This time last year, Bay Street was in something close to a deep depression. Oil was about to crash through $30 (U.S.) a barrel. Mining deals were practically unheard of. The pain was immense. And the smaller you were, the more it seemed to hurt.
Boutique dealers, small by definition, were cutting deep or closing up shop altogether. Money managers were grappling with a plummeting stock market, which lowered the fees they earned. Even some of the largest lenders were wrestling with energy loans that suddenly looked much more risky.
Heading into 2017, rebounding metals and energy prices have staved off some of the carnage. But, even with glimmers of light, no one escaped scot-free thanks to a troubling, escalating trend: In financial services, bigger has become much better.
More than ever, the industry is a scale game that favours the largest players. It's an issue that could make the big problems of 2016 seem relatively small. Commodities, after all, are a cyclical problem. Scale, though, is a systemic issue.
Scale matters because it helps immensely with costs. The most obvious example of its benefits exists in money management. The value of assets managed by exchange-traded funds is exploding – Vanguard now oversees nearly $4-trillion globally – and that means it has a strong base to spread its relatively fixed expenses over. Doing so allows ETF players to keep their fund fees low, sometimes under 10 basis points, or 0.1 per cent.
But scale is also relevant to investment banks, particularly those that have retail adviser arms. Since the financial crisis, dealers must comply with scores of new compliance and cybersecurity issues, and the back-end systems needed to keep up cost a pretty penny. It's one of the unspoken reasons why FirstEnergy Capital Corp. and GMP Capital Inc. merged last year – that and the dearth of commodity deals for smaller firms.
Some people argue that all of this added compliance cost is unfair to the smallest dealers. They're already at a disadvantage to bigger rivals, because they don't offer a full suite of services – such as corporate lending alongside investment banking – so the cost problem is only salt in an open wound. But the progressing phenomenon is even affecting the country's largest lenders. No one is safe.
Toronto-Dominion Bank has been particularly vocal about the issue. At an investor day in 2015, chief executive officer Bharat Masrani stressed that expanding in the United States is ever more important, because it ties into a continental, not just Canadian, strategy. "One thing that has changed about TD over the last few years and that we are very proud of is that we are becoming much more North American. We believe scale matters and, for that matter, we believe you need scale to win," he said.
Scale was also a driving force behind a related-company deal, with TD teaming up with TD Ameritrade to buy Scottrade for $4-billion. To some the move seemed a bit counterintuitive, because trading costs for retail investors keep tumbling. But the buyers saw something different. "I think when you look at it, it's really a scale play," TD Ameritrade chief financial officer Steve Boyle said on a conference call. "I think that, as we bring the two organizations together, we will be able to reduce expenses significantly."
In a world where scale is becoming a bigger issue, do smaller financial-services firms even stand a chance?
Take what's happened with ETFs. First they established a solid base, and now they're gaining incredible momentum because their costs are so unbelievably low. More than half of the $286-billion that flowed into ETFs in 2016 went to funds that charge nine basis points or less, according to Bloomberg News.
They're such a powerful force now that even mutual-fund giant Fidelity, which fought the trend for so long because it worried about slashing its own margins, has been forced to act. The global behemoth launched six more low-cost funds last year and also slashed fees on existing products. If a company as big as Fidelity is compelled to play ball, imagine how smaller asset managers must feel.
Some boutiques will find ways to survive. One strategy deployed in disrupted industries where scale already matters immensely – including media – is for smaller firms to double down on niche markets. Effectively, go where the big players won't, and charge clients, or readers, for it. To this end, a commodity rebound would certainly help.
But there may not be enough business to go around. Should that be the case, some independents have already embraced unique strategies to deal with the reality. Raymond James is a small to mid-sized firm in Canada, but it leans on its much larger U.S. parent for things such as cybersecurity software.
Rivals are likely going to have to pool their costs, too, and that means more mergers. Marriages can be hard to pull off on Bay Street, because there's a lot of ego involved. But when the other option is folding, tying the knot isn't so bad.