Exasperated by dismal deal flow and wary about their dire prospects, Canada's boutique dealers are taking aim at the country's biggest banks. The contentious issue in their crosshairs: a practice known as tied selling.
The practice has many forms – it even crops up in foreign-aid circles – but the version that has independents bent out of shape centres on corporate lending. Canadian banks have massive balance sheets, and they use them to lend megamoney to corporations. The allegation from independents is that these loans are too often "tied" to other fees.
Because corporate borrowers so desperately need credit lines, they are said to give banks first dibs on their investment banking business, because it helps keep the lending taps stay open. Boutique dealers pitching for the same advisory business are left fighting for scraps.
Corporate lending, you see, is a decent business. But with interest rates so low, its returns are rather small. Banks promise their shareholders returns on equity somewhere around 15 per cent, and a 3-per-cent or 4-per-cent loan spread just isn't going to cut it. Some of the best money in capital markets is made advising on financings and mergers and acquisitions. Enbridge Inc. raised $2-billion last week, and fees paid to the underwriters totalled $68-million.
In a letter to employees in January, GMP Capital CEO Harris Fricker justified a restructuring by arguing "there will be no regulatory rollback of anti-competitive practices as the amorphous blob that is the bank oligopoly will continue to expand in search of new revenues and earnings."
Others use more pointed language. "Whereas in the past we could compete on talent, and ideas and creativity and hard work," FirstEnergy co-founder Jim Davidson said in an interview, he believes the banks now have enough power to say to corporations, "I'm leading your next financing – full stop."
Mr. Davidson argues it's been a 30-year evolution. Before 1987, the banks were banned from even owning dealers, but a federal rule change broke down the barriers and the banks have slowly crept in. Early on, their participation in investment banking was rather innocent. "There was a veiled attempt at tied selling," he said, meaning banks would suggest that corporate and investment banking should be aligned, "but it was an inference. It wasn't as caustic and as straightforward and as matter of fact as it is now."
The Canadian Bankers Association, which represents Canada's banking industry, said it does not deal with this specific issue, but cited the legislation governing competition.
The reason this hasn't blown up into a bigger issue seems to be two-fold. Under Canada's Competition Act, tied selling is a serious offence, and publicly arguing the banks engage in it is something you don't take lightly. The independents know that. It's just that they are now struggling so much, they feel less reason to be as reserved.
The second reason is more complicated. To really make their case, the independents need data, because the Competition Act demands it. The best chance these dealers have of making changes is filing a claim under Section 79 of the act, which covers abuse of dominance. The bar is high: The independents would have to prove the banks have market dominance, that they engage in anti-competitive acts (i.e. tied selling) and that there is a substantial lessening of competition.
The last point is the hardest to prove. Even if there's an intuitive feel to it – of course the banks elbow us out of the market! – the independents need numbers as backup. Everyone I've talked to in the competition world stresses it's a tricky case for this reason.
Even more complicated, the competition issue butts up against the banking watchdog's wishes. From a prudential standpoint, the Office of the Superintendent of Financial Institutions believes it is better to have banks that are as diversified as possible, because it helps them withstand crises. Personal loan losses in Alberta may spike during this downturn, but energy companies may eventually merge in the province, driving M&A fees.
To my eyes, the merits of this framework is the bigger issue. Whether tied selling exists is incredibly difficult to prove, but it's obvious that the banks keep pushing into new businesses. Most recently, they won the war on wealth management, vaulting to top spot in long-term mutual-fund sales.
At some point, we, as a country, have to debate whether the prudential tradeoff is used too often, and whether the status quo is excessively unfair to independent companies of all stripes.