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February 1, 1998

The Great Canadian Pipeline: Canadian Dealers Tap Surge in U.S. Order Flow

By Michael L. O'Reilly

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  • The Great Canadian Pipeline: Canadian Dealers Tap Surge in U.S. Order Flow

The economic boom ushered in by the industrial revolution of the late 19th century sped the modernization of North American cities, and the laying of railroads connecting major centers of commerce in the U.S. and Canada.

At the dawn of the 21st century, technological advances and a surge in stock-market investing among U.S. residents have opened the Canadian markets as never before, propelled not by rail links, but an electronic pipeline, transporting an increasing volume of business.

A network of order-routing and execution systems is carrying Wall Street stock orders for execution on Canada's exchanges.

For Canadian dealers, tapping accessible U.S. equity order flow has become a popular trading strategy, helping broker dealers to reap record profits in recent years.

"Cross-border trading [with the U.S.] is increasingly important," said Paul Bowes, vice president of equity markets at the Toronto Stock Exchange (TSE), Canada's largest exchange. "We [Canadian stock markets] are just beginning to tap our potential."

Surge in Trading

According to the Securities Industry Association, U.S. investors made U.S. $20.42 billion in gross transactions in Canadian equities in the third quarter of 1997, up 9.5 percent from the previous quarter.

Only U.S. equity activity in the U.K. and Japan exceeded the third-quarter gross transactions or purchases plus sales of Canadian stocks.

The New York-based trade group noted U.S.-investor acquisitions of foreign securities in the third quarter of 1997 totaled nearly U.S. $38.6 billion, representing almost half of the U.S. $77.5 billion acquired through the first three quarters of the year. These acquisitions helped push U.S. holdings of foreign stocks and bonds to a record U.S. $1.5 trillion.

"The U.S. interest in Canadian stocks is probably consistent with prevailing implications of global investing by Americans," said Andrew Karolyi, a professor at the Richard Ivey School of Business at the University of Western Ontario. He added that the widespread diversification of global trading has risen with the demand among investors to diversify their portfolios.

With global investing on the rise, Canadian firms are benefiting greatly. The Investment Dealers Association of Canada estimates brokerage revenues accounted for one-half of the financial-industry's revenue in 1997. The Toronto-based trade group reported that brokerage revenues partly through the surge in U.S. business have expanded at an average rate of 18 percent annually since 1993.

"We are dealing with a large number of American firms following the global trend of international investing," said Paul Chalmers, director of international trading at Vancouver-based Canaccord Capital.

Indeed, more than half of Canaccord's 35 equity traders in Vancouver work with U.S. retail and institutional order flow, according to Chalmers. "The population of the U.S., about 270 million people, is almost ten times that of Canada," he added. "Americans are twice as likely to buy stocks as Canadians. Americans are spreading their investments across all markets, and we are benefiting." Chalmers estimates his firm works with 500 broker dealers in the U.S. each year.

In fact, according to Lawrence Booth, a professor of finance at the University of Toronto's Rotman School of Business, a large number of Canadian stocks have as much U.S. ownership as Canadian.