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Canada's Asset Managers Take Prudence in Risk Management to the Global Market

Considering the state of the global markets, you'd think Canadian firms would avoid trading outside their own country. But Canadian asset managers are looking to trade with the same preparedness that helped them survive the 2008 credit crisis.

As investment firms in the U.S. throw a tantrum over allegedly "prohibitive" regulations such as the Volcker Rule, major buy-side firms north of the border are showing the same prudence and risk-awareness that allowed Canada — along with Australia — to largely avoid the devastation of the 2008 credit crisis. According to a report underwritten by Omgeo, Canadian asset managers are taking risk seriously and making progress cleaning up their back-office systems as they prepare for future investment opportunities.

Two years after Dodd-Frank became law, the financial reform package appears to be dying a slow death, and many experts suggest that the Volcker Rule — perhaps the most important and controversial aspect of financial reform — will never work. Advanced Trading's July digital issue looks at what, if anything, on Wall Street has changed since the credit crisis and examines the challenges regulators face in enforcing the ban on proprietary trading.

The study, which was conducted by Stratix Consulting of Toronto, surveyed 15 of the top Canadian asset managers, with total estimated assets under management of US$1.37 trillion. The sample included officials from the buy-side arm of major Canadian investment banks as well as other buy-side firms, which make up 30 percent of the 50 Canadian investment managers with individual AUM exceeding $10 billion.

According to the survey, investments by Canadian managers outside the country jumped from 32 percent in 2010 to 40 percent in 2011. Canada's two largest pension plans reported that more than 50 percent of their investments are outside the country. "The rapid pace of the increase of cross-border trading" was a positive surprise, according to Matthew Nelson, Omgeo's executive director of strategy, who notes that the recent study is a follow-up to a similar survey conducted in 2010. "The jump from 32 percent to 40 percent in one year shows the need to diversify in global markets" to reduce risk, he says. "Canadian institutions had fixed requirements about investing overseas, and this was removed a few years ago. Now the increase is interesting."

[Why Launching a Hedge Fund Is Harder Than Ever.]

In addition, the survey revealed that Canadian firms are embracing OTC derivatives. While the use of derivatives inside Canadian firms remains small (1.5 percent in 2011), it doubled from the year before (0.8 percent). The two top drivers for this growth, according to the study, were "risk mitigation and a way to increase Alpha." "Operations interest in this asset class results from increasing use by portfolio managers and regulatory plans to have OTC derivatives trading move to exchanges," the report says.

According to Nelson, the reason for OTC derivatives growth up north is the same as it is in the States: They are a way to hedge risky trades. "A savvy investor is going to look at the OTC market and the ability to hedge against specific risk," he says, adding that this is a natural evolution paired with the recent push for greater transparency in the OTC market.

A History of Attention to Back-Office Detail

Canadian firms, according to the study, also are doing the back-office work that needs to be done to improve transparency. While industry observers note that U.S. firms typically settle transactions three days (T+3) after the trade, Canadian counterparties are set to reach T+1 by the end of the year. Only 20 percent of survey respondents said they had not achieved compliance with the Canadian Securities Administrators' (CSA) mandate to achieve 90 percent trade matching by noon on T+1, but all expect to be fully compliant by year's end.

The Canadian market has a history of back-office prudence. Roughly 10 years ago, a study of the market highlighted the steps needed to make the nation's banks and asset managers more competitive in a risky global market. What emerged from the process was National Instrument 24-101, the CSA's initiative requiring T+1 matching. This had a major effect on accelerating the Canadian marketplace, according to Nelson. "The point that stuck out was that 15 of the 15 investment managers expect to be ready by the end of this year to meet that requirement," he says. "You have a really efficient marketplace now in terms of trade matching — and that has happened in a relatively short period of time and has been driven by regulation."

With this level of detail and attention to risk, the next buy-side offer in a global dark pool just might hail from Toronto.

Phil Albinus is the former editor-in-chief of Advanced Trading. He has nearly two decades of journalism experience and has been covering financial technology and regulation for nine years. Before joining Advanced Trading, he served as editor of Waters, a monthly trade journal ... View Full Bio

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