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Challenges and opportunities for Canadian financial institutions at home and abroad

Charlie Coffey
Executive Vice-President
Government & Community Affairs
RBC Financial Group
Gowlings' 2002 Professionals' Meeting
Royal York Hotel
Toronto, Ontario
Friday, June 7, 2002


It is a pleasure for me to come and speak to a group of people that are among the most important service providers to, and partners with, the financial services industry.

The focus of this session is on the principal forces shaping our capital markets. Almost all of the challenges and opportunities the financial industry faces have direct implications for your law firm and the nature of your work.

Globalization / North American Integration

In Canada, successive rounds of trade liberalization have not only opened access to foreign markets for Canadian companies, but have also made access to foreign suppliers much easier for Canadian consumers.

Canada's removal of many of the perceived and real barriers to entry by foreign financial institutions have led to a very open market.

As well, regulatory policy changes have eased the limits on permissible activities under taken by financial institutions (FIs), and have enabled these FIs to offer a range of new products and services.

New information technology, such as the internet, has led to new delivery channels which have increased access for Canadian consumers to more suppliers of products and services from both inside and outside the country.

Finally, relative to the past, consumers of financial services are better informed, have more sophisticated needs, are willing and have the means to seek out suppliers and are more demanding.

All of these developments are removing geographic and functional limitations which have previously shaped the financial services industry.

In the U.S., recent legislative changes have paved the way for geographic diversification and the eventual emergence of nation-wide banking. As well, they have permitted the trend towards functionally converged financial services enterprises, combining the activities of banking, insurance and securities.

This functional convergence was permitted in Canada much earlier than in the US. As a result, all our major financial institutions became diversified in the early 1990s. RBC, for example, has a significant presence in insurance, wealth management and securities dealing in addition to its traditional base in banking.

For Canadian institutions, the current trend is for growth to occur internationally, or more aptly in the United States. This is because of the increasing economic integration of Canada internationally.

For example, Canada's trade in goods and services, combining both exports and imports and cross-border investment flows, have both increased at rates almost twice those of the general economy (or GDP) since 1988, the year we signed the FTA.

In capital markets, large corporations always had the capacity to access suppliers of financial services both in Canada and in foreign markets, particularly in New York. Now, with globalization, smaller corporations and even retail customers have access to those U.S. and other foreign suppliers. As a result, our domestic markets and participants are facing a huge challenge to remain both viable and vibrant.

The economic integration of the North American economy poses both opportunities and challenges for Canadian FIs like RBC

Opportunities have emerged as U.S financial deregulation opened the way for nation-wide branch banking and convergence between banking, securities and insurance sectors.

In recognition of the increasing importance of the U.S. and having reached limits to growth in Canada, we in RBC have added to our capacity to deliver our products and services in the US.

Since April 2000, we have invested almost U.S.$5 billion to make significant strategic acquisitions in the States.

In banking, our major acquisition was Centura, for US $2.2 billion, under which we have also placed some of our other banking related acquisitions, such as Prism, a mortgage originator.

In insurance, we have added Liberty Life and Liberty Insurance, an investment of US $580 million.

And to round out our presence in wealth management and corporate and investment banking we have added capacity by the acquisition of two major securities firms, Dain Rauscher, for US $1.2 billion, and Tucker Anthony Sutro for US $495 million.

Despite the opportunities, globalization, or "North Americanisation", also poses some major challenges for Canada's financial sector; and by implication, for your business, especially as you are key suppliers to our industry.

Need for Domestic Regulatory Efficiency

Let me start first with the challenge for capital markets.

Given the size of the U.S. economy, the most liquid and deep capital markets for North Americans are in the U.S. That was the case 20 years ago and that is even more the case today.

US capital markets were always a competitive challenge for Canada's capital markets. But now the competition from them is even more intense as a result of North American integration.

In this environment, while Canada's capital markets may lack size, we could tilt the field a bit by being more efficient in regulation, where unfortunately, Canada does not measure up well.

Are 13 regulatory agencies with their own overlapping and duplicative frameworks necessary for regulating securities in a country of 30 million, when other countries many times our size, like the UK and even the US, seem to be able to do with less?

For this reason, the recent renewed interest in a national regulatory system for securities regulation, and possibly eventually a national regulator for all market conduct is welcome.

Regulatory efficiency could also be enhanced in other areas of financial services by avoiding duplication and overlaps, speeding approval processes, increasing reliance upon market based self-regulation and eliminating capital taxes.

There are also initiatives that can be taken for broad application to the entire economy to encourage productive investment in new technology and education. However, I think my co-panelists may have more to say on that.

Need for Scale:

The second challenge that globalization poses is the need for scale.

As institutions are freed from the shackles of being confined to regional markets, they can grow to the level that economies of scale require. To remain competitive in this environment, global financial institutions have had to become considerably larger than in the less integrated world of the past.

Through a combination of domestic policies against mergers of large FIs, Canada's weaker economic performance relative to the US and more accommodative attitudes towards bank mergers abroad, Canada's banks have been left behind in size.

As a result, they have missed out on some of the benefits of scale enjoyed by their international competitors and so have been forced to narrow their range of products and markets.

Some have vacated all but a few major global syndications; some have outsourced their entire technology departments; others have sold off chunks of their businesses where their size was too small to be competitive with huge scale driven competitors.

Today, for example, only RBC of the major banks retains an exclusive presence in the custody business, while CIBC has a presence through a JV, and all banks have vacated the payroll business.

Impact of Financial Reforms (C-8)

The recent financial reforms, as reflected in bill C-8 and its accompanying administrative policy have tried to address some of these issues. There is no question that there are a number of potentially positive elements in these reforms.

Examples include, expanded business powers, the ability of insured depositories such as banks to also set up uninsured deposit-taking affiliates for wholesale banking services, and the ability of a Canadian bank to establish another de novo Canadian bank as a subsidiary.

These and other changes will lead to improved efficiency and the ability to offer a wider range of products and services to clients.

Less clear seem to be initiatives aimed at increasing competition. While at RBC we welcome competition, we doubt whether these reforms will have much impact on increasing the number of players in the market.

A key reason why there are only a few large FIs in Canada is very competitive banking markets with limited potential for profitable growth. These are signs of a mature and overbanked market, rather than one with barriers to entry. One also wonders whether the policy makers have been consistent, in that, the two areas where studies show greater competition would be beneficial - insurance networking and auto leasing - they have chosen to retain existing restrictions.

Similarly, while the new federal market conduct framework including the creation of the Financial Consumer Agency of Canada is welcome, it will mainly cover the banking sector. Non-bank financial institutions will continue to face the multiple and duplicative market conduct regulation through the provinces.

It is, however, in the merger area that the reforms are the most ambiguous. While accepting that mergers between banks may be a legitimate business option, the process articulated for achieving a merger is extremely onerous, highly politicized and uncertain in terms of outcome.

And there is a prohibition on mergers between the two large demutualized insurance companies, Sun and Manulife, and large banks.

These policies on mergers seem disconnected from the economic reality that scale matters.

In a global world, scale is increasingly important for long-term growth and survival in almost every industry. Some of the global non domestic FIs have enormous size, the cost advantages of which they may well be able to use to challenge Canadian FIs in the Canadian market place.

Canadian FIs may find it difficult to match their prices. This has already occurred in some financial services which Canadian banks had to vacate.

This disjointed policy with respect to mergers and scale has the potential for some unintended consequences. If Canadian FIs can't achieve scale through domestic mergers, they have only two options. Grow abroad and / or exit activities where they do not have scale advantages - and they have done both.

Erosion of Canadian Based FIs

Growing abroad is positive from the business perspective up to a limit. Indeed, developing our U.S. presence is a requirement with the growing integration of North America.

However, to get competitive scale advantages, foreign operations may require very large commitments.

At the same time, if scale remains an elusive goal in Canada, Canada's banks may have to exit more of scale dependent businesses, continuing the recent trends mentioned earlier.

With presence increasing in foreign markets and shrinking in domestic markets, would it remain possible to be Canadian based in a real sense, even though technically one might well continue to be so classified due to a figurative head office in Canada?

One only has to note the relocation of business functions which occurred in our Canadian context during the threat of Quebec succession for an example of the trends that can surface.

The advantages of having strong, Canadian-based but globally relevant, financial institutions may be underestimated. These advantages are not entirely measured in business terms.

For example, Canadian based FIs, can more readily accommodate international aspirations of Canadian firms than foreign based ones.

They create high value jobs, such as in head-office functions and technology, contributing to the creation of core knowledge based clusters.

They provide an important source of government revenues through taxation and contribute also culturally and socially.

Finally, they ensure "mind of management" in Canada, which may enable a better focus on issues unique and relevant to Canadians than possible with management based abroad.

Implications for your business

Let me now conclude with two observations for your business, since it is so closely tied to ours.

Firstly, as North American economic integration continues, the market will become increasingly a North American one for your business, as it has for ours. As our RBC platform becomes increasingly focuses on North America, over time it is inevitable that we will prefer suppliers who can work with us in both Canada and the US. As key suppliers to RBC, Gowlings should pay serious attention to this as it is happening fast.

Secondly, as we are finding, to the extent that your business has scale dependence, you also face two challenges. Firstly, many of our products which have a legal component are becoming commodities. An example of this is our new "bricks and mortar" project where, for our commercial mortgage product, we are conducting an RFP for legal services seeking one supplier across Canada. The second challenge is for you to recognize that in this sector, your competitors will likely include non traditional suppliers such as Title Insurers, who likely are much larger and better scaled competitors and have cross border delivery capability. This project illustrates well both the changing nature of an important part of your business and the competitive landscape you face.

For RBC and Gowlings, if trends continue as they are, both of our business strategic thinkers may have to start paying much more attention not only to what is going on in Washington than they have done in the past, but also to the demands that scale necessitates. Thank you.

 


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