- Broker licensing change exempts bonds but banks get out anyway
- Investors say it's harder to trade Canadian junk bonds in U.S.
Some of Wall Street’s biggest banks have stopped trading Canadian high-yield bonds with local investors after regulators made changes to the country’s licensing rules.
While the restrictions placed on a type of dealer’s license often used by foreign desks to trade in Canada don’t apply to bonds, Goldman Sachs Group Inc. and Deutsche Bank AG have opted to stop transacting locally in the U.S. dollar-denominated debt of the nation’s junk-rated firms as well, according to two people familiar with the matter who asked not to be identified because the information is private.
The moves have raised concern that bonds from the likes of Bombardier Inc., Air Canada, and Quebecor Media Inc. may become more difficult for Canadian investors to trade, making it harder for companies to borrow in the $1.3 trillion U.S. junk-bond market. They come as global regulations implemented since the 2008 financial crisis squeeze banks’ profit margins and make them more selective about what businesses they operate in.
"Most of these Canadian companies issue bonds in U.S. dollars, and they’re only traded on Wall Street, on U.S. desks," Nicholas Leach, who manages C$2.5 billion in high-yield debt at CIBC Asset Management, said by phone from Toronto. "So right now it’s creating a lack of liquidity, and that’s contributing to higher volatility of some of these Canadian issuers."
The Canadian Securities Administrators, a coalition of the country’s provincial and territorial securities regulators, on July 11 restricted the ability of institutions to deal privately in exchange-traded securities using the "exempt market dealer" designation that many foreign trading desks have used to do business with Canadians. After the change, the only way for banks and similar firms to trade off exchange in listed securities with Canadian investors is through a fully registered Canadian investment dealer.
Though bonds are always privately traded, and therefore classified as over-the-counter securities not subject to the restriction, uncertainty caused by the change has foreign trading desks hesitant to trade Canadian bonds with Canadians, according to Geof Marshall, who runs C$11 billion ($8.3 billion) in high-yield bonds for CI Investments Inc. in Toronto.
"The sales people and the traders are beholden to a compliance department that’s exceedingly cautious," Marshall said. "The hesitation is to err on the side of conservatism, whereas prior to 2007 it would have been, ‘go for it.’"
While many of the world’s biggest banks have registered brokers in Canada, not all those units are set up, in terms of personnel and systems, to trade all types of securities. U.S. dollar high-yield bonds are often traded from New York desks, even if they’re issued by Canadian companies.
“Goldman Sachs’ Canadian broker-dealer in Toronto supports Canadian equity share trading with local clients," said Michael Duvally, a spokesman for the bank, in an e-mail statement. "Our Canadian clients’ needs are very important to us and we are currently evaluating whether to extend local broker-dealer support to trading of other Canadian products with Canadian clients.”
Goldman is the 11th most active underwriter of Canadian high yield bonds in U.S. dollars this year, while Deutsche Bank is the 12th most active, according to data compiled by Bloomberg. Royal Bank of Canada, JPMorgan Chase & Co., Barclays Plc., Morgan Stanley and Credit Suisse Group AG are the top five, the data show.
Troy Gravitt, a spokesman for Deutsche Bank, declined to comment.
Kate Betts-Wilmott, a spokeswoman for the Ontario Securities Commission, referred questions about the effect the rule change is having on the high-yield bond market to the text of the amendment, which includes the exemption for over-the-counter securities.
Junk bonds of all kinds have become more difficult to trade in the U.S. as other post-crisis regulations make it costlier for banks to hold the securities on their balance sheets, making them less willing to fill their traditional role as intermediary in trades.
U.S. dollar borrowing costs are already rising faster on average for junk-rated Canadian firms than their American peers. Canadian companies’ $49 billion of U.S. dollar high-yield bonds are heading for their worst annual loss since the 2008 credit crisis, according to Bank of America Merrill Lynch data, amid plunging commodity prices and global market volatility.
Because Canadian investors make up a large part of the market for Canadian high-yield bonds south of the border, cutting them off from some dealers may make the securities harder still to trade, according to CI’s Marshall.
"You’re taking away a little bit of demand from that order book," he said. "Therefore you’re slightly increasing the prices. You’re making it slightly more difficult for Canadian companies to fund."