doubt that this exists. Research which we have referred to in the Report indicates that the discount is 25 basis points from the price attracted by comparable equities in the U.S. Whether this is accurate is not the issue. It offers an order of magnitude. Multiply this by the equities financed in Canada annually and one can see that there is a critical need for improvement. 34 This proposition seems to refer to the cross-listing premium, observed when a domestic company cross-lists. At this time, its value appears to be higher than similar but non-cross-listed companies. Such a premium is observed for companies from all countries, and is not specific to Canada. On average, the cross-listing premium is estimated at between 17% and 22% (depending on the estimation method) for a listing on an American exchange, regardless of the home country of the newly crosslisted company. 35 This premium results from the fact that a company that is listed in the U.S. subjects itself to a more stringent regulatory environment as well as to greater scrutiny by the authorities, analysts and institutional investors. This environment improves the governance system. The premium can also be linked to better possibilities for financing growth. When Canadian firms cross-list in the U.S., the premium seems to disappear after a few years, and it does not constitute a permanent advantage for these firms. 36 The bottom line is that Canadian firms that list in the U.S. can benefit from a temporary cross-listing premium, but as firms from all countries benefit from a similar advantage, it is premature to link this premium to Canada-specific factors. As asserted by the Wise Person Committee Report In addition, these [regulatory] costs, when combined with the other weaknesses of the current system...result in an increased cost of capital for Canadian firms. While the precise increase may be difficult to quantify, any unnecessary increase in the cost of capital results in a competitive disadvantage that Canada cannot afford to bear. 37 The general wisdom is 34 T. Allen, Chairman of the Task Force to Modernize Securities Legislation in Canada Presentation to the Economic Club of Toronto (Toronto, Ontario, 10 October, 2006) online: fr.pdf. 35 G. Doidge, A. Karolyi, & R. Stulz, Why Are Foreign Firms that List in the U.S. Worth More? (2004) 71:2 Journal of Financial Economics M. R. King & D. Segal, The Long-Term Effects of Cross-Listing, Investor Recognition, and Ownership Structure on Valuation (2006) EFA 2007 Ljubljana Meetings Paper, online: It s Time, supra, n. 1 at 39.

16 302 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] that the cost of capital is higher when the investor protection, governance rule and enforcement are weaker. 38 Accordingly, several papers have proposed such comparison between Canada and the U.S. It should be mentioned that the estimation of the cost of equity is a very difficult task. 39 Moreover, differences between national costs of equity may simply be a product of differences in the industrial structure of these countries. Natural resources justify a higher cost of capital than utilities, for example, and both sectors weigh differently across the countries. This can explain the heterogeneity that emerged from in previous results. King and Segal 40 established a lower cost of equity in Canada than in the U.S., but the other studies can be summarized as follows. 41 Overall, based on a measurement of data for large-cap businesses, the cost of capital in Canada seems to be identical to the cost of capital in the U.S. On the whole, Hail and Leuz attribute a slight advantage to the U.S. (10.2% compared with 10.5%), while Claus and Thomas attribute a 20 basis point advantage, but in favour of Canada. Comparisons between the two countries, however, are difficult due to differences in their industrial structures. He and Kryzanowski therefore analyze each sector and find no such differences. Indeed, Canada has a net advantage of 38 We follow the literature by using the terms cost of capital and cost of equity indiscriminately. 39 The cost of equity is the rate required (expected) by the investors to own shares, and it depends on the perceived risk of the shares. To estimate this cost, researchers have posited several hypotheses and used complementary methods. See L. Hail & C. Leuz, International Differences in the Cost of Equity Capital: Do Legal Institutions and Securities Regulation Matter? (2006) 44:3 Journal of Accounting Research 485 for a good description of these methods and challenges. In a seminal paper dedicated to the estimation of the cost of equity for sectors, Fama and French estimate that standard errors of more than 3.0% per year are typical in the estimation of the cost of capital. This indicates that when one claims that the cost of equity is 12% in a sector, we can only conclude that this cost is between 9% and 15% with a probability of 68%. See E. Fama & K French, Industry Costs of Equity (1997) 2 Journal of Financial Economics M. R. King & D. Segal, Valuation of Canadian vs. U.S. Listed Equity: Is There a Discount? Bank of Canada Working Paper No , online: stract The main studies dedicated to the comparison of the cost of capital between Canada and U.S. are J. Claus & J. Thomas, Equity Premia as Low as Three Percent? Evidence from Analysts Earnings Forecasts for Domestic and International Stock Markets (2001) 56:5 The Journal of Finance 1629; C. Freedman & W. Engert, Financial Developments in Canada: Past Trends and Future Challenges (2003) Bank of Canada Review 3; L. Hail & C. Leuz, supra, n. 37; Z. He & L. Kryzanowski, Cost of Equity for Canadian and U.S. sectors (2007) 18 2 The North American Journal of Economics and Finance 215; J. Witmer & L. Zorn, Estimating and Comparing the Implied Cost of Equity for Canadian and U.S. Firms (2007) [unpublished, online: /wp07-48.pdf ].

17 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 303 some 100 basis points in the finance and resource sectors. Recently, Witmer and Zorn re-examined these differences, using various methodologies and taking enterprise characteristics into account. 42 On average, they analyzed 180 Canadian businesses per year, of which one-third were cross-listed. The financial sector was excluded. The authors estimate that the cost of equity is 30 to 50 basis points higher in Canada, but this difference has decreased since 1997, a decrease the authors attribute to changes in the relationship between interest rates in the two countries. Given the diversity of results, the small sample sizes and the findings of the various studies, it appears difficult to state that there are major differences between the cost of capital for Canadian companies and American companies in recent years. The differences reported are in fact minor, given that measuring the cost of capital invariably results in significant estimation errors, regardless of the method used. This literature survey indicates that there is no strong empirical support for the so called Canadian discount. Nor is there a significant difference between the cost of equity between the U.S. and Canada. 4. CONCLUSIONS AND IMPLICATIONS To scrutinize the changes in the Canadian stock market over the past 18 years, we closely analyze various indicators of the health of a stock market. We pay particular attention to problems arising from double counting of stocks before the merger of the Canadian exchanges, listing of very large but low-traded foreign stocks, and the trading volume in the U.S. of cross-listed Canadian stocks. The results of this thorough analysis of the indicators measuring the changes in the Canadian stock market can be summarized as follows. First, the number of listed stocks remains high relative to other developed markets. However, unlike non-north-american markets, the number of listed stocks has decreased notably. The public policies implemented to stimulate the listing of new firms have not resulted in a significant increase in the total number of listed securities. Approximately 3,477 companies vanished from the exchanges during this period. This death rate is abnormally high. 42 Figure 1 in Witmer & Zorn study, ibid., illustrates the diversity of findings in previous studies on this subject.

18 304 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] Second, the growth of the Canadian stock market capitalization is comparable to that of other developed stock markets. It is higher than that of large stock markets the U.S. and Japan but lower than that of smaller stock markets Hong Kong, Australia, and Spain. The net increase in capitalization is estimated at 2.37% per year. The net proceeds of equity by corporations have thus become relatively low. Third, the trading volume on the Canadian stock market is lower than on other size-comparable stock markets. However, when we also take into account the American volume of cross-listed Canadian stocks, the Canadian stock market compares favourably to global markets. The average figures hide important cross-sectional differences, because growth stocks listed on NASDAQ drive most of the American volume. The importance of cross-listing is a singularity of the Canadian stock market. This particularity is likely to increase the liquidity of interlisted Canadian stocks. However, it raises difficulties relative to the capacity of the Canadian market to retain Canadian corporations, given the power of attraction exerted by the most important market of the world, the U.S. stock market. The U.S. volume of Canadian cross-listed stocks is growing at a much faster rate than the domestic volume. The relative position of the Canadian market appears to decline relative to the London market place, but a similar observation can be made for the U.S. market. Several reports, 43 as well as the study carried out by Goldman Sachs 44 and that of Doidge et al., 45 show that a number of factors, other than the regulatory system, explain the success of the London marketplace. The growth of the European and Asian markets is the first factor. In many countries, market capitalization represents a much lower portion of the gross national product than in North America. This gap is being closed and financing activities are refocusing on Europe and Asia. London has a significant time zone advantage, providing an overlap of trading hours both with Asia and with the Americas, whereas the markets open on the U.S. East Coast only after the close of all other markets. London is integrated in the European Union, even though it has not adopted its currency. Finally, the growth of hedge 43 Supra, n. 2 and n Goldman Sachs, Is Wall Street Doomed? (14 February 2007) Global Economics Weekly See Doidge et al., supra, n. 33.

19 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 305 funds, mutual funds and pension plans is, and will continue to be, more rapid outside than inside North America. The same is true of economic growth, particularly in India, China and Russia. According to McKinsey & Company, the availability of human resources is also a key component of financial market competitiveness. Finally, Doidge et al., show that changes in listing choices are largely reflective of changes in the nature of issuers. Companies that obtained listings on AIM would generally not have been able to list themselves on the large American exchanges. The foregoing explains the following finding by Goldman Sachs: Legal and regulatory factors probably do matter, and policy reform might strengthen New York s competitiveness. Nonetheless, we do not see them as the critical drivers behind the shift in financial market intermediation, even in the aggregate. Quite simply, economic and geographic factors matter more. Our work documents the competitive position of the Canadian securities market. The extreme view that proposes that this market is totally unable to compete is not in line with the data. The slipping of Canada in terms of capitalization and number of listed company is low, and can be explained by worldwide factors. The main challenge faced by the market is probably the transfer of large trading volume toward the U.S. market. There is scant evidence of a significant advantage for Canadian firms to be listed in the U.S.: costs of capital are similar and the difference in value, which is not specific to Canada, vanished after a few years. Mainly, the transfer of trades concerns very large companies that have been cross-listed in the U.S. for years. It is worth noting that this dimension is not frequently evoked in the debate surrounding the Canadian securities regulation. One explanation for this is probably that this evolution is more grounded in the market structure and liquidity than in the securities regulation.

20 306 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] Table 1: Annual distribution of market capitalization, gross trading volume and number of listed corporations on the Canadian exchanges (Alberta, Vancouver, Montreal, Toronto, CDNX and TSX venture exchanges) between 1990 and Market capitalization and gross trading volume are expressed in CAN$ billion. Year Number of listed corporations (noncorrected) Total market capitalization (non-corrected) TSE number of listed corporations Corrected number of listed corporations Corrected Canadian market capitalization ,696 1, ,193 4, ,342 1, ,138 NA ,055 1, ,119 NA ,080 1, ,193 NA ,180 1, ,251 NA ,128 1, ,258 NA ,247 1, ,323 NA ,425 2, ,420 NA ,431 2, ,433 NA 1, ,943 1, ,456 3,814 1, ,124 1, ,398 3,996 1, ,122 1, ,316 4, ,888 1, ,304 3, ,401 1, ,340 3,331 1, ,440 1, ,421 3,369 1, ,640 1, ,537 3,557 1, ,801 2, ,598 3,678 1, ,945 2, ,613 3,789 1, NA means not available. To eliminate the effect of double-counting from interlisting, we have estimated the amount of Canadian interlisted share capitalization from interlisted companies in Canada in 1998, and from capitalization for these securities for each year from Sources: Montreal Stock Exchange: Rapport d activité au 31 décembre 2002 à 2007, Revue mensuelle, ; Statistiques, Recherche et information sur le marché (1991), Statistiques, faits saillants: Négociations, inscriptions, membres (1992, 1993); Revue boursière et répertoire des sociétés (1994, 1995, 1996, 1997 and 1998). Toronto Stock Exchange Review, Alberta Stock Exchange Review, Vancouver Stock Exchange Review, and CDNX monthly Review, and TSXV review.

21 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 307 Table 2: Annual trading volume of Canadian securities in Canada and in the U.S., Trading volume are expressed in CAN$ billion. Trading volume on Canadian securities Proportion of U.S. Trades relative to Canada and U.S. Canada U.S. Canadian and US Volume (%) Canadian Volume (%) , , , , , , , , , , Average Growth rate % 19.52% 23.04% Average Growth rate % 26.59% 23.75% Average Growth rate % 13.57% 22.41%

22 308 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] Table 3: Ranking of sampled countries according to the number of listed corporations at the end of 1990 and 2007 Rank Number Rank Number Variation (%) United States (NYSE, NASDAQ, AMEX) 1 5, , % Canada (all markets) 2 3, , % United Kingdom (London SE) 4 3, , % Japan (Tokyo & Osaka SE) 5 2, , % Canada TSE 1,613 1, % Australia (Australian SE) 6 1, , % Korea Exchange 7 1, % France % Spain a 3 3, ,33% Switzerland (Swiss Exchange) % Germany (Deutsche Borse) % Hong Kong 8 1, % Italy (Borsa Italiana) % Euronext b 1, % OMX c % Sources: Statistical data available online at the World Federation of Exchanges website ( ) 421&document 4880, Euronext web site (2007), and Standard & Poors, Emerging Stock Market Fact Book, New York, 1995, 2000, 2001, Global Stock Markets Factbook 2007, and TSE Review, 1993 and 2007, Five Year Statistical Summary. a In June 2001, the governing companies of the four Spanish stock exchanges signed a protocol involving creation of a company that would act as an integrating centre of all Spanish markets and as a decisive instrument for their international projection. The Bolsas y mercados espanoles was founded in Since then, the international statistics have reported the number of listed stocks of the integrated market, while previously, only the main exchange was covered ing. b We estimate the number of listed corporations in 1990 by summing the values reported by Amsterdam, Brussels and Paris Stock exchanges. c OMX Copenhagen, OMX Helsinki and OMX Stockholm have integrated OMX in 2005; we summed the number of listed corporation of these three stock exchanges to obtain the reported value for 1990.

23 THE COMPETITIVENESS OF THE CANADIAN STOCK MARKET 309 Table 4: Ranking of the sampled countries at the end of 1990 and 2007 by market capitalization, in US$ billion capitalization 1990 capitalization Annual mean growth of cap.(1) Annual mean growth of the MSCI index (2) Net annual mean growth of capital (3) (1)- (2) rank cap. rank cap. in % in % in % United States (NYSE, NASDAQ, AMEX) 1 19, , Japan (Tokyo & Osaka SE) 2 4, , United Kingdom (London SE) 3 3, Germany (Deutsche Borse) 6 2, France 4 2, Canada TSE 7 1, Switzerland (Swiss Exchange) 9 1, Italy (Borsa Italiana) 12 1, Spain a 8 1, Australia (Australian SE) 10 1, Korea Exchange 11 1, Hong Kong 5 2, Euronext b 4, OMX c 1, Sources: Statistical data available online at the World Federation of Exchanges website ( ) 421&document 4880, Euronext web site (2007), and Standard & Poors, Emerging Stock Market Fact Book, New York, 1995, 2000, 2001, Global Stock Markets Factbook 2007, and TSE Review, 1993 and 2007, Five Year Statistical Summary, Bank or Canada exchange rate at the end of the year, and market index per country in US$. a SeenoteaofTable3. b We estimate the number of listed corporations in 1990 by summing the values reported by Amsterdam, Brussels and Paris Stock exchanges. c OMX Copenhagen, OMX Helsinki and OMX Stockholm have integrated OMX in 2005; we summed the capitalization of these three stock exchanges to obtain the reported value for 1990.

24 310 BANKING & FINANCE LAW REVIEW [24 B.F.L.R.] Table 5: Ranking of the sampled countries at the end of 1990 and 2007 by value traded in US$ billion Value traded 1990 Value traded Annual mean growth of cap. (1) Annual mean growth of the MSCI index (2) Net annual mean growth of capital (3) (1)- (2) rank cap. rank cap. in % in % in % United States (NYSE, NASDAQ, AMEX) 1 45, , Japan (Tokyo & Osaka SE) 2 6, , United Kingdom (London SE) 3 10, Germany (Deutsche Borse) 4 4, France d Korea Exchange 8 2, Switzerland (Swiss Exchange) 9 1, Canada TSE 10 1, Italy (Borsa Italiana) 6 2, Spain a 5 2, Australia (Australian SE) 11 1, Hong Kong 7 2, Euronext b 5, OMX c 1, Sources: Statistical data available online at the World Federation of Exchanges website ( ) 421&document 4880, Euronext web site (2007), and Standard & Poors, Emerging Stock Market Fact Book, New York, 1995, 2000, 2001, Global Stock Markets Factbook a SeenoteaofTable3. b We estimate the number of listed corporations in 1990 by summing the values reported by Amsterdam, Brussels and Paris Stock exchanges. d As value traded in 2007 is not available, the value traded in 2006 is reported.

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