Canada in the Global MarketPlaCe · 36 Safe-haven credits adapt to new life after crisis ......

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Canda in the Global Marketplace | September 2013 | EUROWEEK 1

Foreword by the Minister oF Finance2 Canada: the right place to invest

econoMic overview4 From safe haven to growth driver: Canada faces challenge of recovery

trade diversiFication11 Playing catch up after a lost decade for Canadian exports

toronto as a Financial centre14 Toronto out to prove stodgy is the new sexy

bank oF canada proFile17 Inflation remains core concern for Bank despite change at the top

Governor poloz interview18 Exports, animal spirits and spaghetti sauce

bankinG reGulation23 Zealous approach to regulation pays off for Canada’s banks

interview with Julie dickson, osFi24 A rare beast: a financial watchdog with real teeth

the bankinG sector and bank FundinG26 A world-class industry

canadian GovernMent bonds31 Govvies set to perform despite tough times ahead

provinces and crown corporations32 International investors in search of Canadian opportunities

canadian sovereiGns, supras and aGencies roundtable36 Safe-haven credits adapt to new life after crisis

pension plans and investMent Funds46 Prolific pension plans extend global leadership

inFrastructure Finance50 Closing the infrastructure gap with P3

enerGy sector55 Midstream sector offers most potential for capital markets

hiGh Grade corporates57 Lively bond market eager for M&A deals, corporate Maples

hiGh yield58 Canadian high yield issuers: spoilt for choice in funding

Maple bonds60 A sweet future in store for Maple market

canada in FiGures62 An economic snapshot

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EUrOWEEK

Canada in the global MarketplaCe

Foreword by the Minister oF Finance

2 EUROWEEK | September 2013 | Canada in the Global Marketplace

In January, 1995, The Wall Street Journal proclaimed Can-ada to be “an honorary member of the Third World” and called the Canadian dollar the “northern peso”.

How times have changed. Today, Canada is among only a handful of countries in the very top tier of sovereign credit. Both the IMF and the OECD expect Canada to have one of the strongest growing economies in the G7 over this year and next. For the sixth year in a row, the World Econom-ic Forum has named Canada’s banking system the world’s soundest. And as of June 2013, the Canadian dollar is now one of the ‘reserve’ currencies tracked by the IMF, alongside the US dollar, the euro and the Swiss franc.

The latest chapter of this story is how Canada weathered the Great Recession. Real GDP is significantly above pre-recession levels and there are over 1 million more Canadians working than in July 2009, when the recovery began — the best performance in the G7.

In the eight years I have served as Canada’s Finance Minis-ter, our country has consistently adhered to solid policy fun-damentals to achieve this success, as well as an unwavering commitment to act against economic threats from outside our borders.

Prudent macroeconomic policiesAt the start of 2008, Canada already had an enviable econom-ic record, which served us well in the challenging years that followed. Our government’s responsible fiscal management, successive budget surpluses and a declining debt-to-GDP ratio in the years leading up to the recession left Canada in a position of strength.

As we move on from the Great Recession and the deep stim-ulus that helped Canada weather the storm, ongoing restraint measures and efficiencies are expected to yield a declining deficit every year until 2015, when we expect to return to bal-anced budgets. The IMF projects a total government net debt for Canada of about 35% of GDP in 2018 — the lowest ratio, by far, amongst the G7. And Canada has recently set a 25% debt-to-GDP target by 2021.

In an uncertain global economic environment, the most important contribution the Government can make to bolster confidence and growth is to maintain a sound fiscal position. Responsible fiscal management ensures the sustainability of public services and low tax rates for future generations, while providing room to manoeuvre in the event of adverse devel-opments outside our borders.

Canada has also enjoyed low, stable and predictable infla-tion, thanks to a well-established monetary policy framework, the goal of which is to keep inflation near 2% — the mid-point of a 1%-3% target range. The credibility of this framework allows Canadians to make spending and investment decisions with more confidence and encourages longer-term invest-ment in Canada’s economy, while providing the flexibility to respond to economic shocks.

Sound financial sector policiesCanada’s well-regulated and prudently supervised banking sector was able to withstand the financial market crisis in part due to higher capital, leverage and liquidity standards in place prior to the global recession.

Going forward, Canada actively supports the global finan-

cial reform agenda. On Basel III implementation, our domes-tic, systemically important banks already meet the Common Equity Tier One capital requirements, a full six years ahead of schedule.

Canadian financial institutions have traditionally taken a prudent approach to mortgage lending. Canada’s mortgage market had a much lower share of sub-prime and other alter-native mortgage arrangements than in other countries.

Our government’s ongoing monitoring and strong regulato-ry framework have allowed Canada to maintain a strong and stable mortgage market, limiting the housing market imbal-ances seen in other countries. For example, the government has adjusted the rules for government-backed insured mort-gages four times since 2008, including stronger standards for down payments, shorter amortisation periods and higher debt servicing standards.

An open, dynamic economyBuilding on our strengths, Canada also boasts a well-diversi-fied resource-rich economy that includes energy, manufactur-ing, financial services, commodities and technology, sus-tained by one of the most highly-skilled labour forces in the world.

Our government has also made continued investments to foster a world-class research and innovation system that inte-grates Canadian businesses and manufacturing, bringing sci-entific discovery from the laboratory to the marketplace.

Add to this a concerted effort to strengthen business tax competitiveness through broad-based business tax reductions and improvements to our international tax regime.

Canada now has an overall tax rate on new business invest-ment which is the lowest in the G7, and below the average for member countries of the OECD.

And our government is vigorously pursuing better and more open trade. Since 2007, we have concluded six free trade agreements with nine countries, including the European Free Trade Association. We are now focused on achieving major new free trade deals with the European Union, India and Japan, as well as free and open trade with Asian countries through the Trans Pacific Partnership (TPP) negotiations, linking North American and Asian markets and value chains.

Strong demand for Government of Canada securities Canada’s debt is highly sought globally. Bond auctions con-tinue to be well-covered across all sectors, with bond coverage ratios above five-year averages.

Our approach to debt management seeks to achieve stabil-ity in spite of market uncertainty. We have temporarily real-located short-term bond issuance towards long-term, and implemented a robust Prudential Liquidity Plan to cover at least one month of net projected cashflows. Consistent with international commitments, we are implementing measures to reduce exposure to counterparty credit risk, and reliance on external credit ratings.

Resiliency shall never cede ground to complacency. Though Canada’s track record speaks for itself, it is the future prosper-ity of our economy that preoccupies us. We are continuing to pursue with vigour jobs for our citizens, opportunities with our trading partners, continued stability for our banking sec-tor and a prosperous future for all Canadians. s

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Economic ovErviEw


When Canada returned to the uS dollar market after a 10 year absence in September 2009, demand for its five year $3bn global bond underscored its status as the safest of safe havens within the sovereign, supranational and agency (SSa) uni-verse.

despite being priced at 15bp through mid-swaps, the tightest level any borrower in the sector had achieved since the previous October, Canada’s marquee offering generat-ed demand in excess of $15bn from 299 investors.

Canada’s coruscating global bond in 2009 was by no means a one-off, but was emblematic of inves-tors’ apparently insatiable appetite for Canadian risk-free assets, which remain in short supply in the inter-national capital market. as Michael Gregory, senior economist at BMO Capital Markets in toronto, wrote in a research update in august, “during the heady days of late 2009 through early 2011, global foreign exchange

(FX) reserve managers started looking at Canada as a destination for diversification.”

“In the wake of the global finan-cial crisis,” Gregory’s piece goes on, “these investors were attracted by Canada’s pristine sovereign credit rating (only one of eight nations with an unencumbered, undisput-ed aaa rating) and strong banking system (the soundest on the planet according to the World economic Forum).”

With some shorter-dated Cana-dian government assets even offer-ing a pick-up to treasuries, foreign investors piled into loonie-denomi-nated assets. according to Gregory’s research, having plunged from well over 35% in the early 1990s, the share of Government of Canada bonds held by non-residents surged from under 15% in the second quarter of 2009 to over 30% by the second quarter of 2012 and to 31.3% in august 2013.

the credit metrics that encour-aged these inflows, say economists,

came about neither by accident nor by default. at national Bank in Montreal, chief economist Ste-fane Marion says that the outper-formance of Canada during the global financial crisis had its roots in policies implemented well over a decade earlier. “don’t forget that the 1990s was a very painful period for Canada which was marked by low growth, budget deficits that the gov-ernment strove to eliminate and a debt to GdP ratio that needed to be reduced,” he says.

Canada might have won the economic war in the past five years, weathering the global financial crisis with a minimum of damage to its economy. But can it win the peace? As Philip Moore reports, much will depend on whether the US can sustain its recovery and whether Canada can succeed in reorientating itself to the growing economies of the next century.

From safe haven to growth driver: Canada faces challenge of recovery

Copplestone on Canada: EuroWeek’s cartoonist celebrates the country’s successful return to the bond markets in September 2009

“Population growth driven by

immigration will be a formidable anchor

for the housing market”

Stefane Marion, National Bank

in Montreal

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Economic ovErviEw


ECoNoMiC ovErviEW

1990s’ sound measures pay offthe consequence, adds Marion, was that a number of measures were taken that — be it by luck or judge-ment — would fortify Canada against the downdraught of the recent crisis. “Important decisions were taken in the 1990s which involved the reduc-tion of the government’s indebted-ness and a significant improvement in the productivity and flexibility of the labour market,” says Marion. Specifically, a deficit of 6% of GdP in 1995/96 was quickly eradicat-ed, while net debt to GdP, which was over 70% in 1995/96, had been reduced to just under 23% by 2007/08. It is now 35%, compared with a G20 average of 85%.

this, twinned with the inher-ent conservatism and low lever-age of the banking system, meant that when the shockwaves of the global crisis started to spread across the globe, Canada’s government had much more room for manoeu-vre than those in the uS and most of europe. “Because it did not need to bail out the banking system, the Canadian government was able to confine its help to areas such as infrastructure spending in order to support a revival of growth,” says Marion. “historically, you’d assume that it would be impossible for Cana-da to escape when the uS enters into a recession, but it did so because the government was able to step in.”

there were a number of other factors that helped to shield the Canadian economy from the global financial crisis, say economists. Fore-most among these was the strength of emerging economies and the demand this created for commodi-

ties, which supported the performance of resource-based economies such as Canada and australia.

the num-bers tell the story plainly enough. after falling by 2.8% in 2009, real GdP bounced back to grow by 3.2% in 2010 and 2.6% in 2011. according to the IMF, “supported by the strong monetary and fiscal policy response and a quick rebound in the terms of trade, the Canadian economy grew well above potential in 2010-11.”

“Our peak to trough decline in GdP was very similar to what we saw in the uS, at a little over 4%,” says Craig Wright, chief economist at royal Bank of Canada in toronto. “But in Canada’s case this took place over three quarters, whereas in the uS it was over a period of six quarters, so the recovery in Canada was much quicker.”

Where there was a marked differ-ence between Canada and the uS, says Wright, was in employment. While Canada had a 2.5% drop in employment during the crisis, in the uS the fall was closer to 6%. “Cana-da regained all the lost jobs within a year and half, whereas the uS is still a couple of million jobs short of its pre-recession employment level,” he says.

Growth slowed in 2012, to 1.7%, which the IMF attributes to a combina-tion of fiscal consolida-tion, high lev-els of house-hold debt and “exter-nal head-winds” which depressed exports and business spending. neverthe-less, the speed with which

Canada recovered from the crisis was an impressive testimony to the restructuring made in the 1990s.

Victim of its own success?the paradox, today, is that Canada may be a victim of its own success in managing the global downturn as effectively as it did. “We were able to supercharge domestic demand, and with interest rates so low and the job market remaining strong, there was inevitably an increase in household debt,” says Marion. “But because we front-loaded domestic growth, I’d ague that there’s no way the domes-tic economy will be able to outper-form the rest of the world as it has in recent years. So we are about to face a period of slower growth, meaning that we will be increasingly depend-ent on exports going forward.”

avery Shenfield, chief economist at CIBC World Markets in toronto, agrees. “Low interest rates worked the way they’re supposed to work, by encouraging Canadians to bor-row and spend on consumer goods and housing,” he says. “Inevitably that has created a hangover in terms of a high level of houseful debt. this doesn’t threaten a wave of defaults, but it will constrain the ability of the economy to grow on the back of housing and leveraged consump-tion. We don’t think there is a risk of an imminent credit crisis, but we do see some signs of borrowing fatigue.”

that may be. nevertheless, a num-ber of Canada-based economists bri-dle with indignation at what they regard as gloomy and ill-informed chit-chat about the prospects for the Canadian economy.

More specifically, they rankle at

real GDP growth and output gap (Q/Q, SAAr)

Sources: IMF

-4

-3

-2

-1

0

1

2

3

4

-10

-8

-6

-4

-2

0

2

4

6

8

10

2007Q3 2008Q3 2009Q3 2010Q3 2011Q3 2012Q3

Real GDP growth and output gap (Q/Q, SAAR)

(% of potential GDP)

Real GDP growth

Output gap, RHS

Source: Haver Analytics

Sources: IMF

Net public debt

0

20

40

60

80

100

120

2011 2012 2013 2014 2015 2016 2017

Net public debt

(% GDP) Canada Euro area G-7

Sources: Fiscal Monitor and Fund sta� estimates

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Economic ovErviEw


the oft-repeated concerns about over-indebtedness among Canadian households and potentially unsus-tainably lofty house prices. doug-las Porter, chief economist at BMO Capital Markets in toronto, distrib-uted an especially punchy rebuff to the doomsayers in July. “Concocting dire scenarios for Canada’s economy and financial markets has become a veritable cottage industry among domestic and, more notably, global pundits,” he wrote.

that’s quite a charge, given that one dictionary definition of the verb ‘concoct’ is “to invent an excuse, explanation or story in order to deceive someone”.

But Porter is clearly frustrated by external prophets of doom. “We flat-ly reject the extreme negativity of many recent analyses — which have mooted everything from made-in-Canada recessions, to a Canadian bond bubble, to a housing collapse (the favourite call among the pun-ditocracy), to a deep dive in the loo-nie,” he wrote in July.

Truth in the rumour?the doubters are, however, not exclusively from overseas, nor are they all mischief-making traders looking to short Canadian assets. the local regulator, OSFI, has made no secret of its misgivings about stretched house prices. The Econo-mist, meanwhile, reckons Canadian homes are more overvalued rela-tive to rents than in any country in its sample other than hong Kong. relative to income, according to the same analysis, only French hous-es are pricier. On both measures, australian houses — fre-quently identified by ana-lysts as a bubble in the making — look reasonable relative to Canada’s.

On the surface, a grow-ing number of interna-tional investors seem to have become increasing-ly disenchanted with the prospects for Canada. In June, foreign investors reduced their holdings of Canadian securities by $15.4bn, which is the larg-est monthly drop since October 2007. the decline was driven entirely by bond sales, with foreigners

dumping $7.1bn of federal bonds and $3.4bn in provincial issues in June.

economists caution against read-ing too much into the summer sell-off. “there was an unprecedented amount of maturities in June, so I wouldn’t put too much credence into one month’s figures,” says Gregory at BMO. “It’s clear that for-eign purchases of Canadian bonds have fallen since their 2010 peak, but accumulation of reserves by central banks are also down from 2010.”

the reduction in foreign inves-tors’ holdings of Canadian securi-ties, Gregory adds, has nothing to do with economic fundamentals. nor is it any reflection of concerns over Canada’s rock-solid triple-a rating. “the triple-a rating is not in jeopardy,” says Shenfield at CIBC. “We’re still making good progress with reducing deficits, and as long as the economy con-tinues to grow at a reasonable pace we would expect that to continue.”

although slowing in 2013, the outlook for economic growth remains respectable. the OeCd has just revised its forecast for GdP growth in 2013 to 2% from the 1.4% it was anticipating earlier this year. the Bank of Canada’s most recent projections, meanwhile, are for growth of 1.8% in 2013 “supported by very accommodative financial conditions,” and 2.7% in both 2014 and 2015.

economists in toronto concede that household debt and house pric-es are both potential banana skins worth monitoring. “the main risk in the housing market is over-invest-

ment, which creates over-supply and downward pressure on hous-ing,” says Gregory. It’s a valid point. ask virtually any property developer on Spain’s Costa del Sol.

Demographics look goodBut Canada-based economists also insist that there are some impor-tant factors that some commenta-tors have a habit of overlooking in their analysis of the Canadian hous-ing sector. “One dynamic that peo-ple tend to ignore is Canada’s demo-

graphics,” says Marion at nBF in Montreal. “the population within the 20-44 age bracket, which is the age group that fosters the strongest increase in household formation, is one of the fastest growing in the OeCd. While some european coun-tries expect a decline of 7% or 8% within this age group over the next five years, Canada is projecting a growth of 3% in absolute terms.”

In some provinces, Marion adds, the expected growth rate is even higher, with alberta forecasting a rise of 7% in its 20-44 year olds in the next five years — an expansion

bettered only by India. “Population growth driv-en by immigration will be a formidable anchor for the housing market, so I find it fascinating that people seldom take this into consideration,” he says.

another broader dynamic that is some-times missed by overseas commentators is rela-tive affordability levels. In a note published in June entitled Debunk-ing Doomsday Predictions for the Canadian Econ-

omy, td pointed out that

Average house price

Sources: IMF

100,000

200,000

300,000

400,000

500,000

600,000

700,000

Oct

20

02

May

20

03

Dec

20

03

Jul 2

00

4

Feb

20

05

Sep

20

05

Ap

r 20

06

No

v 20

06

Jun

20

07

Jan

20

08

Au

g 2

00

8

Mar

20

09

Oct

20

09

May

20

10

Dec

20

10

Jul 2

011

Feb

20

12

Sep

20

12

Canada British Columbia Alberta Ontario Quebec

Average house price

C$, s.a.

Sources: CREA

“Productivity is probably the main challenge Canada

faces today”

Michael Gregory, BMo Capital

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Economic ovErviEw


“Canadian households are far less financially vulnerable than their uS counterparts were heading into the crisis.”

It added that “largely owing to a continued low interest rate envi-ronment, mortgage interest costs as a percent of personal disposable income have fallen despite the sharp rise in the debt-to-income ratio.”

Beyond the twin threats of house-hold debt and high house prices, there are other broader challenges still facing the Canadian economy. One is continued doubts over the productiveness of the labour force, in spite of the reforms made in the 1990s. “Productivity is probably the main challenge Canada faces today,” says Gregory at BMO. “But Canadi-an companies are becoming more productive and stepping up their investment in machinery in order to become more competitive.”

nBF’s Marion adds that produc-tivity in the Canadian labour force has come a long way. he says that according to parameters used by the World economic Forum, Can-ada now ranks fourth in the world for labour force flexibility. “We ranked way below this in the 1990s,

now we’re only behind Singapore, hong Kong and Switzerland,” he says. “Our flexible labour market and our corporate tax rates, which are among the lowest in the OeCd, mean that Canada is well positioned to capture more inward investment.”

the relative flexibility of the Canadian labour force was empha-sised by former Bank of Cana-da Governor Mark Carney in May, when he delivered his last speech before taking up his new job at the Bank of england. Observing that by some estimates Canada’s labour force is almost four times as flexible as europe, he pointed to the mobil-ity of Canadian workers as compel-ling evidence. “an obvious example of this flexibility is the way Cana-dians have responded to the higher wages and employment opportuni-ties in the energy sector,” he said. “Last year, there was a net inflow of more than 40,000 people into alberta from the rest of Canada, a level of mobility that approaches its previous peak.”

Loonie rallyanother challenge identified by economists — which many say that won’t go away in a hurry — is the strength of the Canadian dol-lar, which has rallied recently fol-lowing strong building permits and employment numbers. It may be too soon to conclude that the loonie has bottomed against the uS dollar. But performance of the currency in recent weeks would seem to vindi-cate those who argued that it was an over-simplification to assume that the Canadian dollar would go the way of its australian counterpart

because both currencies are influ-enced by global demand for com-modities.

CIBC, for one, advised in a report published in July that “we view the bout of Canadian dollar softness this year as an opportunity to buy it ahead of a likely appreciation in 2014.” One reason, said this report, is that “the export focus of Canada is much more varied than that of australia.”

Camilla Sutton, managing direc-tor and chief currency strategist at Scotiabank Global Banking and Markets (GBM) in toronto, agrees that exporters will need to get used to a strong dollar. “at just below parity today, the Canadian dollar is extraordinarily strong by historical standards,” she says. “even though we have some weakness built into our forecasts until year end and a stabilisation next year, in a histori-cal context this is still 30% strong-er than it was 10 years ago, leaving exporters facing a strong currency.”

the strength of the Canadian dol-lar is inevitably a concern, given the general consensus that exports will need to lead the economy going for-ward.

But a number of economists say they are comfortable that Canadian companies have made the necessary adjustments to deal with a strong currency.

Besides, they argue that the impact of a strong currency should not be overestimated, for two rea-sons. “the bulk of capital equip-ment is imported from the uS, so a stronger Canadian dollar is support-ive of business investment,” says Gregory at BMO.

“additionally,” he says, “although the exchange rate obviously is not favourable for Canadian export-ers, the main driver of uS imports is demand, rather than price.” In other words, the benefits to Canada of a sustained economic recovery in the uS are likely to outweigh the impact of a stronger currency.

Signals that this is already hap-pening may already be emerging. “the good news for us is that the recovery in the uS is taking place in the sectors that Canada exports to, such as auto equipment and the housing sector, which is positive for the Canadian forest products indus-try,” says Wright at rBC. s

“We don’t think there is a risk of an

imminent credit crisis, but we do

see some signs of borrowing fatigue”

Avery Shenfield, CiBC

Canada and global peers: real GDP growth and unemployment rate, Moody’s 2013 forecast

Source: Moody’s

Canadian Recovery is Weak, but Favorable Compared with Global Peers

Canadian & global peers: Real GDP growth & unemployment rate, Moody’s 2013 forecast

Source: Moody’s

Canada

France

Germany

Italy

Spain

Australia

United Kingdom

United States

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

0% 5% 10% 15% 20% 25% 30%

Rea

l GD

P g

row

th

Unemployment rate

Trade diversificaTion

Canada in the Global Marketplace | September 2013 | EUROWEEK 11

Glance at a map of canada and the province of Manitoba seems an unlikely candidate to spearhead the diversification of the country’s trade. It is, after all, only 30km from the provincial capital, Winnipeg, to the hamlet of landmark, which claims to be at the longitudinal centre of can-ada. From here, you can take your pick which coast to travel to: each is 4,000km away.

Unsurprisingly, the US remains Manitoba’s major trading partner, but its share of the province’s exports has declined precipitously over the last decade. narendra Budhia, director in the research department at Mani-toba Finance in Winnipeg, says that while the US accounted for 81% of Manitoba’s exports in 2002, by 2012 this share had fallen to 67%. Over the same period, exports to non-US markets increased by 7.5% annual-ly. Particularly striking, says Budhia, has been the rise of exports over the last decade to the Brics (Brazil, Rus-sia, India and china), which have expanded by an average of 26.1% annually.

For a province which tends to act as a reliable barometer to what’s going on elsewhere in canada, Mani-toba appears to have had a rather dif-ferent experience from other prov-inces in recent years. “the volume of canadian exports today is at the same level it was a decade ago,” notes

a recent report published by cIBc. “and after rising for most of the pre-vious decade, the share of non-US exports in total exports has hardly changed in the past four years. In fact, recently it has been moving in the wrong direction.”

according to the cIBc report, while global trade in goods has surged by 70% since 2002, in cana-da the volume of imports has risen over the same period by 45%, while exports have remained essentially unchanged. “Regardless of how you look at it, this was a lost decade for canadian exports. and for a small, open economy, this is not a positive trajectory,” says the report.

A nation of SMEsIn part, that reflects the structure of the canadian corporate sector, which is heavily populated by relatively small companies. craig Wright, chief economist at RBc in toronto, says that 99% of canadian companies employ fewer than 500 people, com-pared with closer to 85% in the US. “We’re a nation of SMes, and SMes

tend to be less export-oriented than large companies,” he says.

that may also explain why those companies that are successful exporters have tended to focus on their closest neighbour. that works fine in the good times, but leaves the corporate sector vulnerable to downturns south of the border. as the IMF observes in its most recent assessment of the canadian econ-omy, the country’s exporters have suffered “disproportionally from the Great Recession, given their

heavy exposure to some of the US sectors hardest hit by the crisis (e.g. housing and automotive). While the recovery of the US economy will help strengthen canada’s trade balance over time… full absorption of the US output gap would still leave canada’s current account balance about 2-3

percentage points below its norm.”all the more reason, says the IMF

report, to recognise that it is “essen-tial to increase the competitiveness of canadian firms and reduce their dependence on US markets.”

US self-sufficiency poses problemBy far the most important rea-son why canada urgently needs to explore opportunities beyond in mar-kets other than those across the 49th Parallel, however, is the rapid expan-sion of US domestic oil and gas pro-duction and the subsequent effect on canadian exports.

this is a drum that Jim Prentice was banging as early as 2008. at the time, he was minister of industry, which was one of a number of port-folios that he held in the canadian government between 2006 and 2010. Since January 2011, Prentice has been senior executive vice president and vice chairman at cIBc, where he is responsible for expanding cIBc’s relationships with corporate clients across canada and internationally.

Prentice’s thesis on the challenges and opportunities created for can-ada by the production boom in oil and natural gas south of the border is straightforward enough. “It surprises many people to hear that the largest supplier of oil to the US is not Saudi arabia, Venezuela or Mexico, but canada,” he says.

canada’s oil and gas exports in 2012 were worth $93bn, almost all of which went to the US, according to Prentice. “canada has enjoyed a priv-ileged trading and economic rela-tionship with the US, and particu-larly in the energy sector since the implementation of the north ameri-can Free trade agreement (nafta) 20 years ago,” he says. “So it is difficult to envision any scenario in which canada ceases to be the largest single foreign supplier of oil and natural gas

The energy revolution south of border means the pressure on Canada to look towards other markets, most notably those in the Asia Pacific region, is building quickly. Philip Moore reports.

Playing catch up after a lost decade for Canadian exports

“Canadian producers are under pressure

to become more competitive, and to

develop access to new markets such

as through LNG exports”

Derek Neldner, RBC

Trade diversificaTion


to the US,” he says. that’s the good news. the bad

news is that the volume of those sup-plies are in steep and probably irre-versible decline — partly because of improvements in energy efficiencies in the US, but largely as a by-product of growing self-sufficiency south of the border.

“In 2005,” says Prentice, “about 60% of the oil the US needed to meet its domestic requirements was sourced from overseas. today, that share has fallen to below 45%, and is headed towards about 35% in the next five years.”

To Asia, quick!this leaves canada with no choice but to look towards other markets, most notably those in the asia Pacif-ic region. “canada has to diversify, because if it wants to be an ener-gy superpower it can’t have all its eggs in one basket,” says Prentice. “I would go so far as to say that in light of the importance of oil and gas to the canadian economy, this is the single most pressing issue facing pol-icymakers today.”

those policymakers, Prentice adds, are well aware of the need to cultivate closer trading relations with asia. But if canada is to unlock the potential of the asian markets for its exports of oil and natural gas (and other products), it will need to address existing shortcomings in terms of trade agreements and infra-structure.

Progress is being made on both fronts. In late 2012, canada (along with Mexico) became members of the trans-Pacific Partnership (tPP). although china is not a member of tPP, the scope of this free trade agree-ment was considerably enlarged in april, when Japan signed up. this has created freer access for canadian exporters to an asian market of 277m peo-ple and combined GDP of $8.4tr, according to a brief-ing note published by cIBc in May.

the more formidable challenge that canada needs to overcome if it is to achieve a more balanced distribution of its energy exports is creating the

necessary infrastructure to trans-port its natural gas and oil across the Pacific. “We won’t be able to export lnG without very significant invest-ment in infrastructure,” says Pren-tice. “the need to build two or three world-class lnG facilities off the west coast is immediate because at the moment canadian natural gas is trading at a discount in the north american market.”

RBc’s calgary-based head of ener-gy, Derek neldner, agrees that cana-da is inevitably feeling the backlash of the US shale oil and gas revolu-tion. “With over 60% of our ener-gy production being natural gas, and the US becoming increasingly self-sufficient, canadian producers are under pressure to become more competitive, and to develop access to new markets such as through lnG exports,” he says.

Nafta splits opinioneconomists say that beyond initia-tives such as the tPP, there are other opportunities canadian export-ers could harness more effectively in order to bolster exports. “I think canada could do a better job of lev-eraging its membership of nafta,” says Stefane Marion, chief economist at national Bank in Montreal.

canada signed up to join nafta in January 1994, but its membership has been controversial, and the sub-ject of considerable opposition from commentators such as Jim Stanford, economist for the canadian auto Workers Union and founder of the Progressive economics Forum.

Stanford recently blogged that the bilateral trade deficit between Mex-

ico and canada rose by more than 70% between 2009 and 2012. this lopsided trading relationship, he added, has been the cause of about a quarter of the half-million jobs that canada has lost in the manufactur-ing sector since 2000. Half of those job losses have been in the canadi-an auto sector, which explains why Stanford has been such a vocal critic of nafta.

Marion says that canada should embrace rather than oppose the opportunities created by nafta, espe-cially now that the shale gas boom south of the border is pushing down energy costs so sharply in the US. “the US energy revolution is a very significant structural change that canada needs to adapt to,” says Mari-on. “Rather than focusing just on try-ing to increase our energy exports to other parts of the world by building more pipelines, we should be inte-grating our manufacturing base more efficiently within north america to take advantage of lower produc-tion costs there,” he says. “We should also be integrating more closely with Mexico, where production costs are still lower than they are in several asian economies.”

there have been a handful of Mexi-can success stories among canadian manufacturing companies. none has been more striking than the Montreal-based Bombardier, which since 2005 has invested some $500m on its aero-space plant in Queretaro, where its 1,800-strong workforce manufactures parts for the learjet 50. But econo-mists say that Bombardier has been the exception rather the rule in terms of canadian companies capitalising

on the potential of Mexico.they add that there are

other trading agreements beyond tPP and nafta that canadian exporters need to harness in order to diversify further. One of these is the compre-hensive economic and trade agreement (ceta) with the european Union. negotiations aimed at promoting closer ties with the eU, which accounts for about 9.5% of cana-da’s external trade, were launched in May 2009 and are due to be final-ised this year. s

Canadian export volumes Index (2007=100)

Source: Statistics Canada, CIBC

Source: Statistics Canada, CIBC

Canadian Export Vol. Index (2007=100)

606570758085

9095

100105110

97 99 01 03 05 07 09 11

US$/C $ 11%

US$/C $ 35%

US$/C $ 5%

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EuroWeek brings the markets to life.indd 2 29/05/2013 16:11

ToronTo as a Financial cenTre


Bay Street, which is toronto’s ver-sion of Wall Street, used to be a dan-gerous place. So dangerous, in fact, before 1797 it was named Bear Street, not in homage to gloomy stock mar-ket speculators, but to bears of the clawed, grizzly and hungry kind that were occasionally spotted there.

today, the bankers who populate the Bay Street area are in no danger of physical attack from bears of either variety, nor from anyone else. “We don’t hang bankers from lamp-posts,” says Janet ecker, who served as Ontar-io’s finance minister between 2002-03, and is now president of the toronto Financial Services alliance (tFSa). this is a figurative reference to the fact that toronto’s financial services sector emerged from the global crisis with its reputation more or less unscathed.

that is more than can be said for a handful of other financial centres around the world. “the key differ-ence is that Bay Street did not blow up Main Street, which we saw happen in some jurisdictions,” says ecker. “We did not need to bail out our banks, and none of them were engaged in the sort of questionable conduct that some banks did elsewhere. So it’s a very different business environment and a very different culture.”

If that means being much less swashbuckling than banks in some other financial centres, so be it. “Can-ada’s banking industry used to be criticised for being too conservative,” says ecker. “It used to be considered fair game to say that Canada’s bankers and its financial system were stodgy. But as our federal finance minister once quipped, stodgy is the new sexy.”

ecker also says that if stodginess means being home to the soundest banking system in the world (accord-ing to the World economic Forum), four of the world’s 10 strongest banks (according to Bloomberg) and the global bank of the year (according to The Banker), bring it on.

Jealously guard-ing this reputation is important for the health of the Ontario econo-my, because as ecker says, financial services contributes about 20% of toronto’s GDP and accounts for more than 300,000 direct and indi-rect jobs in the greater toronto region.

this job creation, adds ecker, is being driven not just by local banks. “there are 55 for-eign banks in Canada, 45 of which have their head office in the toronto region,” she says. “there is a growing presence of overseas finan-cial institutions in the city, especial-ly among Chinese banks.” Nor is job creation being driven just by banking. In the first quarter of 2013, employ-ment in the financial services indus-try — defined as finance, insurance, real estate and leasing — rose by 3.8% year-on-year, compared with a rise in employment across the province of 1.3%. employment growth in Ontario continues to be underpinned by the province’s services sector.

Local expertsOne of the attractions for financial services companies in toronto, says ecker, is the diverse reservoir of well qualified people living in and around the city. “eighty percent of the people in the financial sector have post-sec-ondary qualifications of various kinds, which is one of the highest levels in the OeCD,” she says.

the diversity of toronto’s human resources provides important sup-port for the toronto Stock exchange (tSX) in general, and for its leader-ship in the energy sector in particu-lar. In 2012, the tSX attracted 372 new listings, compared with 115 for the LSe/aIM and 146 for NySe euronext.

While the total capital raised, $56.3bn, was dwarfed by NySe ($124.2bn) it comfortably outpaced the $35.7bn raised on LSe/aIM.

In the energy sector, meanwhile, the tSX is home to 35% of the world’s public oil and gas companies. In 2012 alone, there were 22 new listings rais-ing $9bn — equating to 15% of the equity capital raised worldwide.

“Our leadership in the energy space is not just driven by Canada’s natural resources,” says ecker. “We have the lawyers, the analysts and the other experts required to bring a new min-ing company to the public market and help it grow.”

While Canada’s pedigree in the energy sector clearly makes an impor-tant contribution to the country’s financial services sector, it also creates an element of fragmentation with-in the industry, with Calgary rath-er than toronto acting as the main hub for much of the financing of the energy industry. “energy banking is very much based in Calgary, because so many of the energy companies are headquartered here,” says Derek Neldner, managing director and head of Canadian energy at rBC in Cal-gary. He says that 40 members of his team are based in Calgary with five in toronto.

Toronto’s financial services sector emerged from the global crisis with its reputation unscathed — stodginess was, after all, a good thing. The next challenge will be to grow its role in the global debt markets. Philip Moore reports.

Toronto out to prove stodgy is the new sexy

On the move: Janet Ecker takes a ride before the qualifying run at Toronto’s Molson Indy

ToronTo as a Financial cenTre


Roadshow destinationWhile toronto remains a focal point for many companies in the global equity market, it is also playing an increasingly important role in the debt market. although toronto has not always been the most obvious stopping-off point for issuers from europe or asia roadshowing in North america, this appears to be chang-ing — and so it should, given the size of the institutional investor base in Canada. toronto is, after all, home to a handful of the world’s largest, most sophisticated and most cosmopolitan pension funds.

“On the high yield side, we’re see-ing more companies tack on a day in toronto, because it’s easy to do,” says Sean Gilbert, managing director, debt capital markets at CIBC in toronto. “Over a lunch and a couple of meet-ings issuers can get access to an inves-tor base that is used to buying high yield bonds in the US dollar market in 144a format. So if you’re travelling from New york to Chicago, toronto is an obvious place to stop for a day.

“On the investment grade side, we haven’t seen a similar development yet, probably because the yankee mar-ket is so deep and liquid that few see the need to come to toronto. But over time we may see that evolve.”

Lofty ambitionsWhile its sturdy reputation for probity will help to attract bright young grad-uates to toronto’s financial services

sector, the city’s cosmopolitan charac-ter and its quality of life should con-tinue to attract more investment and personnel from overseas.

according to The Economist, if you’re planning to start a family in 2013, Canada is the ninth best coun-try in the world to do so. More specifi-cally, toronto ranks fourth among the world’s cities in this year’s eIU Live-ability index.

Canadian bragging rights go to Van-couver, which is third, behind Mel-bourne and Vienna, but toronto is placed well ahead of financial centres such as London and New york, which languish unflatteringly at 55th and 56th in the index respectively.

toronto certainly has lofty ambi-tions — very literally. there are reportedly twice as many high-rise buildings now under construction in toronto than there are in New york. that means that within a couple of years the Canadian city will have 44 skyscrapers more than 150m high, compared with just 13 in 2005.

there are obvious downsides to the furious construction activity that is clearly visible to any visitor to toronto today. traffic congestion in the cen-tral business district is an increasing source of frustration to downtown employees, and real estate prices con-tinue to climb in the commercial and residential sectors. the average cost of a detached home in the city of toron-to reached $784,000 in august.

rising prices and an increasingly

stretched infrastructure do not seem to deter individuals from choosing toronto as a place to live and work.

Senior professionals from in the financial services industry in toronto say that they have encountered no dif-ficulty in recruiting the highest qual-ity professionals — from overseas as well as locally. that has been espe-cially important for the three largest toronto-based public pension plans, for example, which between them manage assets of about $380bn.

“In the early years it was a chal-lenge to find people locally,” says Don raymond, senior vice president and chief investment strategist at the Canada Pension Plan Investment Board (CPPIB), which employs 823 people in toronto. raymond himself returned to toronto 12 years ago from New york, where he was at Goldman Sachs, and he says he is by no means exceptional in having made the switch across the 49th Parallel. “as we’ve become more high profile we’ve been able to attract more senior people from places like the US with no prior connections to Canada at all,” he says.

toronto recognises that there can be no room for complacency in the management of its human resources. “at tFSa, we spend a lot of time visit-ing schools and educating young peo-ple about choosing financial services as a career,” says ecker. “We also work closely with the immigration depart-ment to explore ways of bringing more global talent to toronto.” s

Number of issuers by sector — Toronto Stock Exchange

Source: Toronto Stock Exchange and TSX Venture Exchange

Number of Issuers by Sector

* As at December 31, 2012, includes issuers on Toronto Stock Exchange and TSX Venture Exchange (100% = 3827)

Mining 1673

Oil & Gas & Energy Services474

Diversified Industrials 312

StructuredProducts 216

Life Sciences111

ETFs282

Clean Technology 118

CPC170

Financial Services121

Real Estate83

Technology 171

Utilities & Pipelines 28

Comm & Media 46

ForestProducts 22

We see capital in TorontoOur goal as a public-private partnership is to work with fi nancial services companies from around the world that are exploring opportunities to do business in Toronto. We provide answers and the right connections – saving them time and money.

Get in touch. tfsa.ca.

TFSA_13015_Euroweek_Ad_FNL.indd 1 13-09-20 2:05 PM

Bank of Canada Profile


“New GoverNor, same policy”, is how Lombard Street research entitled its update on the prospects for Cana-dian monetary policy published soon after the release of the first Monetary Policy report (MPr) under the ten-ure of Stephen Poloz, who succeeded Mark Carney as governor of the Bank of Canada on June 3.

If there was any doubt about the continuity of policy at Canada’s cen-tral bank, the new governor was quick to emphasise his commitment to its core mission, which is maintaining inflation within a narrow range of 1%-3%.

“The Bank of Canada’s role in the country’s economic reconstruction is, as always, to keep inflation low, stable and predictable,” said Poloz in his first speech as governor in June.

Inflation targeting became the cor-nerstone of the Bank’s monetary poli-cy in 1991 — for good reason. Canada went into the 1980s with double-digit inflation, and although it halved from 10.9% in 1982 to 5.8% in 1983, over the rest of the decade it only dipped below 4% briefly, averaging 3.9% in 1988.

The policy announced in 1991 by the then governor, John Crow, set a clear target of reducing inflation, as measured by the total consumer price index, from about 5% in late 1990 to 2% by the end of 1995.

According to the central bank: “Inflation reached the target well ahead of schedule; and so the focus in the 1995 agreement shifted towards keeping it low, stable and predictable over the medium term, at an annual rate of 2% — the midpoint of a control range of 1%-3%.”

Inflation-targeting is a key part of the clear communications policy that the Bank has pursued for several dec-ades, and which has been re-empha-sised since the global financial down-turn. “The crisis has reinforced the fundamental importance of effective communications,” said Carney in one

of his last speeches as governor.

It was important for Poloz to pin his infla-tion-targeting colours to the mast early, because when his appointment was announced, con-spiracy theories ran riot about it heralding the demise of the Bank of Canada’s independence.

His appointment was, after all, a surprise — so much so that at least one Toronto-based bank reportedly had to hastily re-write a press release welcoming the red hot favourite, Tiff Macklem, to the post.

A former deputy finance minister, Macklem had been senior deputy gov-ernor since 2010, and as a member of the bank’s governing council had been closely involved in shaping monetary policy.

Independence questionedThe Bank describes itself as a “special type of Crown corporation”, adding that it “has considerable autonomy to carry out its responsibilities.”

It was that autonomy that came under question when Poloz was appointed. This was principally because his background as president and Ceo of export Development Can-ada (eDC) raised suspicions that the choice may have been at least partially politically motivated.

It was widely recognised that Poloz, who spent 14 years at the Bank from 1981-1995, was an outstanding candi-date.

Nevertheless, mischievous press comment may explain why he has played down the issue of the currency since his appointment.

“People recognised that Governor Poloz would understand the plight of exporters well and wondered if

that would influence his policy-mak-ing,” says Camilla Sutton, managing director and chief currency strate-gist at Scotiabank Global Banking and Markets in Toronto. “He has not done that at all. He has barely refer-enced the currency, mentioning it only twice in his first monetary policy report and one of those was to high-light how a strong Canadian dollar is good for business investment. Those who thought he’d be sympathetic to the plight of exporters facing a strong Canadian dollar have so far been dis-appointed.”

That may not remain the case indefinitely. “I don’t see any mate-rial change to monetary policy in the short term,” says Michael Greg-ory, senior economist at BMo. “But given his background he may be more attuned to what things are like on the ground for Canadian exporters. So we may get a bit more jaw-boning from Stephen Poloz about the strength of the Canadian dollar than we had from Mark Carney, who leant more towards benign neglect of the currency. I don’t see Poloz being interventionist, but he may be willing to talk about the cur-rency as a matter of policy more than Carney did.”

See page 18 for an exclusive interview with Stephen Poloz. s

The appointment of Stephen Poloz as the new Bank of Canada governor might have wrong-footed many commentators who had expected Tiff Macklem to get the job. But that’s it as far as surprises go. Poloz has wasted little time in re-emphasing the central bank’s commitment to keeping on top of inflation. As Phil Moore reports, continuity of policy is the name of the game.

Inflation remains core concern for Bank despite change at the top

The old and the new: Mark Carney (left) hands over to new governor Stephen Poloz

Governor Poloz IntervIew


EUROWEEK: Governor, you’ve spoken about the nor-malisation of the Canadian economy after what has been described as “a good crisis”, for want of a bet-ter phrase. But rather than normalisation, given fall-ing commodity prices, lower emerging market eco-nomic growth, domestic wage stagnation, higher mortgage rates and the high level of household debt, are there not major risks to the downside for Cana-da’s economy?

Poloz: In the near term, perhaps, and indeed some of those things may be longer term. They’re parts of what I would say is a new normal that we’re converg-ing towards. So when I talk about normalisation, I have in mind a fairly narrow economist’s view of a normal yield curve, inflation on target, a reasonable level of real interest rates, and then behind that consumers are in balance and firms are generating what I would call self-sustained momentum, or self-sustained growth, which really hasn’t started again yet.

If we go back to pre-crisis when the economy was growing at, say, 2%-3% on trend, we had a population of companies that was growing at about the same rate. So although you have corporate, or company deaths every year, you have more births than deaths. The net growth in the population is small companies that are emerging and they’re the ones that create these big moves in pro-ductivity, big moves in employment, and that process is, we think, just getting restarted. It’s the same obser-vation I would make actually for the US economy and there are symptoms similar in the UK.

So, for me, that is the self-sustaining process of Schumpeterian creative destruction. Whereas the net creation is the part that we’re watching to see happen and that takes time. So that’s what I mean by normal but behind that, the Canadian economy will look signif-icantly different than it did pre-crisis and you’ve men-tioned some of the things that will matter. There aren’t necessarily downside risks but there are things that we will adjust to.

In the near future, of course, we’re watching emerging markets. It’s an important export market segment for Canada. Companies have done a lot of work during this cycle to diversify out into emerging markets — we pick it up in surveys and we can see it in the numbers. It is

still a small piece of our total trade, but a growing piece, and that’s something we wouldn’t want to see a major downside to.

But behind it you have to be ready for the world to look different. We got used to China growing at, say, 8%-10% at least every year. A lot of that trend line was pumped up by the bubble period in the US and we know that wasn’t sustainable.

But the whole world wasn’t sustainable including China. Everything kind of gears back and for an export-er like Canada, 6%-8% growth in China today is worth a similar amount of new demand every day than it was five years ago when growth there was at 10%. It all works out to something we have to get used to, which is the numbers looking different.

So I’m not particularly troubled, but in the near term you’re absolutely right. There are downside risks. We’ve got our eyes on those, and not least of which is trade that we’re expecting to be the catalyst to that self-sus-taining momentum process that I talked about before — the US is the piece that’s been missing but it’s looking much more encouraging.

EUROWEEK: With rates at 1% and stuck there for the foreseeable future, do you feel that the Bank of Canada has enough wriggle room to adjust for any downturns greater than expected?

With Mark Carney succumbing to the charms of UK Chancellor of the Exchequer George Osborne, Canada needed a new central bank governor. Rather than picking the heavily fancied Tiff Macklem, Carney’s senior deputy, the Bank turned to Export Development Canada’s president and chief executive Stephen Poloz.

In one of his first interviews since taking on the job in early June, Poloz explains how exports will play an increasingly important role in the post-crisis Canadian economy, why this is an era of creative destruction and renaissance for the Canadian economy, the thinking behind his spaghetti sauce model and just why he is so confident that Keynes’ animal spirits will return. He spoke to EuroWeek’s Ralph Sinclair in early September.

Exports, animal spirits and spaghetti sauce

Poloz: “I can’t believe that the distortions that were built up over seven years can be fixed in less than seven years”



Poloz: Well, I think we do have room to manoeuvre. As you suggest, we would prefer not to need to use it given our starting point.

The household sector is quite indebted and did all the heavy lifting during the weak global growth period and so we wouldn’t want to rely on that, but in fact the household sector seems to be stabilising as opposed to going into a retrenchment, and so it puts a base under things.

I would guess that if one of those downside risks did materialise, then yes, Canada’s growth would ease back again, but we’d have a pretty good base underneath it. Certainly companies are in good shape, households are indebted and yet showing good promise.

It’s always hard to put a pin on what is truly a sus-tainable level of debt for the household sector. It’s so complicated now. Just thinking of the demographics, we’ve got this post-war baby boom generation moving through the system and their parents are living longer than ever before and they’re very old!

As a consumer what’s guiding you through all that? If you’re going to get money from parents someday, well, that’s OK, you don’t have to be retiring in per-fection perhaps. There are a lot of complicating fac-tors and I don’t pretend to understand them. Just now indebtedness is rolling over in the consumer sector and that’s what we like to see, or at least a stabilisation of that.

EUROWEEK: So stabilisation rather than continued growth?

Poloz: That’s it.

EUROWEEK: But you do not seeing it going down at all?

Poloz: At the moment it’s rolled over. It does appear that income growth is sufficiently strong that it’s lead-ing to a flattening, or a slight diminution, of our debt ratios and I think that’s a positive development. Pro-vided that good context is maintained, then I don’t think we see anything major happening there, just a gradual healing process, or consolidation process. That’s good for everybody while maintaining that base in growth.

EUROWEEK: I want to return to that image of the new normal Canadian economy and how different that looks. What do you see as the main drivers of growth? Presumably growth will be export-led busi-nesses rather than domestic demand?

Poloz: Yes.

EUROWEEK: And what is the way for exporting firms to attract that sort of investment into their

business with rates low and growth also low? How does Canada remain a place to attract that sort of investment?

Poloz: Well the part that’s fallen short so far has been the demand side and it’s probably best to distinguish here between the resource sector and manufacturing — and that’s not a very clean distinction. But for the sake of exposition those are the two ends of the story.

During the downturn, commodity markets did pretty well because we kept pretty good growth rates as did economies in the emerging market world, and so we had an unusual cycle from Canada’s perspective. Normal-ly commodities would be weaker and often the Canadi-an dollar would track downwards with that and act as a buffer for the manufacturing sector.

In this case what happened was the opposite. The Canadian dollar strengthened. It didn’t just maintain itself, it strengthened giving the manufacturing sector a harder cycle than has historically been the case.

When we came out of the other end, what we discov-ered was that it’s been such a long a cycle that it’s not like in your text book where you have a recession where companies cut back on production, cut back on employ-ment, and then nine months, or a year later, they start putting that production back up to where it was and bring the workers back. The companies have perma-nently downsized or in lots of cases that you can name, they’ve exited, they’ve gone.

As the upturn gets into its higher momentum phase — and we seem to be entering that phase now — you bump up against capacity constraints much sooner than you otherwise would expect.

So our measures of what we call output gaps are not that large. They’re important but they’re not as big as what you see if you look at labour market indicators of capacity. That distinction is because of this destruction phase of the cycle. So as we come out of the destruc-tive phase, what happens is companies that are in busi-ness see that they’re tapped out and it’s time to invest in more capacity.

That investment decision takes into account all the uncertainty that we see and so it may take a little longer for companies to be certain enough to make it, but it’s a natural part of that return to normality.

In addition, beneath those firms are all the budding entrepreneurs that are ready to enter markets and so their decision is perhaps an even bigger one to make because they have to start afresh.

Both of those groups’ decisions are primarily invest-ment decisions and require maybe a little more certain-ty than we have right now. If we’re sitting around the boardroom table, all it takes is a couple of board mem-bers to say ‘what if Europe has more problems?’ or ‘what if this China thing really is a slowdown?’

Then the CEO has got to admit that it is going to take them longer to overcome their hurdles and they say



‘we’ll wait a little longer before making the decision to jump’. But the firepower is there, they’re ready to go.

So growth is going to come from a capacity constraint with a clear sight that the orders are there, people want to buy things, and so that’s where the US economy is so key.

EUROWEEK: And are the conditions for accessing that capital for Canadian firms conducive enough for that growth? With mortgage rates up it looks as if banks are more cautious about lending.

Poloz: Everything we see suggests that credit is well available. Obviously larger firms have no problems what-soever. They’ve got plenty of cash. They have very strong balance sheets and the credit markets for high rated credits have been very strong.

For the small or medium sized firms I see no indica-tion that anything’s different from normal. It may be slightly more expensive to borrow, in terms of spreads, but they will also still get a good deal relative to histori-cal borrowing costs.

Our banks are in very good solid situations. The mar-ket has performed very well. So it’s more a question of when is the borrower ready to borrow and make that decision, as opposed to whether or not the lending capacity is available.

Some will say there’s a problem with small firms that can’t get this or that access to capital but that’s always a bit of a problem. It’s not a complete and perfect mar-ket. However, I don’t see anything unusual there. Things seem to be functioning quite well.

EUROWEEK: The Canadian economy has always exported, particularly to the US, and you’re saying that’s set to increase. Is there not a risk of becoming over-reliant upon the US economy?

Poloz: I’m not sure what that would look like. There is a lot of integration between the Canadian and US econo-mies, which is perfectly natural. It’s mutual reliance as

opposed to dependence.We did come through a period where people were con-

cerned about being overly dependent on demand from the US. That gave rise to extra impetus to diversify. The crisis forced some of that and the result is a lot more diversification, according to Export Development Cana-da figures. That’s a positive thing because you’re attach-ing your trade to faster growing economies for the next 10-20 years.

All of that is a positive thing, but an extra two or three or five percentage points of market share for the US is not going to hurt or improve Canadian trade. The US is the biggest and most dynamic economy in the world and a lot of the trade between Canada and the US is in inter-mediate goods, which are destined for the international market anyway. So if you’re a supplier to a GE factory in the US, you may think you are exporting to the US and that’s what the data will record, but GE has got that end product going to 120 countries. If your component is part of GE making a jet engine, it goes into aeroplanes all around the world even though your product was shipped to the US.

EUROWEEK: You are plugging into a bigger grid.

Poloz: Exactly. The United States is a highly globalised economy, so I think of trading with the US as trading with the world.

EUROWEEK: And where can growth come from domestically given household debt, rising mortgage rates and stagnant wages?

Poloz: It’s clearly going to come from the investment side. We think that in many areas of the economy, capac-ity constraints are not that far away, so as long as the US continues on its healing trend and the rest of the world remains where it is or continues to heal, which would be my forecast, then investment is almost inevitable.

The uncertainty drives a wedge between those invest-ment decisions and their outcomes. That just means you have a bit more of a hurdle to jump. But everything we do that’s constructive is likely to reduce that uncertainty hurdle.

It goes back to Keynes and his animal spirits. Today I talk about uncertainty or risk, but it really is just the flip-side of positive animal spirits. There’s no doubt about it — the experience we’ve had crushed animal spirits and has made people much more cautious to make sure that the light at the end of tunnel’s not an oncoming train before they make their decision. That’s fine. But once we get across a certain undefined threshold, what we know is that the other side of animal spirits will kick in. It usu-ally kicks in earlier in the cycle but has been lacking this time so far.

That’s the immeasurable. I used to do the forecast-ing here back in my first career at the Bank of Canada, and I know this is exactly where we always underesti-mate what can happen, because you can’t put a quantifi-

Poloz: “If you ask any random audience if they think the banking system is more secure, everybody will say yes it is. There’s more capital and more awareness. It’s all good”



er around it and I suppose no one really criticises you for under-predicting a massive upturn. It’s always the other way around.

But when animal spirits get crushed, then they become this weight that holds you back. So just imag-ine if that weight is dissipating at the same time that the fundamentals are improving. I don’t want to be the one predicting it, but in a way it’s almost inevitable at some point that animal spirits will return. It could just take the form of companies deciding we’re in a world where lower rates of return world are the new normal, our earlier rate was too high.

I don’t know what they will be, but they will at some point be unleashed.

EUROWEEK: Canada’s taken a very conservative approach towards its banks implementing Basel III, higher capital requirements and so on. Has that made it harder for Canadian banks to compete inter-nationally?

Is there a risk of over-regulation or do you hear from the banks that they’re happy with the approach and this conservative approach is a better long term strategy?

Poloz: Well, this is the Office of the Superintendent of Financial Institutions’s area, of course. We work with them on all these things, and so my observations are not from a practitioner but from an observer.

First of all, yes, Canada’s banks have always been rela-tively conservative in that sense. I don’t think it’s a prod-uct of regulation per se, but a product of how they’ve conducted their business. And I mean that in a positive way as opposed to a judgemental way. It’s how they do business and the result has always been a well perform-ing corporate and household sector, so I’m not one to argue with that. It stood us well over the course of the crisis, something that is well appreciated.

When you look at the world, we didn’t really have what you might call a level playing field 10 years ago. The whole Basel process is an attempt to strengthen the sys-tem, and it is much stronger today than it was back then.

And we’re building it in a collegial and co-ordinat-ed way so that we do have the next best thing to a level playing field when we’re done.

I do expect the Canadian banks will be as competi-tive as they ever were in both domestic and international markets. I don’t see this as a major issue, but of course we have to continue to participate and work on it, and that regulatory architecture is not complete yet.

I wouldn’t want to predict it. It’s very complicated and it’s a major negotiation with lots of people involved. The Financial Stability Board has done an absolutely superb job of bringing the issues right to the front, harnessing all that energy, getting that sense of common purpose on the table, and setting an agenda that is very rhythmic.

There is always something due. I’m very impressed with how rapidly the system has evolved in a positive direction.

If you ask any random audience if they think the bank-ing system is more secure today than it was before, eve-rybody is going to say yes it is. There’s more capital and more awareness. It’s all good.

EUROWEEK: So perhaps it is the case that even if Canadian banks had stood still from a regulatory point of view, they’d still be in a stronger position than a lot of their international counterparts.

Poloz: Well, they’re all done with complying to the new regulations way ahead of time, of course. There are still plenty of issues floating around and they take a direct interest in those issues. That’s good. That’s part of colle-gial fact finding and a consolidating process.

I have good relationships with all the CEOs of Cana-dian banks and they’re all sounding pretty upbeat about things. They’re proud of how things went.

The key to a really good international banking archi-tecture is that you don’t see it as the regulator versus the organisations. It’s more a case of financial institutions wanting to be part of the system because there are obvi-ous benefits to them to doing so.

When it first happens banks can feel regulators are forcing them to do something. But that’s really not it. We all have a major stake in the fundamental properties of the system, so I think it has to be an enlightened conver-sation.

Most banks would see that as a positive for everybody and as long as somebody else isn’t getting away with something much easier, that makes them uncompeti-tive, then they’re going to be fine with it.

EUROWEEK: Will the Bank of Canada’s job change at all in the Canadian banking sector? Will there be a central clearing counterparty?

Poloz: We have our repo system as a way of working as a central counterparty for the derivatives market in gen-eral, but the architecture itself is the responsibility of the Minister of Finance.

Poloz: “You have to be ready for the world to look differ-ent... the whole world wasn’t sustainable”



We’re primarily seen as a key system adviser. We do our financial stability studies and monitoring. That’s a key part of the monetary policy process — to have a key input to those conversations.

EUROWEEK: What can people expect from your gover-norship that might be different to Governor Carney?

Poloz: The organisation did exceptionally well under Governor Carney’s leadership. If someday somebody said that I did as good a job as Governor Carney did, that would be pretty high praise to me.

I don’t come to the job hoping to change things of that sort. There’s no question about the pillars of what the Bank does. They remain what they are. The inflation tar-get is sacred to us and we’re doing everything we can in the sense of strengthening, or investing in, our analytics so we understand it better.

‘Why is inflation as high as it is given what we’ve been through?’ is a simple question. But it’s not an easy one to answer. It was one of the subjects at Jackson Hole this year. If you can’t really put a pin on that with precision, that’s just an illustrator of how complex this is.

So over time we want to strengthen that side of the Bank’s work and provide something that is even more understandable for people even with all the problems of financial stability that we’ve gone through in the last few years.

To just talk about inflation a bit would be a positive evolution — central banking getting back to its core work.

But I don’t see any of this as my personal mission; it’s more about the economic context evolving. When Gover-nor Carney came to the job he may have thought some-thing was up, but he certainly didn’t expect what we saw. The context changed dramatically during that time and the organisation responded wonderfully, so a lot of new processes and new rigour and new models, which were not there before the crisis, are investments that we’ll use over and over.

EUROWEEK: So it is about moving towards a frank conversation about the inflationary outlook. Being able to say what the limitations are on people’s

insight into that debate, and a more honest accept-ance of them rather than, if I think about, Federal Reserve chairman Alan Greenspan’s era where his every word was being interpreted as if it were some magical code.

Poloz: I always say there won’t be a market for that kind of role with my guidance because I’m more likely to be blunt and try to simplify, make it clear.

But if you look at the historical context of the last five years, we had to be very dramatic in our policy response and for the next I don’t know how many years, but two, three or possibly as long as five years, we’ll be rebuilding all that.

From the private sector standpoint I have likened it to a reconstruction process because you’ve taken capacity out of the economy and now it’s time for it to be rebuilt.

We are in a position to help nurture that and, of course, to explain to people how it is we’re getting there.

I spoke to the Bank’s forecasters at the beginning of our last interest rate cycle, and I said ‘someday you’ll be able to sit with your grandkids and say, I worked at the Bank of Canada during this era and it will be like when the Norse-men started looking for the New World’. They were look-ing at the stars when one night, they were blown into the southern hemisphere and then all the stars were different.

We really are in uncharted territory. The models have failed us in certain ways, but we don’t need new models or new understanding.

I said to our forecasters to use their models not to answer the questions, but to use them to help ask more questions and form judgements. That’s going to help us guide the way.

For me to be able to go out and say to people that it’s complicated, it’s different, but this is what it looks like, that extra dialogue — hearing back from companies about what it actually feels like in the trenches — will help us narrow that margin of uncertainty. That’s what I see as my job.

EUROWEEK: The tail wagged the dog for a few years as far as forecasting models were concerned.

Poloz: As a modeller — an old modeller — it must be awfully frustrating. But if you start back, around 2000 or even before, the models couldn’t really explain that bub-ble. They certainly couldn’t explain what happened after 9/ll.

We had way more spending and it was obviously some sort of a spending binge that created the makings of the bubble.

My model is a simple one. I call it the spaghetti sauce model. If you look closely when a bubble pops in the spa-ghetti sauce, there’s a crater underneath it and it’s exact-ly the same size. It’s not a very complicated model, but I can’t believe that the distortions that were built up over seven years can be fixed in less than seven years.

We are set up for a multi-year crater and we have to get used to the fact that the healing process is going to take longer and needs nurturing. It needs people who under-stand that and we have a role to play in helping them understand it. s

Poloz: “To just talk about inflation a bit would be a posi-tive evolution — central banking getting back to its core work”

Banking Regulation


“Strong SuperviSion impacts the bottom line of a financial institution in a positive way,” said Canada’s chief regulator, Julie Dickson, in a recent speech. “it does not limit opportuni-ties; it expands them.”

Some would dispute this, with a debate continuing to simmer in the uK, for example, about the impact of regulatory diktat on lending volumes and broader economic activity.

But Canada’s banking industry appears to have achieved the best of both worlds, maintaining stability without suffocating innovation or sti-fling growth. “With no bank failures since 1985, Canada has an enviable recent regulatory track record,” says Standard & poor’s in its most recent banking industry country risk assess-ment for Canada. that is a view that nobody would seriously contest.

Since its creation in 1987, that track record has been jealously guarded by the office of the Superintendent of Financial institutions (oSFi), Cana-da’s chief regulator and supervisor, which is an independent agency of the government and reports to the Ministry of Finance.

Since the global financial cri-sis, which was navigated with fewer alarms in Canada than in most devel-oped economies, the vigilance with which oSFi supervises domestic bank-ing has been intensified.

it has required that Basel iii be fully implemented in 2013, rath-er than phased in by 2019, as some other jurisdictions have done. it has slapped a 1% capi-tal surcharge on the so-called Big Six which are deemed to be Domestic Systemically impor-tant Banks (D-SiBs), which will apply from 2016. this will lift the minimum common equity tier one requirement to 8%.

Dickson makes no apology for the zealousness with which oSFi has applied the Basel standards well in advance of

other jurisdictions. She has a simple enough answer to those who ask why oSFi has been in such a rush. As she said in her May speech, “weak bank-ing systems wreak havoc”.

the Big Six already comfortably meet the 8% minimum Cet1 ratio demanded by oSFi. indeed, as oSFi’s assistant superintendent, Mark Zelm-er, explained in a speech in May, “Canadian bank capital ratios are stronger than they look because they are not relying on the transitional arrangements contained in Basel iii.”

Let there be lightthe title of Zelmer’s address in May was “Let there be Light”, which reflects oSFi’s advocacy of improved disclosure standards in general and of the implementation of the recom-mendations of the Financial Stabil-ity Board’s enhanced Disclosure task Force (eDtF) in particular. Canada’s banks, said Zelmer, have already acted on most of the eDtF’s 32 recommen-dations and have indicated that they will implement the remainder over the course of this year and next.

that is a commitment re-empha-sised by bankers such as eric girard, treasurer at national Bank in Montre-al. “the concern that has been raised by some investors and ratings agen-cies about the disclosure standards on liquidity and funding are being addressed,” he says.

Canadian bankers say their inter-ests are aligned with the oSFi’s. “Canadian banks are well rated, well capitalised and conservative, and so i don’t think there is any discon-nect between where we are and where oSFi is encouraging the banks to go,” says Francine Blackburn, executive vice president of regulatory and gov-ernment affairs and chief compliance officer at rBC in toronto.

Blackburn points to the dialogue between the two on non-viability contingent capital (nvCC). “We fully support the concept of nvCC and we have been working closely with oSFi to develop a framework which we think is workable for key stakehold-ers such as bondholders and ratings agencies,” she says. “We understand why other countries have opted for a statutory model, so it will be impor-tant for Canada to explain to the mar-kets why the Canadian approach will work relative to international frame-works.”

Blackburn agrees that strong capital ratio requirements and other meas-ures such as the 3% leverage ratio have supported rather than hampered growth at rBC. “our capital market business in the uS has benefited from recognition of the strength of the Canadian banking system,” she says. “it has grown significantly and in some businesses we are back to where we were pre-crisis.”

the oSFi’s tough regula-tory stance does not seem to have done bank shares any harm. “our share price has been steady over the last five years and has recently reached an all-time high,” says Blackburn. “So the mar-ket seems to recognise that there are still plenty of growth opportunities for the Canadi-an banks to harness.” s

See page 24 for interview with OFSI’s Julie Dickson

Canada’s commitment to a strong banking sector is now world famous. But its banking industry appears to have achieved the best of both worlds, maintaining stability without suffocating innovation or stifling growth. Philip Moore finds out how it has achieved this impressive balance.

Zealous approach to regulation pays off for Canada’s banks

Canadian largest banks: Source of profits by geographical region

Source: IMF / Annual financial reports of banks-5

0

5

10

15

20

25

30

35

2006 2007 2008 2009 2010 2011 2012

Canadian largest banks: source of pro�ts by geographical region

C$bn

From Other International Operations

From US

From Canada

Source: Annual �nancial reports of banks

IntervIew wIth JulIe DIckson, osFI


EUROWEEK: It is generally recog-nised that Canadian banks had a good — or even a very good — cri-sis relative to those in the US and Europe.

Dickson, OSFI: The solidity of Can-ada’s macroeconomic fundamen-tals was one contributing factor. So, too, were capital ratios in the bank-ing sector. We had moved to a 7% tier one environment and a total require-ment of 10% when many other coun-tries had kept Basel minimums of 4% and 8% in place. We had also been pretty strict in terms of requiring that tier one capital be comprised largely of common equity, which proved to be very important at the start of the crisis. We also had a leverage ratio in place, which we think played a role.

I also like to emphasise that we were early in implementing Basel II, which forced banks to develop their risk management and data systems and to increase their risk manage-ment budgets well before the crisis. That also played a role.

We also observed that the quality of supervision is important. You can have as many capital and leverage rules as you like, but it is also essen-tial to focus on what supervisors are doing on a day-to-day basis. Super-visors typically comprise the bulk of human resources of any regulatory agency, and little attention is paid to what they’re doing. People tend to focus far more on what the rules are.

OSFI has had a mandate since 1995 that zeroes in on our solvency role and prudential roles. There is no con-flict of objectives. We were able to hire the resources we needed, and brought in a lot of people from out-side — not the usual practice in some

countries. And we had the independ-ence to make decisions that were sometimes unpopular.

As a regulator, opening yourself to international assessments such as Financial Sector Assessment Pro-grammes (FSAP) is also important.

The Canadian banks also deserve credit for how they fared in the crisis. There are far fewer people employed at OSFI than there are in the banks’ risk management and internal audit groups. Strong control functions enhanced banks’ resiliency and pre-paredness for the crisis.

EUROWEEK: Does OSFI share the concerns of Fitch that “the main domestic threat to the stability of the Canadian banks is the record level of consumer indebtedness and the risk of overvaluation in the housing market”? Is there any-thing a regulator can (or should) do to help address these threats?

Dickson, OSFI: Fitch’s comment is consistent with the views of the Bank of Canada, which have been expressed in a number of its Finan-cial Stability reports.

As a regulator, you definitely need to heed any concerns of this nature. At OSFI, this has led to a fair amount of action. We began looking closely at the Canadian banks’ real estate loan portfolios three or 3-1/2 years ago. We were looking for clear policies on who they would lend to, and on how any exceptions would be dealt with.

We followed up by publishing guidelines, now in effect for over a year, covering a gamut of areas banks should be adhering to. The guidelines really emphasised the message that we wanted extremely close adher-

ence to policies and wanted boards of directors involved in discussions about those policies. We also includ-ed some bright lines on areas like home equity lines of credit, where we wanted to see loan to value ratios of 65% or less. We wanted to see a lower LTV than this on any kind of credit not classified as being of prime qual-ity.

We’ve also been spending a lot of time looking at the models banks are using to determine risk weights, especially for their uninsured books. Mortgage loans above 80% LTV must be insured, so we focus most of our efforts on the uninsured book, which in terms of LTVs are fairly conserva-tive. We’ve taken quite a lot of com-fort from the risk weights coming out of those models.

EUROWEEK: Is OSFI concerned about heightened competition in the Canadian banking industry that might encourage the banks to take more risk overseas?

Dickson, OSFI: OSFI does not express views about banks’ strategies. We do express views on the risks that accompany their strategies. If a bank is looking at expanding its global footprint, or getting into a new busi-ness — even at home — our concern would be that the bank is proactively identifying and dealing with the risks that are created as a result.

EUROWEEK: You said in a recent speech that regulation can expand rather than limit opportunities. Can you expand on this?

Dickson, OSFI: Banks have better ratings and can enjoy cheaper fund-

The Office of the Superintendent of Financial Institutions is Canada’s top banking regulator and is widely viewed as having created a banking system that is the envy of the Western world.

At the top of OSFI is Julie Dickson. She joined the agency in 1999 and, after serving a member of the Basel Committee on Banking Supervision between 2002 and 2006, was appointed superintendent of OSFI in 2007 just as the first signs of the global financial crisis began to appear. Her seven year term is set to end next year but she has indicated that she will not extend it.

She spoke to EuroWeek’s Philip Moore in early September about why Canada’s financial system has been so resilient throughout the crisis, whether the housing sector is overheating and just how regulators can keep on top of the new set of challenges that will surely emerge as global economic recovery gathers pace.

OSFI a rare beast: a financial watchdog with real teeth

IntervIew wIth JulIe DIckson, osFI


ing when they are based in a juris-diction where the effectiveness and robustness of the oversight system is widely recognised. Canadian banks report that they enjoy access to con-sistent and cheaper funding and access to new markets as a result.

EUROWEEK: Why is a 1% surcharge on D-SIBs considered necessary?

Dickson, OSFI: The idea of having a surcharge is definitely consistent with the Basel Committee’s position, which is that each jurisdiction should assess which banks within their sec-tors are systemically important and determine what the consequences of that should be.

When we analysed the Canadi-an system, we reached the view that we have six systemically important banks, and that the failure of one of those banks could have serious implications for the entire economy. That suggests that action needs to be taken to prevent failure, and in the Canadian context the 1% surcharge increases the probability that banks will remain solvent when the unex-pected happens.

We’ve announced a number of other measures combined with the surcharge. We’re following the guide-lines of the Enhanced Disclosure Taskforce set up by the Financial Sta-bility Board, which is recommend-ing that banks release a lot more information. We’re also continuing to implement more robust supervision of systemically important banks.

EUROWEEK: What are the pros-pects for the issuance of non-via-bility capital contingent capital (NVCC) in Canada, and how does this differ from European Cocos?

Dickson, OSFI: Everyone has a dif-ferent definition of what a Coco is. The Basel Committee’s final agree-ment on tier one capital allows banks to include instruments that qualify as non-viability contingent capital (NVCC) as tier one. Our view — and the Basel Committee accepts this — is that if you’re going to qualify an instrument as capital, the trigger has to come very late in the process.

But institutions are free, as are supervisors around the world, to think of other instruments. We have chosen to adopt the NVCC route.

Our stance on non-viability trig-gers has been very clear for a long time, which is that if a bank reaches the point at which it is non-viable, it ought to be closed. This is all part of the aim of the statute that the super-visor be able to take early action to resolve problems, and that a bank failure does not mean the supervisor has failed.

Given that investors have been buying shares and subordinated debt of Canadian banks for a long time, and that legislation has always defined to some degree what non-viability is, we decided that it would make a lot of sense to use it as a trig-ger for this type of contingent capital instrument. People are familiar with it, and it is important that the market has confidence that the supervisor is not going to trigger it on a whim.

EUROWEEK: Where do you stand on the debate over the computa-tion of RWAs?

Dickson, OSFI: We believe the computation of RWAs is extremely important. It’s an outcome of people not emphasising the importance of supervision enough.

As I said earlier, there has not been enough of a focus on what supervi-sors are doing. When banks use their own models for risk-weighted assets, supervisors have to be all over them. When people suggest we go to a sim-pler system and not use models at all, supervisors would need to be even more intrusive.

EUROWEEK: What are your views on stress testing?

Dickson, OSFI: OSFI takes stress testing very seriously and agrees it is extremely important. We’ve been very focused on it over the last few years, as has everyone else.

Where there is some difference of view is on whether it is appropriate to conduct stress tests every year with individual banks named and their results disclosed publicly. Our view is this is not appropriate, because it can potentially increase risk if people use the numbers inappropriately.

We have to remember that stress testing is a giant model and that a lot of assumptions have to be made. You’re trying to estimate the impact of what would happen in a tail event,

and because tail events are few and far between, history may not be a reliable guide.

It is the second round impacts of stress testing that are really diffi-cult to sort out. If you extend stress tests from two or three years to five, the results can look very different, because they will depend on the rates of change of key variables such as interest rates and inflation.

We’ve been emphasising that stress tests are a very good platform for supervisory discussions with a bank about the reasons for its results, espe-cially if it is an outlier in terms of its performance. We think you can get a lot more out of those discussions than if you use them as a tool to base public dividend decisions on.

EUROWEEK: Was this influenced by the market’s response to stress testing in Europe?

Dickson, OSFI: Our views have cer-tainly been informed by what we’ve seen around the world. We’re also asking if the time it takes to pub-lish these results wouldn’t be better spent zeroing in on detailed discus-sions with banks. If the results aren’t published, you can have much more open discussions with banks.

Other supervisors in other juris-dictions have chosen different paths. The path each supervisor chooses has to be based on its own experience. We would prefer that banks issue infor-mation. They’re the ones that should be informing the market about how they would fare under various stress scenarios. That’s why we’re such big fans of more disclosure. s

OSFI a rare beast: a financial watchdog with real teeth

Julie Dickson, Superintendent, OSFI

The Banking secTor and Funding


Canada’s banks could be forgiven for becoming blasé about the acco-lades they have been given on an apparently uninterrupted basis since the global financial crisis began. The most recent of these, in early sep-tember, was the now predictable announcement by the World Eco-nomic Forum that Canada’s banks were ranked as the soundest on the planet in 2013 — just as they were in each of the previous five years.

banks in the Us and the Uk, ranked 58th and 105th respectively in this year’s Global Competitiveness Report, will now be casting covetous glances at a banking system once stereotyped as over-cautious. “Pre-crisis the criticism from abroad was that Canadian banks were unneces-sarily risk-averse and had too much capital,” says Craig Wright, chief economist at Royal bank of Canada in Toronto. “now we’re seeing that that was not such a bad thing after all, and, in fact, many banking sys-tems around the world are looking to copy the Canadian model.”

For at least one bank, maintaining a high capital level that was sneered at by other banks before the cri-sis directly helped to turbocharge growth after the downturn. “Pre-crisis, scotiabank was sitting with a high tier one capital ratio under basel II standards — well beyond regulatory standards,” said Richard E Waugh, chief executive of scotia-bank, in a speech earlier this month. “It was high enough that we were being criticised by some analysts for not undertaking share buybacks or special dividends.

“because of our high capital lev-els and a return on equity that remained in the high teens, we were the only Canadian bank that did not have to issue equity during the crisis period — and we were able to deploy capital to take advantage of a num-ber of strategic acquisitions. In fact,

since the crisis we’ve made some 40 acquisitions for more than $40bn.”

The envy of the worldGiven the intensity of the focus on capital within the global bank-ing system, it is little wonder that Canada’s banks have been increas-ingly regarded as the envy of many of their Us and European competi-tors. as Mark Carney said in his last speech as governor of the bank of Canada, in May: “since the crisis, Canadian banks have become con-siderably stronger. Their common equity capital has increased by 80%, or $77bn, and they already meet the new basel III capital requirements six full years ahead of schedule.”

On a fully implemented basis, the six largest banks reported an aver-age basel III tier one common equity ratio of 8.4% at the end of 2012.

Canadian banks’ innate conserva-tism does not seem to have done any harm to their performance, as their recent results amply illustrate. Fitch noted in its review of 2012 that “the major Canadian banks maintained consistent earnings trends driven by volume growth in retail and com-mercial banking, still modest pro-visioning expenses, and a strong rebound in capital markets-related activity.”

The result was an increase of more than 18% in net income at the big six in 2012. and although Fitch’s report cautioned that the backdrop for future earnings performance would become progressively more challenging, there was little sign of any pressure building in the banks’ recently announced third quarter results. Quite the reverse. Operating cash EPs rose by 4% from Q3/2012, according to research published by bMO Capital Markets, which was 6% ahead of expectations.

Growth in the banking system has

underpinned a continued rise in capital market issuance in 2013. In marked contrast to Europe, where new issuance from the deleverag-ing FIG sector has nosedived over the last year or so, the primary mar-ket for Canada’s banks remains very active. according to data published by bMO Capital Markets, by early august total issuance of term debt (defined as deals of $100m or more with a maturity of more than two years) had reached C$61.2bn. The lion’s share of that total is accounted for by deposit notes in the domes-tic market, which by early august had contributed a record C$27.7bn of Canadian bank funding.

George Lazarevski, research ana-lyst at bMO in Toronto, says that there have been three main drivers of elevated issuance among Cana-dian banks in 2013. The first is the record volume of maturing issues in 2013, at $54.1bn across all currencies.

a second driver of heavy issu-ance in 2013, says Lazarevski, has been refinancing by the banks of the remaining $50.1bn of mortgages securitised under the Insured Mort-gage Payment Programme (IMPP). This was set up by the government as a temporary measure in 2008 to address the liquidity crunch that restricted access to credit for many corporate customers at the height of the crisis.

The third explanation for

Before the crisis, Canada’s banks were derided for being too cautious. Now look at them. Having been ranked the soundest on the planet for the sixth year running, Canada’s banking system is the envy of the financial world. Philip Moore reports.

Canada’s banks: a world-class industry

“Many banking systems around the world are looking to copy the Canadian

model”

Craig Wright, Royal Bank of Canada

the Banking sector and Funding


increased FI issuance this year has been stronger than expected loan growth, in spite of more onerous guidelines imposed by the Office of the superintendent of Finan-cial Institutions (OsFI), says Laza-revski.

according to the bMO data, the Canadian banks were especially active outside the domestic market in the first seven months of 2013, raising $33.5bn in international markets, of which $26.2bn was in senior debt and Yankees Cds issued in the Us.

For Canada’s leading bank issuers with the largest funding needs, the Us market is too deep and too close at hand to overlook as a competitive source of funding diversification. Take the example of an issuer like RbC, Canada’s largest bank by mar-ket capitalisation, which raised over $21bn in wholesale markets in the first three quarters of this year, just under $10bn of which was in senior debt.

“While we have significant fund-ing capacity in the Canadian market, we feel it is sensible to diversify into foreign markets,” says ken Mason, managing director, corporate treas-ury at RbC in Toronto. “It is also important to preserve some capacity in the domestic market in case mar-ket conditions become stressed.

“additionally, we have a natu-ral mix of Us and Canadian dol-lar requirements, and a very strong brand presence in the Us. so there

are plenty of good reasons why we are a regular issuer in the Us mar-ket.” Indeed, as of October 2012, the Us accounted for 49% RbC’s whole-sale term and covered bond funding, compared with 36% in Canada.

A world beyond North AmericaMason adds, however, that the Us market is by no means the only alternative source that is open to RbC outside the Canadian dollar space, with other programmes such as the kangaroo market and the bank’s ¥1tr issuance shelf available if the economics were to make a samu-rai issue viable. “Maintaining access to several different funding options generally means we are able to diver-sify without paying a premium over what we would pay in the Canadian market,” says Mason. “but for some of the other benefits of accessing the Us dollar market we would have a modest tolerance for paying up.”

Other borrowers say that the eco-nomics of issuing in the dollar mar-

ket are of course an important deter-minant of their broader funding strategy. but that does not neces-sarily mean that arbitrage is always the overriding issue. “notwithstand-ing that the domestic market is our cheapest source of funding, there may be capacity constraints in Cana-dian dollars,” says Wojtek niebr-zydowski, vice president at CIbC treasury in Toronto. “Economics are always important, but there will always be strategic reasons for issu-ance from various platforms.”

CIbC, says niebrzydowski, typi-cally issues between one and three senior unsecured benchmarks in the dollar market.

Others are more recent entrants to the Us market for term senior unsecured funding. One of these is national bank, which has a total funding requirement of about $1bn per quarter, most of which is to cover the roll-down of existing facili-ties, according to the bank’s Mon-treal-based treasurer, Eric Girard. “Much of our issuance is in the sen-ior unsecured market, although we are also an active participant in the CMHC CMb [Canadian Mortgage bonds] programme,” he says.

Last year, says Girard, national bank issued its first senior unse-cured Us dollar transaction off its MTn programme in 3(a)2 format. This $1bn three year issue, in June 2012, was priced at 120bp over Us Treasuries, and was followed in november 2012 with a $750m five year transaction at a 75bp spread. both transactions were led by Citi, JP Morgan, national bank Financial and Wells Fargo, and both were well oversubscribed, according to Girard.

“although we issue in short term paper in the Us, in the Yankee Cd and commercial paper markets, this was the first time we funded in benchmark size in the Us dollar term senior unsecured market,” says Girard.

“Most of our funding needs are in Canadian dollars, so we will look at opportunities outside the domestic market when they offer the chance to diversify our investor base and generate cost-effective funding,” he adds. both objectives, he says, were met by national bank’s Us dollar issues last year. “It’s possible that some of the investors in our 3(a)2 programme also participate in our

“We have been issuing for many

years and we visit European investors on a regular basis”

Ken Mason, Royal Bank of Canada

Big Six issuance across all currencies

Source: BMO Capital Markets

Big 6 issuance across all currencies

46.5

57.8

66.0

16.0

58.9

73.7

64.561.2

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

2006 2007 2008 2009 2010 2011 2012 2013

C$bn C$ £ € Other

Note: Excludes issues less than C$100 mm, less than 2 years and extendibles. Source: BMO CM, Bloomberg; As of August 15, 2013 settlement date




Yankee Cd programme,” he says. “but as all the investors were new to our senior unsecured funding, we are pleased with the diversification the programme has given us.

“We have not used the programme this year, because funding condi-tions in the Canadian dollar mar-ket have been good. but last year the new issue concession in Us dollars versus Canadian dollars made it a favourable time for us to issue.”

Covered returnProbably the most striking feature of the leading Canadian banks’ fund-ing programmes over the last year, however, has been their return to the covered bond market. This fol-lowed the extensive revision to the legislative framework governing the issuance of covered bonds, outlined in the budget in March 2012, the details of which were announced by the Canada Mortgage and Housing Corporation (CMHC) late in 2012.

although covered bonds rap-idly became an important fund-ing source for Canadian banks following the launch of the first Canadian issue in 2007, with the outstanding stock of bonds dou-bling in 2010, these were issued under a contractual framework which was considered by then to have passed its sell-by date. a con-sultation paper released in 2011 by the Finance department explained that “this non-legislative, contractu-al approach provides a high level of disclosure to investors on the cover assets and has been successful in developing a covered bonds market for Canadian issuers.” The problem, said the consultation paper, is that it suffers from “two drawbacks that make the market less robust and reduce the ability of Canadian FIs to diversify their funding sources.”

“First,” the consultation document added, “the issuer’s assurances in the prospectus that the cover assets will be available for the benefit of covered bond investors are not a substitute for statutory protection. second, some international inves-tors are restricted from purchasing bonds issued under a non-legislative framework, narrowing the investor base.”

The authorities’ response was the establishment of the new framework

designed to tighten the eligibility criteria for issuers and broaden the investor base for Canadian covered bonds. “The framework is intend-ed to make the market for Cana-dian covered bonds more robust and increase financial stability by helping lenders find new sources of funding,” explained a norton Rose briefing in May 2012.

The response among analysts was mixed. Moody’s commented soon after the release of the CMHC guide-lines that credit risk would be high-er in new programmes, reflecting one of the main changes in the new framework, which excludes insured mortgages from the collateral pool.

“still,” Moody’s added, “the guide-lines do have positive features for investors.” These include disclosure of detailed cover pool data, compli-

ance with a comprehensive set of tests to protect against credit risks, and the creation of an independ-ent cover pool monitor to oversee compliance with collateral require-ments. “In addition,” Moody’s com-mented, “as the covered bond regu-lator, CMHC’s mandate to promote a healthy housing market aligns with the interests of covered bond inves-tors, another positive.”

RBC jumpsbefore the publication of the CMHC’s guide on issuance under the new framework, RbC became the first of the Canadian banks to reg-ister its covered bond programme with the sEC in september 2012. It has since issued two sEC-regis-tered covered bonds, with a five year $2.5bn transaction issued at 35bp over swaps in september 2012 fol-lowed in november with a $1.5bn three year issue at 20bp over.

With European covered bond issu-ance at an all-time low in the first

quarter of this year, RbC capitalised on pent-up investor demand when it re-opened the euro market for Cana-dian issuers in July, launching the first Canadian covered bond for five years. The €2bn five year issue, led by RbC CM, barclays, bnP Paribas and deutsche bank, generated total demand of €3.5bn from 150 inves-tors, allowing pricing to come in from guidance in the low 20s over swaps to 16bp over. demand, says Mason, was such that the book was larger than it had been for RbC’s inaugural issue in 2007.

Later the same month, RbC issued the first australian dollar covered bond benchmark, a a$1.25bn three year floating rate issue led by anZ, nab and RbC which was the first from a Canadian borrower in the aussie market since a a$600m deal from CIbC in July 2011. around 40 orders were generated for a$1.8bn, with about two-thirds of demand from onshore accounts. The trans-action was priced at the tight end of guidance at 53bp over bbsW.

“The australian dollar deal was a longstanding project,” says Mason. “We had roadshowed back in 2011 and explored the possibility of issu-ing aussie covered bonds. Market conditions did not allow us to issue at the levels we wanted, but we mon-itored the market on a continuous basis.

“The fact that the australian banks had been able to get their domestic programmes up and run-ning was helpful for us because it meant there were more investors engaging with the product. We were also able to leverage the positive buzz that was generated by the new legislation and by the success of our dollar and euro deals. but the Us dollar, euro and aussie dollar issues were all independent projects that fell into place because the econom-ics of each transaction lined up.”

CIBC goes eastIn the euro market, CIbC followed soon afterwards with its inaugu-ral CMHC-registered covered bond, which was led by CIbC, Commer-zbank, HsbC and Rbs. Original-ly expected to have been launched before the RbC transaction, CIbC’s €1bn issue generated demand of €3bn from over 100 accounts at 9bp over mid-swaps, 3bp inside initial

“We will look outside the domestic market

when it offers the chance to diversify

our investor base and generate cost-effective

funding”Eric Girard,

National Bank of Canada

the Banking sector and Funding


price talk. This was reported to have equated to around 48bp over dollar swaps, which was about 5bp tighter than CIbC would have priced in the dollar market.

demand was led by Germany, which accounted for 38% of place-ment, with 24% going to the Uk and Ireland and 11% to benelux and France. banks took 38% of the issue, while central banks and agencies accounted for 30% of distribution.

“We were very pleased with inves-tors’ response to our euro issue,” says niebrzydowski at CIbC, “but I wouldn’t go so far as to say we were surprised because we believed we had a good story if you look at the four components that the buy-side will typically look for in any covered bond.”

“In no particular order, these are the strength of the issuing bank, the type of the collateral, the credit standing of the sovereign, and in this particular circumstance the issuance framework,” niebrzydowski adds. “aside from being Ucits eligi-ble, which by definition we can’t be, all the pieces were there for a suc-cessful deal.”

Those pieces included a week-long roadshow, which contrasted with the RbC transaction, which was launched without having been roadshowed. “We believe investor engagement is important, but since we were issuing against a pre-exist-ing pool of prime residential mort-gages we did not feel we needed to roadshow the deal,” says Mason. “bear in mind that we have been issuing for many years and we visit

European investors on a regular basis. Other than the overlay of leg-islation, we were issuing from the same programme as we had on pre-vious transactions.”

niebrzydowski says that CIbC’s circumstances were different. “The only time we had previously issued in euros was in september 2008 under a different programme,” he says. “notwithstanding that we had remained committed to keep-ing European investors informed on developments in the Canadian mar-ket, we believed we would be having a somewhat different conversation with them, given that we were issu-ing under a new legislative frame-work and a different cover pool.”

“so we thought the right thing to do was to spend a week on the road in order to reintroduce investors to our programme,” adds niebrzydows-ki. “The one question we had was whether the middle of July would be the right time to visit investors.” Their response both to the roadshow and to the transaction itself, he says, was a clear vindication of CIbC’s decision to take to the road — even at the height of the European holi-day season.

Valuing scarce Canadian paperdemand for each was such that both approaches to the European inves-tor base were equally productive. “I think European investors are valuing non-European assets from relatively low beta jurisdictions very highly,” says anthony Tobin, head of finan-cial institutions syndicate at RbC Capital Markets in London. “Cana-

dian issuers in general are benefiting from that dynamic. The proof was in the phenomenal demand we saw for the RbC and CIbC trades, which generated some of the largest order books ever seen in the European covered bond universe.

“The australian banks have ben-efited from a similar trend. The dif-ference with the Canadians this year has been that although they’ve been able to come to the market under the new covered bond legislation that has been the driver in terms of sup-ply, issuance has still been relatively low. We’ve seen just the one transac-tion from RbC and one from CIbC transaction versus multiple issues from australia.”

The scarcity of Canadian issuance coupled with the fact that Euro-pean supply has been quite light meant that there was no danger of indigestion arising from two Cana-dian banks issuing so close to one another. “If anything I think inves-tor appetite for the CIbC deal was enhanced by the success of the RbC issue, which is quite a con-trast to other markets where one big transaction can sometimes exhaust demand for the next deal,” says Tobin.

analysts are upbeat about the out-look for covered bond issuance from Canadian banks, with scotiabank having registered its covered bond programme with the CMHC at the end of July. bMO, meanwhile, has filed a preliminary prospectus, but has still to register with the CMHC.

among other issuers, national bank is also assessing the poten-tial of re-accessing the covered bond market, although it has not yet determined the currency of issu-ance. “In the past our preference was to build a yield curve in a sin-gle currency, as we have in the Us when we issued a $1bn three year issue and a $2bn five year bond out of our CMHC-insured mortgage cov-ered bond programme,” says Girard. “because we’re not a frequent issu-er we would likely adopt the same strategy with a legislative covered bond programme.”

Tight capThe issuance capacity of the Cana-dian banks is, however, capped by the 4% encumbrance limit set by OsFI, which is low by international

Historical covered bond issuance — Canadian banks


C$bn

Historical covered bond issuance

2.81.4

17.3

24.7

15.5

7.17.0

0

5

10

15

20

25

30

2007 2008 2009 2010 2011 2012 2013

C$ Other $ €




standards. australian banks oper-ate with a limit of 8%, while in new Zealand issuance is capped at 10%. Few of the Canadian banks are close to this limit, with bMO’s research calculating that issuance capacity is over $20bn at Td, more than $16bn at scotiabank, in excess of $15bn at RbC and over $13bn at bMO.

among the largest issuers, CIbC has brushed up against the 4% issu-ance limit, with bMO’s research put-ting its capacity at a little over $3bn. “This is an efficient funding vehicle that allows banks to access a differ-ent investor base across a number of jurisdictions,” says CIbC’s niebrzy-dowski. “It is also a way of reaching investors that may not be able to buy your bonds in the senior unsecured market because of ratings restraints. Given these factors, there’s room for the Canadian issuance limit to move higher.”

With maturing issues to add to the $3bn-plus elbow room that it has for further issuance, niebrzydows-ki believes CIbC will be returning to the covered bond market in the foreseeable future. “We anticipate further issuance, but whether this is in euros or dollars will be driven not just by economics,” he says. “It will also be determined by more strate-gic considerations such as the need to reintroduce the covered bond pro-gramme in its new legislative form to investors in markets where we previously issued through the struc-tured vehicle.”

Other banks report that the 4% limit has not yet been a constraint on their issuance. “We regard cov-ered bonds as a global programme which is complementary to what we do on the senior unsecured side,” says Mason. “It gives us certain cost advantages and allows us to reach out to different investor groups, be they agency investors in the Us or central banks throughout the world. but we don’t want to over-use the product and we haven’t yet come close to the 4% limit.”

No NVCC yetIf Canadian banks contrast vividly with their European counterparts in terms of their primary market issu-ance, they also differ very markedly from many European banks in their requirements for — and attitudes towards — capital.

To date, there has been no issu-ance by Canadian banks of non-viability contingent capital (nVCC) instruments, which as bMO’s Laza-revski explains are fundamentally different from European-style con-tingent convertible (Coco) notes. “We view Cocos as high-trigger going concern instruments of the type that was issued by barclays,” he says. “We don’t think we’ll see anything like that in Canada. Instead, OsFI has been pushing for the concept of late trigger nVCC which converts into common equity at the point of non-viability.”

at RbC, Mason agrees. “There does not seem to be any obvious need in Canada for the high-strike going concern Cocos that we’ve seen in Europe,” he says.

OsFI issued its advisory on nVCC in august 2011, and as of January 1 2013 all tier one and tier two instru-ments issued by Canadian depos-it-taking institutions (dTIs) are required to comply with a number of provisions set out in the advisory.

These include conversion into equity on the occurrence of a trigger event, defined as an announcement by OsFI of non-viability or the fed-eral or provincial government that the dTI has been offered a capital injection.

analysts say that the regulator has been very clear in defining point of non-viability. “OsFI has been explic-it about the triggers for non-viabili-ty, which include loss of confidence making it difficult for banks to roll over short term funding, erosion of regulatory capital, inability to access funding and so on,” says Lazarevski.

He adds that there are a number of reasons explaining why there has yet to be any nVCC issuance in Cana-da. One of these is that with capital ratios in the Canadian banking sec-tor so strong, there is no urgent need for dTIs to raise new capital.

another, he says, is that very lit-tle detail has yet been given by the government about bail-in in Cana-da. “Until we have more clarity on the bail-in rules in Canada and the role that senior bondholders would play in the event of restructuring at POnV, it will be very difficult for investors to price nVCC,” he says.

Issuers agree that nVCC instru-ments are likely to come into the Canadian market gradually. “as we

see some of the older instruments roll off over the next few years, nVCCs will be a natural replace-ment,” says Mason.

“bail-in is coming to Canada — no question about it,” Mason adds. “but we have not seen many details yet on how it might be implement-ed. We’re supportive of it, as it is part of the global regulatory reform effort for banks. We just need to be sure that it is implemented in a sim-ilar way in Canada as it is in other markets.”

House price dangerWhile senior bondholders may not yet need to lose sleep over bail-in, bank treasury teams continue to be grilled by investors about the danger of a collapse in house prices.

“We are often asked about the housing market,” says Girard at national bank in Montreal. “We argue that the structure of the Cana-dian mortgage market is very dif-ferent to the Us, because 83% of our households have more than 25% of equity in their homes.

“With measures having been taken in 2011 and 2012 to reduce the growth in household debt and cool the housing market down, our base case is for a soft landing in the hous-ing market.”

at RbC, Mason agrees. “We think that the authorities have some very effective controls over the housing market which they have used several times, and tightening the rules has already had an impact on the trajec-tory of the market,” he says.

“We also impress upon inves-tors that we stress test our mortgage portfolio very rigorously for inter-est rates and unemployment ris-ing at the same time. We’re satisfied that even in this extreme scenario the impact on bank balance sheets would be manageable.” s

“There’s room for the Canadian

covered bond issuance limit to

move higher”

Wojtek Niebrzydowski,

CIBC

CANADIAN GOVERNMENT BONDS


At first glance, Canada’s might not be the sought-after government bond market it has been throughout much of the crisis era. the Canadi-an dollar has rocketed in value and rates in the country are low and set to remain that way. Meanwhile, the domestic sector of the economy that dragged the country so ably through the crisis, appears to be running out of steam and the export sec-tor, which will depend in great part on Us and emerging market growth for its own wellbeing, is expected to take up the slack.

But this year the Canadian Department of finance expects the average rate the country pays on its debt to fall below 2.5% despite the fact it also expects the average term to maturity of Canadian government debt to have increased by the end of its fiscal year in April 2014. those are hardly the characteristics of a market on the skids.

Although economic growth may be tapering, Canada still compares well to its advanced economy peers. that economic performance has driven central bank demand for Canadian dollar assets, particular-ly government bonds. the fact that it is cen-tral banks’ money sug-gests that it is likely to stick with the curren-cy for some time. Bank treasury demand has also risen for govern-ment debt given the Canadian banking sec-tor’s sprint to Basel iii and core assets.

But the real driver is on the supply side of the equation. Canada is committed to return-ing to a balance by 2015 and, as prime minister stephen Harper said in russia at the G20 sum-

mit in early september, a debt-to-GDP ratio of 25% by 2021.

the effect of that strategy on gov-ernment bond supply has been for a fall in the size of the programme by C$7bn to C$87bn for fiscal year 2013-2014 from the year before.

the change to net supply is even more telling. from a peak in 2009 of net issuance of C$70bn, the net supply of Canadian government bonds has shrunk to around C$10bn, according to CiBC.

short dated debt volume is also set to fall. Canada’s treasury bill stock stands at around C$200bn at the time of writing. But it is about to plummet to C$150bn by fiscal year-end in April as Canada absorbs cash from around C$40bn of mortgage assets rolling off of its books that it bought from banks in 2009 under the insured Mortgage Purchase Pro-gramme. Another C$10bn of iMPP assets are set to mature the follow-ing fiscal year.

that will extend the country’s average debt maturity profile. But Canada is also looking at other ways to achieve the same thing. it has increased, through auctions, its sale

of bonds in the 10-30 year part of the curve.

the Department of finance, which is responsible for the debt management strategy, in conjunc-tion with its fiscal agent, the Bank of Canada, has also been investigat-ing an ultra-long dated deal. the trade could come this fiscal year and would most likely be sold by syndi-cation.

Away from the Canadian dollar, investors may have new means to buy Canadian sovereign credit. the country is an infrequent visitor to international markets and as such is in hot demand when it brings a new bond issue. its last two trades were a dollar five year, sold in february 2012 and a euro deal in 2010.

the country only borrows in for-eign currencies to manage its for-eign reserves, which it aims to keep at least 3% of GDP, and to meet iMf commitments. it achieves most of this target using cross-curren-cy swaps. it issues global bonds when a cost saving versus domestic funding can be achieved. But it is exploring now the addition of medi-um term note funding to its pro-

gramme.such a programme

would mean that inves-tors desperate for Canadian sovereign paper could originate a bond through reverse enquiry rather than waiting around for a global deal in which it may suffer in the allo-cation process.

the programme would allow the bor-rower cheaper fund-ing costs and to be able to borrow closer to the exact sizes it needs to match its foreign fund-ing needs. s

After five years as the safe haven’s safe haven, the Canadian government bond market is facing up to lacklustre domestic growth, low rates and an increasing dependence on the US to boost the economy. But, as Ralph Sinclair discovers, now might not be the time to dump your Canadian govvie holdings.

Canadian govvies set to perform despite tough times ahead

Holdings of Canadian government bonds

Source: Department of Finance, Canada

Monetary authorities

Government

Chartered banks and quasi-banks

Insurance and pensions funds

Other private inancial

institutions

Persons and unincorporated

business

Non-financial corporations

Non-residents

0

10

20

30

40

50

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02-03 03-04 04-05 05-06 06-07 07-08 08-09 09-10 10-11 11-12 12-13

Provinces And crown corPorAtions


For international inves-tors, Canada’s public sector bor-rowers remain a sought-after but elusive bunch. the appeal is not difficult to spot — a group of high-ly rated borrowers from a country that, almost alone in the Western world, has had a good financial cri-sis. But access to Canada’s crown corporation and provincial debt remains a problem for internation-al investors given the way the sec-tor tends to raise bond funding.

Canada’s provinces — from aa2/a+/nr (Moody’s/standard & Poor’s/Fitch) rated Quebec, nova scotia, new Brunswick, and newfoundland and labrador up to aaa/aaa/aaa rated British Columbia — are all aim-ing for a return to fiscal balance.

that sort of good borrower behav-iour and the benefit of the Canadian halo effect that has beamed down from the safe haven sovereign has drawn international investors into the Canadian provincial bond mar-ket. “international investors appre-ciate that long history of the prov-inces recognising that they need to tackle deficits before demographic pressures come to bear,” says Warren lovely, head government strategist at CiBC.

the most problematic of these markets for investors to enter has been the domestic market, where the provinces raise the bulk of their funding. new provincial bond issues tend to be bought deals, launched and priced in a very short space of time. With the amount of domes-tic provincial issuance falling from its 2010 peak of around C$100bn ($96bn) to C$72bn in fiscal year 2012-13 to C$70bn this fiscal year, the problem of getting hold of the bonds in the primary market is growing ever more acute.

For many international buyers the deal windows, which last a couple of minutes rather than hours, are too

short and take place in the wrong time zone for them to participate. that has kept investors restricted to the sovereign market where pri-mary access is easier, the sovereign-guaranteed Canada Mortgage Bond (CMB) market and the liquid second-ary market for provincial debt.

Growing interestWith a strong domestic bid, the prov-inces have not needed to court inter-national buyers to participate in their Canadian dollar programmes. nonetheless, international buyers are keen to enter the market, says Mark Chandler, managing director in global research at rBC Capital Mar-kets.

“When we go out on the road to see investors, we’re being asked a lot more questions about high grade Canadian provincial and agency products,” he says. “Given the deple-tion of triple-a rated assets around the globe, some of them view Canada as not just an opportunistic measure for a financial crisis, but a market they’re planning to stay in.”

international investors have found two ways around the problem of gaining access to the primary domes-tic market for provincial bonds, prin-cipally those of British Columbia, ontario and Quebec — the three big-gest provincial borrowers. the first is simply setting up a trading desk in the right time zone, typically one in

new York, or using existing Us trad-ing desks as a springboard into Cana-dian markets.

the second has been the use of carve-outs with the Canadian inter-mediary banks that underwrite Canadian provincial deals. Canadian provinces have tried to capture spe-cific large ticket interest — some of it from overseas — with carve-outs of their domestic issuance since 2011, managing about C$16bn worth since they were begun in 2011.

Carve-outs are, in effect, protected orders, only on bought rather than book-built deals. a province will guarantee a certain amount of bonds to a dealer in the syndicate leaving the rest of the issue to be underwrit-ten in the normal way, allowing the underwriter in question more time to engage the overseas or large domes-tic buyer.

What a carve-outthe carve-out system has been use-ful in particular to larger borrow-ers such as ontario which are more often engaged with international investors and can use the carve–outs to track their activity.

ontario and Quebec are the two largest provincial borrowers. ontar-io’s borrowing programme has fall-en by C$5.7bn to C$33.4bn since it was set in March 2012 for fiscal year 2013-14. By august 28 it had raised C$15.4bn — about 5% ahead of where it anticipated it would be at that point. the province has sold more bonds domestically — about 83% of it programme — than it normally does (around 78%).

Quebec is further advanced, hav-ing raised C$9.5bn of its C$11.7bn programme for the fiscal year. With such large programmes, both prov-inces have led their sector’s efforts to sell debt to international investors.

Quebec has been an international borrower since 1879 when it became,

Canada’s provinces and crown corporations, like their sovereign, have been inundated with investor interest from overseas since the financial crisis began. As the Canadian economy grew, so did international Canadian dollar portfolios. Ralph Sinclair discovers that cash is attempting to reach ever further into the Canadian public sector.

International investors in search of Canadian opportunities

“There is a strong international

following for CMBs. We continue to

educate new investors in the

programme”

Warren Lovely, CIBC


Canada in the Global Markeplace | September 2013 | EUROWEEK 33

according to the New York Even-ing Post, the first foreign borrower on Wall street. it has been borrow-ing in european currencies since the 1960s, most recently issuing an oversubscribed €1bn 2.25% July 2023 bond earlier in the summer. ontar-io’s most recent international sale came six days later on July 16 — a $2.5bn three year deal that attracted a $3.4bn book.

the international buyer base offers Canadian provinces a chance to reach a more diverse range of buyers and a bigger pool of liquidity.

But, for all the new portfolios of Canadian dollars that have been built internationally in recent years, there are still swathes of investors, particularly in the Us, who have no means or intention of buying Cana-dian dollar-denominated securities, but have every will to expose them-selves to Canadian credit.

“Us investors can make up to three quarters of an order book for a dollar deal from a Canadian prov-ince,” says Paul Hadlow, managing director and head of Us debt capital markets at CiBC. “Central banks and bank treasuries tend to buy the three and five year deals, with asset man-agers more prevalent in longer dated trades.”

in addition to the traditional asian central banks and Us asset manag-ers, Canadian public sector bankers say they are now seeing increased interest from supranationals and latin american central banks in Canadian provincial dollar debt.

in turn, Canadian borrowers can use this demand to drive down their borrowing costs or relieve pressure on the domestic borrow-ing programmes.

the biggest market for Canadi-an provinces is by far and away the Us dollar market, with Us buyers the main source of demand. the Us remains the first and most fre-quent port of call on Canadian bor-rowers’ roadshow schedules.

But there is also growing inter-est from outside of Canada’s nearest neighbour and biggest trading part-ner. Quebec’s euro deal testifies to the interest in europe for Canadian provinces. Meanwhile, asian central banks have been long time buyers of Canadian province dollar deals.

Diverse marketsand their interest is not restricted to american dollars. in early sep-tember Manitoba became the latest Canadian province to tap the Kan-garoo market, bringing a a$100m 10 year trade although that remains the only province deal outside of Us or Canadian dollar markets, with the exception of Quebec’s euro bench-mark, since July 2012 when Mani-toba did another 10 year Kangaroo, that time for a$200m.

Manitoba is also a province with a medium term note programme. the borrower, which by early octo-ber had raised just over half of its C$4.8bn programme for the fiscal year, uses private placements and floating rate notes to augment its

visits to the dol-lar benchmark market and its domestic fund-ing. the deals offer reverse enquiry buy-ers a chance to buy Manitoba paper in smaller size on a one-off basis.

senior Cana-dian public sec-tor bankers say that Mtn pro-grammes have proliferated throughout the market in recent years. “if an investor comes

in looking for say, an eight year bond, borrowers will look at that now,” says one toronto-based head of government finance. “in the past they wouldn’t have been interested but now they realise they can drive some price tension that way. they realise that when an investor comes to them, they have the power.”

export Development Canada (eDC), bearing the explicit, irrevo-cable and full faith and credit obli-gation of Canada, remains the one way to buy Canadian sovereign risk in international markets away from the sovereign’s once-in-a-blue-moon appearances in dollar or euro bench-mark markets.

the country’s export financing agency is also a borrower with a pro-gramme that is set to grow if fore-casts for the Canadian economy bear out. With domestic demand sag-ging, Canada’s growth is likely to be export-led in the coming years, in particular with exports to its big-gest trading partner the Us on the increase if the Us economy contin-ues to grow. (See interview with Cen-tral Bank Governor Stephen Poloz on page 18).

that will mean a greater demand on eDC’s services. With Canadian banks’ lending conditions still some-what tighter than the pre-crisis lev-els, there is even bigger reason to suspect that eDC will need to be in the markets more often or in bigger size in future.

Currency rangethe agency has a borrowing pro-gramme for 2013 similar to last year’s which started at Us$6.5bn-$7bn and grew to $8bn. it has gone about meeting that target in a range of currencies. so far this year it has issued bonds in Chilean pesos, new Zealand dollars in the Kauri market, australian dollars, norwegian kro-

“US investors can make up to three

quarters of an order book for a

dollar deal from a Canadian province”

Paul Hadlow, CIBC

Canadian provincial funding, fiscal year 2013-14

Source: SSA Markets

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

Alberta

British

Colu

mbia

Manito

ba

New Bru

nswick

Nova Scotia

Ontario

Québec

Saskatc

hewan

CS$ bn Remaining Completed



ner, sterling, turkish lira and made its debut in offshore Chinese ren-minbi.

the dim sum trade, a CnH100m 2.1% July 2014 bond done in July, was unlike many of eDC’s interna-tional offerings.

“our first dim sum bond was investor specific,” says Chad Buf-fel, eDC’s senior portfolio man-ager. “as it is a new market for us, we are assessing our requirements and what we can provide. We don’t want to create expectation and then not deliver.”

that cautious approach is in char-acter with eDC’s approach in gen-eral. the agency only tends to enter markets when it knows it can main-tain a long term strategic presence.

“We have needs in all currencies but our bond deals aren’t linked to specific projects,” says Buffel. “they are strategic markets for us. We want to be in the market when the inves-tors are there. it might be more costly but we’d rather have inves-tor demand so that the product per-forms.”

eDC aims to be adaptable to mar-ket conditions. But that does not just apply to non-dollar markets. the borrower was happy to issue short-dated dollar floating rate notes this year because investors clamoured for them.

it avoided big deals in the format as most of the trades done had a two year maturity whereas eDC looks for three or five year deals, typically. But it was still quick to tap demand when it arose.

“that’s the point of investor rela-tions work,” says eDC’s vice presi-dent and treasurer, susan love. “it is not just to tell them about your credit but to find out what investors need and to be open to their ideas.”

eDC says it has seen greater inter-est from the Us as government sponsored enterprise issuance has declined.

another new market that eDC is monitoring is the socially responsi-ble investment (sri) market through themed bonds. With a lending port-folio as diverse as eDC’s it must review its own portfolio to see if a green bond would suit the sort of assets it has.

“our lending side promotes on the clean technology sector and any-thing environmentally or socially

responsible,” says love. “so it makes sense that treasury looks at ways to support those sorts of efforts.”

Mortgage-backedthe other large presence in the Canadian public sector debt mar-ket is that of the Canada Mortgage and Housing Corporation (CMHC). it issues Canada Mortgage Bonds (CMBs) through a special purpose trust, the Canada Housing trust (CHt). the bonds are guaranteed by CMHC and backed by the Canadian sovereign.

CHt pools mortgages packaged into national Housing act Mort-gage-Backed securities (nHaMBs) from a list of approved mortgage sellers, which it then repackages into CMBs — bullet maturity bonds paying fixed semi-annual interest in either five or 10 year maturities, and floating rate notes.

CMHC issues and guarantees around C$40bn of CMBs every year through the CHt — a volume it does not expect to change anytime soon. around 25% of the programme is sold internationally.

But there is growing interest in the market. “there is a strong inter-national following for CMBs,” says CiBC’s lovely. “We continue to educate new investors in the pro-gramme.”

analysts predict that with yields and supply falling in the govern-ment bond market, the CMB market could be set to become a govern-ment bond proxy as investors search in new places for yield.

that is reckoned to be a far more important factor for the CMB mar-ket than either the prospects of a housing bubble in Canada, which Canadian bankers and CMHC say are overdone, or the recent cap on the amount of guarantees CMHC can provide on nHaMBs products.

“the amount guaranteed under the CMB programme is separate and distinct from the national Hous-ing act Mortgage-Backed securi-ties guarantees,” says Mark Chamie, CMHC’s treasurer. “the market for nHaMBs has an C$85bn volume limit for 2013 and that limit has no impact on our ability or willing-ness to provide guarantees on CMB issues.”

Drill down for yieldaway from the big issuers, the hunt for credit quality combined with yield continues. senior Canadian public sector bankers say that inter-national investors are drilling down beyond the provincial and crown corporation level to find every last source of Canadian public sector credit.

“We’re seeing international inves-tors coming in for triple-a rated municipalities,” says one senior toronto-based ssa banker. “We have not seen them there before and they show up wanting to take C$25m tick-ets. that’s a big ticket in those mar-kets.”

Bankers say that is a direct result of growing international Canadian dollar investment portfolios. once overseas investors have grown accus-tomed to the government bond mar-ket and as its yield levels fall, they are sacrificing a degree of liquidity by looking into smaller markets such as municipal bonds.

“We used to go to asia and it was strictly corporate bond chatter,” says one senior Canadian public sector banker. “now we take along our cor-porate analyst and talk about lots of other products that are available to them now they have a dedicated portfolio in Canada. these portfolios appear to be sticky.”

Whether those pools of cash remain in Canadian dollars and continue to find new havens ever deeper in the Canadian public sector remains to be seen.

a great deal is riding upon Can-ada’s economic growth, which is expected to be export-led in the years to come with the domestic trend set to be sluggish. But the Canadian public sector is wedded to the idea of fiscal balance which will keep bond supply suppressed and an already rare group of credits in international markets rarer still. s

“Our lending side promotes on the clean technology

sector and anything environmentally or

socially responsible”

Susan Love, EDC

EUrOWEEK



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36 EuroWeek Canada in the Global Marketplace

Public Sector Issuers Roundtable

EUROWEEK: Splashed all over this morning’s edition of the Globe and Mail was perilous news of Canada’s household indebtedness. There’s been debate recently about domestic stagnation, a housing bubble, commodity prices have been on something of a recent slide. Should we be worried about the Canadian economy?

Warren Lovely, CIBC: We have seen the Canadian economy lose some momentum in general terms but also due to some specific shocks that we certainly wouldn’t expect to see repeated.

From a public finance perspective, the more muted tone to growth is something to watch going forward.

You will see governments acknowledge a slightly

tamer growth backdrop as we move through the year. We still hold out hope that we will see an important global reacceleration into next year and 2015, which would provide some significant fiscal upside for public sector issuers in this country.

Jeremy Rudin, Department of Finance: In terms of the economic prospects, we are just beginning the process of updating the forecast. The quarterly GDP numbers will be coming soon and then as usual, we’ll update our fiscal projections, based on the average economic outlook that we take from a group of private sector forecasters.

In the short term, it’ll be interesting to see how individual forecasters interpret the data because we

Participants in the roundtable were:

Grant Berry, managing director, RBC CM

Mark Chamie, treasurer, Canada Mortgage Housing Corporation

Mark Hadden, managing director, head of government finance, Scotiabank

Andrew Hainsworth, managing director, debt capital markets, BMO

Susan Love, vice president and treasurer, Export Development Canada

Warren Lovely, executive director, head government strategist, CIBC

Mike Manning, executive director, capital markets, Province of Ontario

Jeremy Rudin, assistant deputy minister, Department of Finance

Jason Stewart, managing director and head of government finance, National Bank Financial

Garry Steski, director of capital markets, Province of Manitoba

Bernard Turgeon, associate deputy minister, Province of Quebec

Ralph Sinclair, SSA markets editor, EuroWeek

Safe-haven credits adapt to new life after crisis

Canada, its crown corporations and provinces have proved sought-after safe-haven assets for investors during the crisis era. Central banks have re-allocated assets to invest in the currency and Canada’s bond markets, underscoring the growth of the country’s economic importance. With bond supply set to fall as Canada and its provinces aim to return to a balanced budget by 2015 and a debt-to-GDP ratio of 25% by 2021, the outlook for Canadian public sector borrowers appears rosy.

But all is not a picture of robust health in the Canadian economy. Domestic demand has started to sag, wages are stagnant and there are fears of a housing bubble. EuroWeek met in Toronto with senior Canadian public sector debt figures to discuss the extent to which these problems can harm Canada’s run of form, what positive factors there are to look forward to from outside the country and the outlook for their market.

Canada in the Global Marketplace EuroWeek 37


know that in June there were some special factors — flooding, strikes — that weighed on growth in the last quarter. However, we anticipate some bounce back from this in the third quarter.

From a fiscal policy point of view, we have a robust fiscal planning process and a very strong commitment to return to budget balance in 2015. We also build prudence into the economic forecast that underlies the fiscal projections.

That is of much greater importance from an investor point of view, much more so than short term fluctuations.

EUROWEEK: Are any of the dealers around the table fielding tough questions from investors about the Canadian economy?

Mark Hadden, Scotiabank: One of the more frequent questions we field from international investors are related to the housing market — first, how that’s going to impact the Canadian Mortgage Bond (CMB) programme and then second of all, how it’s going to impact the provinces if we do see a housing slowdown, especially the possible effects on borrowing programmes.

Jason Stewart, National Bank Financial: There are two other reasons why we are continuing to see inflows of foreign money into Canada from international portfolios.

The first is the much greater exposure of the Canadian economy to the United States, which is a huge advantage in both the near term and the medium term with the US’s economic prospects. The second reason is the dwindling number of triple-A and robust double-A rated issuers worldwide.

Both on a relative basis and absolute basis, Canada continues to stand out as do the provinces and the federal crown corporations.

Grant Berry, RBC CM: There’s no question that we’re closely tied to the US and so clearly our situation’s very similar. Despite all the economic forecasts, the Canadian markets continue to be in very good shape.

Over the last couple of days we’ve seen very well taken-up transactions. The transparency offered in the Canadian bond market is key to what we’re doing in this market place. We will not suffer any more than in the US.

Andrew Hainsworth, BMO: We’re perhaps a little bit more bullish than some others on the US’s growth prospects over the next couple of quarters, but it is a rising tide that is going to lift a number of boats, including Canada’s.

We will have a little stronger US growth than Canadian growth over the next couple of quarters.

But the fears of the housing market bubble — if you want to call it that — in Canada have been very much overstated. Our economists are fairly comfortable that household formation and demand for housing show that the market’s in pretty good shape. There are excesses in certain pockets but overall, housing is in balance and the economy’s in OK shape. It’s not robust, but it’s OK.

EUROWEEK: What’s Canada Mortgage Housing Corporation’s take on the housing bubble?

Mark Chamie, CMHC: From CMHC’s perspective, overall we find the demographic and economic factors that everyone has spoken about remain supportive for the housing market in Canada overall.

We also include into that the expectations for continued economic growth and high net levels of immigration. We think all of that is in line with historical standards and is supportive for the housing market.

So we don’t necessarily see it as a bubble within Canada. We think that the market is well supported from a fundamental standpoint and we’re not expecting any drastic changes to it overall and this conclusion is supported by the OECD.

Lovely, CIBC: There’s a misguided tendency on the part of some international investors to project a US-style housing correction on to Canada.

We’ve examined housing risks from every conceivable angle at CIBC. A lot of other analysts have likewise tackled this issue and concluded that the two housing markets are fundamentally different. Moreover, the government response to the markets has also been very different.

The federal government in particular has taken some very proactive steps in Canada to help ensure the long term sustainability of the housing market and to prevent a US-style correction — or crash — from settling down on our shores.

We continue to educate investors and, as Mark points out, the state of the housing sector continues to be the topic of the first, second, and third questions you tend to get from international investors. But we’re pretty comfortable that due to some good policy action and governmental response, as well as Canadians taking a more cautious stance going forward, that we will prevent a more dire outcome from arriving.

EUROWEEK: Mark, since we’re talking about housing, CMHC has now a cap on the amount of mortgages that it will guarantee. Will have any impact on your yield curve or supply?

Chamie, CMHC: The short answer to your question is no.

The amount guaranteed under the CMB programme is separate and distinct from the market National Housing Act Mortgage-Backed Securities (NHAMBS) guarantees that you’re speaking of.

Mark Hadden,Scotiabank



The NHAMBS market has an C$85bn volume limit for 2013 and that limit has no impact on our ability or willingness to provide guarantees on CMB issues.

We’ve been issuing and guaranteeing approximately C$40bn of CMBs per year over the last few years and our expectation for 2013 is that we won’t deviate significantly from that.

EUROWEEK: And what is the outlook for the other borrowers’ funding programmes over the coming year? Mike Manning, Ontario: Ours has been moving along relatively well. We have a requirement of about C$33.4bn of which we have raised C$15.4bn as August 28 — so that’s about 46.2% of our programme that’s now completed, which is about 5.1% ahead of pace. We’re happy with that because we’ve been a little bit behind pace for most of the year.

But this year’s programme has had very much a domestic flavour with about 83% of our bonds sold domestically. We had targeted doing at least 70%.

The average over the last 10 years is about 73% so that 83% is a bit on the high side. We think it’s going to come down, and we think we are likely going to be accessing the US market sometime in the autumn, possibly as early as September.

We’ve been very fortunate that the demand for our bonds has remained very strong.

We’re in a bear market in terms of interest rates but our average term of debt is about 14.2 years. For us that’s quite high. Our average last year was about 12.4 years. For the last three years we’ve been extending term — 13 years, which we reached the year before last, was the longest we’d had until now.

We think that reflects the fact we’re seeing good demand but it also gives us the flexibility later on in the year to move down the yield curve where we can achieve lower funding costs.

And in terms of our requirements this year, we’re very pleased that the C$33.4bn that we’re borrowing is C$5.7bn less than the amount we thought we would need when we published the budget in March 2012. Our short term borrowing requirement is C$1.5bn less than we thought it would be in March too.

Bernard Turgeon, Quebec: This year we have a C$11.7bn programme. More than 80% is now completed. We have raised C$9.5bn so far. That means

that a further C$2.2bn remains to be borrowed, and we have seven months to do that.

The markets have been very good to us. We did a euro deal last July for €1bn and had 79 investors in an oversubscribed order book.

Investors like the fact that Canadian provinces and the federal government have plans to go back to budget balance and put public finances back in order.

Garry Steski, Manitoba: Our borrowing programme for the current fiscal year was announced at just under C$4.8bn. We’re slightly over 50% done. Our programme is really separated into two parts — the province’s needs and those of Manitoba Hydro, our hydroelectric utility, which requires a significant amount of borrowing.

Manitoba Hydro is undertaking a huge capital expansion for both transmission and generation and so their needs are fluctuating. That has left us a little bit further behind than what we would normally want, but there’s also some uncertainty as to how quickly those projects are going to proceed. We would expect for next year the programme will be around the same amount.

We did a US dollar global issue at the start of the year. We like to get into the US dollar global markets at least once a year and more often if the opportunity presents itself.

Chamie, CMHC: We’re on track to raise approximately C$40bn by year end if we continue at the exact same speed that we’re issuing right now. We’ll probably be C$1bn-C$1.5bn short of that maybe, but that’s why I always say it’s approximately C$40bn a year. It depends on the interest from mortgage originators and investors at the time that we’re issuing.

We tend to balance our issuance overall based on the demands of both sides. We do the same for our product mix as well because we issue both five and 10 year fixed rate issues as well as floating rate issues which have historically been offered on a quarterly basis. We try to rightsize those issues to balance the needs of both sides of the funding equation.

Susan Love, Export Development Canada: EDC’s story this year is similar to last, where we started out thinking we would borrow somewhere between $6bn-$7.5bn in 2012 and we saw our needs increase so that we borrowed just over $9bn in the end.

This year we started again expecting to raise $6bn-$7bn and we’re now forecasting needs of just over $8.2bn.

To date we’ve borrowed $5.5bn, so over 65% has been done. We’re well on track.

Given the markets this year, we’ve had to be flexible in terms of what we’ve done and in fact, we just recently issued our first syndicated floating rate note. The debate about the tapering of quantitative easing and potential rate hikes in the US means investors have been looking for shorter term money that’s floating rate in nature.

So EDC adjusted its strategy and we issued a floating rate note in the two year sector which isn’t as typical trade for us.

In these types of market conditions, it’s important to be flexible. Given the continued uncertainty, issuance windows are not open as widely as they have been

Mike Manning,ontario



in the past, so you must make sure that you’re aware of the environment and enter the markets with the appropriate product tailored to the investors at the right time.

EUROWEEK: EDC is probably the Canadian borrower with the most natural need to be in a variety of different markets. Are there any that you anticipate entering into in the short to medium term? And other than the floating rate note you sold, are there deals that you’ve done so far this year that were new and innovative for you?

Love, EDC: We did our first Dim Sum bond, a bond that was issued to investors in Hong Kong in Chinese renminbi.

We had been exploring the idea for about a year and a half. We put the documentation in place which allowed us to access the market when the timing was right. It was a very successful transaction, and we were pleased to be able to do it. On the heels of that, we will be visiting with investors in Hong Kong in a couple of weeks’ time. We will continue to follow market developments in this area and look to explore other markets in a similar way. As well, EDC has a number of assets that would be qualified as environmentally friendly or socially responsible. We are examining those assets and will look to potentially issue a Green Bond based on those assets in the future. That would be something new for us and would respond to the growing demand for socially responsible investments.

EUROWEEK: Bernard, you mentioned Quebec’s euro deal earlier. Can you talk to us a bit about what motivated that and how you found the experience?

Turgeon, Quebec: Quebec has traditionally been a borrower on foreign markets. Our first borrowing on the US market was done in 1879. We were the first foreign borrower on Wall Street, according to the New York Evening Post of that time.

In European currencies, Quebec has been borrowing since the 1960s, so it’s natural for us to be on the euro market.

Our first deal on the euro market was a private deal made 11 days after the currency was created in 1999. We did our first benchmark issue in June 2001 and have done six benchmark issues since then. The European market is a huge market and investors there

want to buy Quebec paper. We monitor conditions on a continuous basis and

this summer, after having done a non-deal roadshow in June in Europe, we concluded that the time was right to do a bond issue.

The transaction was a huge success with a large number of high quality investors taking part.

We are very glad to have done it. We had not done any deal on the euro market since 2009, so it was a long period between the two deals.

EUROWEEK: Canada has also issued euro denominated bonds but not since 2011. Is Quebec’s success the kind of thing to whet the sovereign’s appetite for more euro issuance? Rudin, Department of Finance: We issue in foreign currencies to fund our foreign reserve programme, otherwise we issue for general government purposes in Canadian dollars only.

We use a mix of foreign currency funding sources and we have emphasised trying to diversify our funding sources over time.

Cross-currency swaps are still the most important source, but in recent years we have also returned to the global bond market — once in euros, and most recently in US dollars.

As set out in the Debt Management Strategy, released as part of the budget in March, we have an interest in potentially going back into the global market. Not only will it provide a certain diversification of funding sources, it also sidesteps the counterparty risk which still exists to some extent in the swap book.

But the economics have to be there to justify a deal and so it remains to be seen when, and in what currency, we might consider issuing.

That said, we are, for this year, planning on getting back into the medium term note market. Investors will have an opportunity through a reverse enquiry process, to show their interest in Canada and get an investment that is tailored to their needs. Issuance of medium term notes is a good tool for us because it can help us to manage the matched funding of our foreign currency assets, avoiding some of the lumpiness that’s involved with issuing global bonds.

We’ll be starting that off in our typically prudent Canadian manner, but we do expect that that will be a success and we’ll be speaking to dealers about it in the near future.

Bernard Turgeon,Quebec

Susan Love,export Development canaDa



EUROWEEK: What sort of volume do you anticipate that could bring?

Rudin, Department of Finance: Well as I said, we’ll start out modestly and based on experience and we’ll have more to say about potential volumes, I presume, in the upcoming Debt Management Strategy.

EUROWEEK: So it’s a case of toes in the water first?

Rudin, Department of Finance: Yes. With respect to domestic issuance, our stakeholders know that our general approach is to release the Debt Management Strategy with the federal budget shortly before the beginning of the fiscal year, and that we rely on a planned, regular, and transparent issuance schedule.That makes it quite predictable and we’re certainly tracking quite close to the Debt Management Strategy we set out in March of this year.

Generally speaking, our financing requirements are down, partly because of our improvement on the fiscal track but also because of the maturing over the coming months of most of the assets that were purchased during the financial crisis under the Insured Mortgage Purchase Programme (IMPP).

As a result, our planned bond issuance for this year is about C$87bn. That’s down from the previous year and certainly down from the peak during the financial crisis. The treasury bill stock is projected to decline from about C$190bn now down to about C$150bn at the end of the year. Much of this impact is the maturing of the IMPP assets.

We have also adopted the practice of reassessing the bond programme over the course of the year to see if we need to make a material adjustment to the programme.

If we do make an adjustment we announce it.This has given us the opportunity to be more

nimble, rather than being locked into a rigid annual plan even as circumstances change. At the same time, it doesn’t seem to have undermined our reputation for predictability and transparency. I’d argue it has enhanced it.

EUROWEEK: And the Canadian sovereign is also interested in an ultra-long deal. Whereabouts is that project?

Rudin, Department of Finance: We made it explicit in the Debt Management Strategy that that is something that we would consider and we’ve been looking at it quite actively and discussing it with market participants. No decision has been made at this point.

EUROWEEK: So it may come this financial year?

Rudin, Department of Finance: It remains an option.

EUROWEEK: What do the dealers think are the opportunities for Canadian public sector borrowers in international markets?

Berry, RBC: International markets have always been a important portion of Canadian public sector borrowing programmes, accounting for about 20%-25% of total borrowing. Over the years the percentage has varied with the provinces issuing in Canadian dollars and US

dollars, followed by euros, Swiss francs and sterling. Of course, cost is always a factor when borrowing

abroad. Sometime borrowers focus only on cost while others execute these trades as investments to broaden the basket of investors they can access.

Sterling and Australian dollars are open to Canadian issuers — those are the more opportunistic markets.

Stewart, NBF: The sheer growth in central bank buying of provincial or domestic issues has been quite staggering.

We are dealing with six to seven times as many central banks as we were three years ago. A growing number are looking to buy Canadian dollars.

Every borrower around this table has the option to do all of its funding in Canadian dollars, with the exception of EDC.

International investors will participate either in Canadian or US dollars as well as a range of other currencies. Canadian borrowers’ fiscal strengths and their disciplined approach have given them much more flexibility.

Hadden, Scotiabank: International investors still hold a positive view of the Canadian provinces from a credit perspective, especially given the strong fundamentals and sound financial system.

From an issuance standpoint, although it’s a little more challenging to fund cost effectively in markets such as Australian dollars and sterling, it certainly seems like US dollars continues to be a focal point. The US market provides a great opportunity to broaden exposure to international investors (away from and in the North American region) while in some cases achieving a more reasonable cost of funds when compared to the domestic market.

Hainsworth, BMO: The US dollar market certainly represents a very large liquid transparent market for Canadian provinces. It’s a great safety valve, especially for some of the larger provinces whose financing programmes are almost a bit too large for the domestic market to accommodate in a cost-effective manner.

Ontario has a flexible approach about how much of its borrowing gets done in Canada while wanting to keep a core presence in the US dollar market.

I think euros has probably been a little bit disappointing in general for provinces over the last decade. They used to be quite active issuers, in

Jason Stewart,nbF



Deutschmarks and French francs and so on. It would be nice to see that market broaden its

appeal and I think certainly there’s demand for provinces, as Quebec has demonstrated.

Sometimes the challenge for a number of provinces is just the cost effectiveness of that market, especially with some of the cross-currency swaps involved in those trades. They can be capital intensive.

EUROWEEK: Can Canadian public sector borrowers serve an international investor base in Canadian dollars just as well as they can in foreign currency markets?

Hainsworth, BMO: Yes and no. There are a lot of investors who are still not active in the Canadian dollar market. A number would still like to see provinces more in the US dollar market than they would in Canadian dollars.

Also sometimes the issuance style of provinces in the Canadian domestic market can work against international distribution. Canada has a very unique approach for provincial financing in terms of bought deals that are launched, priced and distributed very quickly.

CMBs, for example, are a much easier way for international investors to participate. They leave a 24 hour window typically between launch and pricing — more like a global bond.

It’s not to say either approach is better or worse, it’s just they have different implications in terms of investor distribution and appeal.

Berry, CIBC: That being said we have seen some innovations in the Canadian domestic market over the past two years in terms of trying to accommodate large investors offshore. The additions benefit both investors and issues alike.

Lovely, CIBC: My read of the investor demand and bond supply fundamentals leaves me overwhelmingly constructive on the Canadian public sector. We’ve talked about the greater breadth of investor participation but what I continue to find most striking and I think is an underappreciated element is that the net supply is in decline. And that’s really the key consideration here.

Canada’s governments are increasingly borrowing to refinance maturing debt. If you control for this

and examine the net supply of bonds brought to the market, you’ll find that while we’re not quite in an entirely scarce environment, net bond supply is dwindling. That makes for a very constructive picture — strong, broader demand against a more constrained supply outlook.

Hainsworth, BMO: One other source of demand for Canadian public sector issuers has been financial institution treasuries, especially Canadiana banks in Canadian dollars.

In the last couple of years with the demand for banks to hold more tier one assets, we’ve seen bank treasuries, in particular, much more active as a source of demand. It mirrors what’s been happening globally.

EUROWEEK: Garry, has that matched your experience?

Steski, Manitoba: Yes. We completed an investor relations trip to Asia in early March and met with several investors in Seoul and Beijing, and a lot of the conversations turned to Canadian dollar issuance and the process of issuing Canadian dollar bonds.

The deals are put together and distributed very quickly and the fact is that international investors can’t react as quickly as what they would like to that process.

We were surprised at the amount of discussion around Canadian dollar issuance while we were over there.

EUROWEEK: Have you done anything to make your Canadian dollar deals more accessible to international borrowers?

Steski, Manitoba: The public issuance process is what the public issuance process is going to be in Canada for the time being. It’s not a book-building type of process for the Canadian provinces and international buyers would rather participate in some of these larger transactions but they happen so quickly.

Having said that, we do an awful lot of MTNs and FRNs as well, which are one-off, smaller, reverse enquiry type transactions, so those options are also available to investors.

Stewart, NBF: The other aspect to highlight is that a number of Asian and European central banks now have offices in New York and that has changed their accessibility.

Andrew Hainsworth,bmo

Garry Steski,manitoba



It is facilitating their participation, but it is moving far beyond just central banks as well.

The number of institutions in the Canadian and Australian dollar markets has risen now that those currencies are a focus for international monetrary reserves for various countries around the globe and are now being tracked by the IMF.

So Canadian dollar issuance is pretty powerful for Canadian borrowers.

That being said, US dollars continue to bring a whole range of US-based investors who just do not purchase Canadian dollars yet, as well as a number of offshore investors.

EUROWEEK: Those Canadian dollar investment funds then are presumably quite sticky if they’re central bank funds. They’re not likely to just shut up shop and vanish back into whatever they were invested in before.

Stewart, NBF: There are different investment management styles among the central banks.I think there has been a net positive inflow into Canadian dollars but some central banks are active managers and others make adjustments less frequently in terms of their index, whether it’s monthly, bi-monthly, or quarterly.

There are a range of styles, but an increasing number of active investors.

EUROWEEK: And do you see that money sticking in Canadian dollars?

Berry, RBC: Well, it’s very different than it was back in 1990 when we had a lot of hedge funds in play, and we had public sector money from Germany, France and Dublin coming into Canada. The buying of unrated public sector bonds was good value.

With the meltdown of course, that all unwound — in 2009 that all changed.

We came into a new situation where the number of central banks buying these bonds went from probably five to 20 very, very quickly, and they have been high quality investors. However, as Jason has said, the investment styles do change.

But the desire to get into Canadian markets is still there and I think the combination of more access, more information and a continued view of Canada as a good place to be, is unlikely to go away any time soon.

Hadden, Scotiabank: Global investors see much better transparency in terms of borrowing intentions from our public sector issuers. The deeper liquidity pool has been a strong positive as well, especially as investors look to manoeuvre through entry and exit points for very large, concentrated positions.

The depth of liquidity has also been a benefit for issuers too. As secondary product moves fluently there hasn’t been much disruption to available windows for issuers looking to access the primary markets. We’ve found international funds have been more comfortable operating in this type of environment.

EUROWEEK: What are investors demanding more of from Canadian borrowers, especially in terms of instruments, and the sort of contact they have? Susan, EDC has a very international investor base. What are they telling you?

Love, EDC: They’re interested in the Canadian economy and what’s happening in terms of growth. Naturally, as an export credit agency, investors ask us about Canada’s exports. As well, they are focused on Canada’s level of debt and the impact that at US recession would have on Canada.

They’re very concerned about the Canadian housing market and whether or not there’s a housing bubble in Canada.

In terms of products, investors are asking for simpler ones than they wanted before the crisis when structured products were more popular. They want instruments that they can understand and explain.

Given the volatility in the markets right now and the uncertainty with respect to US interest rates, many investors are looking for shorter term products as there’s less risk in terms of what they might lose if interest rates go up — hence why EDC did their short dated floating rate note.

When there’s more certainty about where rates are going we’ll see investors moving out further on the yield curve, five years and beyond.

Manning, Ontario: Our philosophy is when we’re issuing in foreign markets, we have a responsibility to keep those investors informed about what’s happening. For example, we did $9.75bn in US dollar deals last year, right across the yield curve. We did three years, five years, a seven year deal, and a 10 year deal.Standards are getting higher. Investors are getting a better understanding of Canada and the provinces, and they like the fact that people do take the time to meet with them personally.

The demand for investor relations remains high and the standards are getting higher as well in terms of the amount and quality of information we provide.

Turgeon, Quebec: What strikes me with foreign investors is that, in addition to the fact that they want to understand what is going on in Canada, Ontario and Quebec and so on, they want liquidity.

They want to be able to have access to the market — to get in and out. For the larger investors, this is their first priority and the provincial bond market in Canada is very liquid. The dealers do what is necessary to achieve that, and that’s why foreign investors are coming to Canada and they will continue coming into the Canadian market.

Grant Berry,rbc cm



Love, EDC: Investors also like to see the sustainability of a programme because, with the amount of work they have to do in order to get a credit approval, it’s preferable if the issuer plans to access the market on a regular basis.

So if you are going into, say, the Kangaroo market, as EDC has, it isn’t just for one issue. Investors want to know that you’ll be able issue on a regular basis throughout the year. That’s what makes it worthwhile for them to do the work to approve a credit and to keep it on their approved list as well.

Steski, Manitoba: Our programme is relatively small compared to the other issuers on this panel and as a result we’re more of an infrequent issuer into those international markets.

One of the things we hear from international investors is they’d like to see us back in the markets on a more regular basis. We will also continue to try to accommodate them in terms of meeting with them while doing investor relations work.

EUROWEEK: The sovereign doesn’t have that problem, does it? It can pick and choose which market it enters and when, and its international borrowing needs are relatively low compared to the rest of its programme.

Rudin, Department of Finance: Yes, very much so. International investors are interested in the Canadian story. There are very few sovereigns left that are considered in the top tier of credits. And of those, I’d say Canada has the deepest and most liquid bond market.

That said, we haven’t needed to pursue an active investor relations programme. Investors have been coming to us, which is another way of saving taxpayer money.

We have invested some effort into improving the information we provide to investors. We have a long standing commitment to transparency and predictability of the issuance. In communicating with Canadians about the fiscal plan, the government is also communicating with investors at the same time.

The medium term notes programme will meet an important need being expressed by international investors. That said, whether it’s in the foreign issuance or it’s in the domestic market, our aim is to try to come up with a bond programme that is going to raise stable,

low cost funding in the interest of Canadian taxpayers, and that will also be welcomed by investors.

For example, certain investors have welcomed the recent increased emphasis in the 10 and 30 year sector in our programme but we haven’t done that specifically to cater to investors. We’ve done that because we feel from a taxpayer point of view that it’s prudent to lock in longer term funding at historically low rates.

EUROWEEK: And has there been greater demand on the sovereign for investor relations or from investors? Or are people just happy to buy, regardless?

Rudin, Department of Finance: We are available in Ottawa for investors who wish to come to see us. Over the past couple of years, we’ve had numerous delegations visit. I’m sure investors would like us to issue globals more regularly to build a curve, etc. But our experience is that even though Canada chooses not to commit to be a regular issuer of globals, this hasn’t prevented our global bonds from being strongly oversubscribed and, from our point of view, very attractively priced.

EUROWEEK: From a dealers’ point of view, are there things that Canadian public sector borrowers could do more of in terms of IR work?

Hadden, Scotiabank: Our public sector issuers recognise the importance of getting out on the road, and meeting investors face to face. Obviously, a key target continues to be the US investor base. However, focus isn’t lost on the importance of discussing their respective stories through Europe and Asia as well, answering questions on fiscal and borrowing plans. Collectively they all see IR as a crucial investment, whether that’s in person, over the phone, or communicating the story or fundamentals through a website platform.

Lovely, CIBC: Canada has held a prominent position on the world stage for five-odd years now and, increasingly, international investors require less of an introduction to the country and its issuers, and want instead a deeper look at economic and fiscal prospects in order to fine tune their view.

In that regard, Canada’s public sector borrowers are very good at demonstrating transparency in their financial reporting.

IR work will always have a very important role to play. As more and more investors increase their understanding of the country, get more and more comfortable with its credits, we could see an evolution in their participation in the public sector, whether that is across products within an individual credit, across the term structure or across the credit spectrum.

We fully expect that this evolution in investor participation will be facilitated by the changing supply situation, which we view as constructive overall for Canadian public sector issuers.

Hainsworth, BMO: The breadth and types of credits that some of the foreign investors look at — covered bonds from Canadian banks, for example — have been extremely well received in various currencies, both when they were the CMC insured mortgages, and since

Jeremy Rudin,Department oF Finance



the last few months when they haven’t been. The high yield market in Canada has had a very

significant renaissance in the last couple of years and there are foreign investors in that as well. So they’re very willing to look at various types of credits, and not just in Canadian dollars. That is the halo effect of public sector Canada, the rising tide, lifting all Canadian boats.

Berry, RBC: Even when you look at the municipalities, they are getting more coverage and more term access. Investors are doing the work. They are going down that extra level to find value, and looking at that pick-up versus the provinces. We haven’t seen that in a long, long time.

There were municipal deals that were being driven by hedge funds. That’s encouraging for public sector in general.

In Canada, of course, really there are only four or five big issuers. You compare it against, say, the US where there are thousands of municipal issuers. Anyone coming into Canada can figure out how this market works. That’s a benefit to investors and issuers.

There is also great liquidity. There are 10 or 12 banks in intense competition which ensures we do a good job.

Investors coming to Canada recognise that the banks are strong, they’re committed, and there’s a reason why they’re going to be there every day making sure things work.

Stewart, NBF: The public sector has done a great job of addressing issues that have been at the forefront of investors’ minds. Not only is there a very sophisticated IR programme run by each of these borrowers, but they are right on point in terms of addressing issues like the housing sector and, quite frankly, a lot of the misinformation supplied by the popular media coverage of the issue.

Secondly, there is no substitute for one-on-one visits or small group presentations to help separate what passes for information but is actually noise. By getting in front of investors, you focus them on the credit, and every issuer around this table has been very good in that regard.

Demand for IR work is going to increase with the number of new investors.

One side bar to this trend is that the ability to trade in large size with very modest impacts on spreads is a distinguishing feature of the Canadian market versus elsewhere.

It ties into the IR side — how big a size can I purchase? What’s the bid-offer spread? How regular is that market? It makes a big difference.

EUROWEEK: Is the biggest challenge to the Canadian public sector borrowers dealing with that misinformation about the economy?

Stewart, NBF: The bigger question is how the US Federal Reserve implements tapering of quantitative easing and the distinction between tightening and tapering. None of us around this table can miss that. We were having a discussion five months ago about this risk. If one looks at the rise in US rates and Canadian rates since the beginning of May, the ability of every issuer here, whether it is Canada, whether it is CMBs, or the provinces, their issues have performed

impressively. Also, in a bear market, you have more volatile

opportunities. You have shorter-lived opportunities and you have multiple issuers trying to take advantage of those opportunities. A bear market is much more challenging to manage.

Manning, Ontario: Since May 2 until the end of August, yields between five and 30 years bonds have risen 80bp-100bp. Throughout that period, as a borrower, we have found demand very sporadic. Demand was very lacklustre at times and so, as you go through this type of environment, you’re a bit concerned about your overall programme.

We don’t know what the Fed’s going to do and what the market reaction’s going to be over the next couple of months.

There are always other geopolitical events that are out there as well that could have an impact on access to markets. As a large issuer, we are always worrying but access, given the bear market, is something that we’re all concerned about.

Berry, RBC: The key question right now is what are the risks that we can’t even see? It was only two years ago when all of a sudden we had extreme violence in North Africa. We had a nuclear meltdown in Japan. Right now we have Syria.

Everyone’s trying to be very well funded ahead of time. It may not look like an opportunity, but an extra buffer is prudent, especially in a bear market.

If you go back to 1994, we could not do a long dated deal from January to August, and a lot of players now have never even seen a bear market. It’s a different trading mentality. We’re all going to be looking at the next Federal Open Market Committee in mid-September. No one knows what will happen, but I think being ahead of the game is where to be.

Chamie, CMHC: The US debt ceiling is starting to arise in conversations again and there is still ongoing implementation of regulations which could be game changers in some markets as well.

All of these issues point back to volatility. That is what has the biggest impact for us and most issuers in terms of our ability to be able to execute deals, continue to provide and find liquidity in the markets and so on. This remains something that we monitor very closely. Rising or declining interest rates, as

Mark Chamie,cmHc



long as it’s done at a measured pace don’t worry investors too much.

It’s when there are sudden unexpected movements that investors tend to step back, keep the cash on the sidelines and re-evaluate, and it’s those sorts of situations that I think we are the most concerned about.

Steski, Manitoba: From the treasury’s standpoint, we continue to worry about access to markets and being able to fund ourselves when we need to.

For the big picture, with the challenges the federal government and some of the provincial governments are having in returning to surplus, I think we have to remain diligent in getting cost effective funding for the province and not introducing any long terms risks related to that.

Rudin, Department of Finance: We continue to re-learn the lesson, that there’s a degree of uncertainty that you have to live with; that it’s irreducible in some sense and can be quite significant.

From the point of view of fiscal planning and debt management planning, being aware of that and planning to deal with its potential amplitude is more important than listing all of the potential sources of worry.

We have also now completed the implementation of our prudential liquidity plan. This ensures that we always have enough prudential liquidity available to meet our needs over the coming month, and that includes government expenditures, coupons and debt refinancing.

That said, this is a plan very much for tail risk based on our experience with recent liquidity events.

Canada has been able to access the market when others can’t. The important lesson has been in learning to plan for this sort of uncertainty. In terms of being able to execute the debt programme, as I mentioned, what we rely on is domestic issuance — bonds auctioned on a predictable schedule.

We do some funding, notably globals and soon medium term notes, where market conditions could conceivably deter us from issuing for an extended period. But we aren’t reliant on those programmes, we can fund entirely in the domestic market using planned and predictable auctions.

Hainsworth, BMO: Some of the dangers in the world almost play into Canada’s strengths. It is a strength that we have such experience in the public sector in terms of accessing financial markets. There’s a great diversity of markets that these public sector borrowers are tapping into. The borrowers are prudent in terms of either pre-funding or having large liquid reserves — having options. There are a lot of elements that work in Canada’s favour.

I don’t want to sound complacent but I think this group of borrowers here has done a pretty good job over the last few years and I think that gives investors a lot of comfort that you know where you stand with Canada and its public sector borrowers.

Lovely, CIBC: One of Canada’s key strengths, perhaps our country’s chief strategic advantage, is a financially sustainable government sector. In that sense it’s vitally important that federal and provincial governments maintain their fiscal discipline, even in the face of what could be some disappointing or muted growth ahead, or, in some cases, political pressure.

I’m encouraged by what I’ve heard and seen from Canadian governments, those represented around this table and the others not in the room. I think it’s also vital that governments continue to budget prudently to maintain liquidity and access to markets and to position themselves for what really are the known large scale challenges that lie ahead, be they demographic or other pressures, and to leave room, fiscal capacity, and fiscal flexibility to respond to that next shock that unfortunately might be around the corner.

Hadden, Scotiabank: Rising consumer debt levels should be a red flag to monitor. If it worsens, how that might transition into public finances will be important to watch as well.

Market liquidity is important too. Our public sector borrowers see exceptional liquidity in the market. We’ve looked at dealer secondary trading statistics in the second quarter. Trading in just Ontario bonds maturing in 10 years out to the long end of the curve almost surpassed the total secondary trading volume in the entire corporate market. Liquidity is very strong — I think another risk to provinces, especially the smaller issuers, is if that starts to dry up.

Turgeon, Quebec: I share the preoccupations that were expressed by my colleagues about the Fed tapering and the other challenges faced by the markets. I think that, as governments, the best we can do is, first of all, to stick to the fiscal consolidation plan, eliminating deficits and reducing debt.

A second thing is to manage financing and debt in a very prudent way. In Quebec we have put in place over the past year a prudential liquidity fund. There is now C$6bn in that fund. We can be out of the market for about six months with that. We didn’t have that before. So in a volatile environment you must put in place instruments that will allow you to face difficult situations, and this is what we have done.

Love, EDC: A constant theme for this year has been volatility. How borrowers are able to manage themselves through periods of uncertainty and maintain access to a variety of markets are key. Keeping in touch with investors, addressing their concerns, listening to the types of products they’re asking for and being able to adapt yourself as a borrower to their needs are all important. That’s what will allow you to come through this period of volatility successfully. s

Warren Lovely,cibc

PENSION PLANS AND INVESTMENT FUNDS


Neil Petroff, executive vice presi-dent and chief executive officer at the toronto-based ontario teachers’ Pen-sion Plan (otPP), says that in 2012 his investment team travelled a total of 12.5m miles. that, he adds, is the equivalent of going to the moon and back 26 times.

otPP may not yet have explored investment opportunities on the moon, but it has done so more or less everywhere else. “We have invest-ments on every continent except Ant-arctica,” says Petroff. “that calls for a lot of work and plenty of travel, but when you own an asset in Australia or Chile, you need to make sure it’s being well managed.”

Given that all Canada’s leading pen-sion plans are prolific global travel-lers, it is fitting that the largest of them all — the Canada Pension Plan investment Board (CPPiB) — was part of an investor group that bought a 65% stake in Skype from eBay in 2009. At the time, the investment in an apparently speculative internet company by a pension plan regarded as a conservative institution shocked onlookers. But when Microsoft made its $8.5bn bid for Skype two years later, it was estimated that CPPiB’s stake, originally acquired for $300m, was worth a little over $1bn.

So not only did the pension plan generate a $700m-plus windfall for Canadian workers. it also contribut-ed to the growth of a company viewed as a godsend by millions of travel-lers, who are now able to connect with loved-ones by video from lonely hotel rooms on all corners of the planet.

it is forward-thinking investments in enterprises ranging from Skype and formula one to countless airports and the world’s largest manufactur-er of potty seats, that has enhanced Canada’s pension plans’ collective reputation as what The Economist has dubbed the “Maple revolutionaries”. “We didn’t set out to be revolutionar-

ies,” says otPP’s Petroff. “We sim-ply set out to run pension plans as viable businesses staffed by invest-ment-centric people that would earn high risk-adjusted returns over the long term.”

that was back in 1990, when ontario’s government set up teach-ers’ to administer a pension plan that had existed since 1917. Before the establishment of otPP, the government-sponsored plan had invested almost entirely in illiq-uid Province of ontario deben-tures, with obvious implications for the fund’s performance. By the end of 2012, otPP had net assets of $129.5bn invested across a highly diversified range of asset classes.

“We were the first Canadian pen-sion fund to invest in real estate, the first direct investor in infrastructure, the first into timber and the first to invest in hedge funds,” says Petroff. “today, all pension funds around the world will tell you they invest in real estate and hedge funds, but back then these were genuinely seen as being alternative asset classes.”

Global role modelthe establishment of otPP sparked a movement that has since evolved into one of the most successful pension plan systems in the world. While Can-ada’s economy, its credit rating and its banking industry have frequently been held up as role models for other developed countries in recent years, so too has its pension fund sector. According to a recent oeCD report, having grown at 10.6% over the last 10 years (versus a global average of 6.4%), total Canadian pension fund assets are now estimated at C$1.1tr.

the oeCD’s report notes that Can-ada’s funds now hold 5.6% of total pension assets in oeCD countries of $20.1tr, which puts Canada in sixth place, behind the US, Japan, the UK, Australia and the Netherlands. in

terms of the ratio of pension assets to GDP of 64%, Canada ranks eighth.

Critically, Canada’s pension funds are generally much more strong-ly funded than those in many other jurisdictions. According to an exhaus-tive study of 461 defined benefit (DB) pension plans in the US, Canada, Japan and europe published by DBrS in July, the aggregate pension deficit is now “in the danger zone”. the entry point at which pension plans slip into this danger zone is defined by DBrS as a funded status of 80%, “below which the challenges associated with funding the deficit would become more formidable”.

Not so those in Canada. “DBrS has found that Canadian plans have a higher funded status than the US plans and other international plans in the sample set reviewed,” says the preamble to the 542-page report. “the aggregate funded status of Canadian plans is higher at 84.4%, which is safe-ly above the 80% threshold. only 12 [Canadian] plans were below 70%, and all were above the 55% funding level.” By contrast, says the DBrS analysis, some of the worst funded plans are now below 50% funded.

While there are more than 5,000 corporate pension schemes spread across Canada, the bulk of the indus-try’s assets are concentrated among a handful of super-large public plans, led by CPPiB, ottP and the ontario Municipal employees retirement Sys-

Well funded, world class, global scale, ambitious and innovative: Canada’s state pension plans and investment funds richly deserved being dubbed ‘Maple Revolutionaries’ by The Economist. Philip Moore reports on a C$1.1tr sector that has made the rest of the world envious of Canada.

Prolific pension plans extend global leadership

“Investing in a private capital fund

would probably cost us about 6% of our

returns, whereas managing our

exposure internally costs basis points”

Neil Petroff, Ontario Teachers’

Pension Plan



tem (omers). According to the oeCD, Canada has seven pension funds in the global top 100 and 19 in the top 300.

it is these largest plans that are gen-erally regarded as providing a blue-print that other jurisdictions have increasingly looked to replicate. A recent report on the top 10 public plans, published by the Boston Con-sulting Group (BCG), says that these 10 “are consistently regarded as global leaders by their international peers in terms of their approach to govern-ance and their investment policies, the scale of their assets and their solid performance”.

“this reputation has helped estab-lish Canada as a centre of excellence for managers of quality, large-scale investments,” adds the BCG report.

The right influencethe plans themselves and toronto-based bankers give a number of rea-sons for their success. the consensus is that the most important of these is the plans’ governance structure that ensures that they operate as commer-cial asset managers at arm’s length from the federal or provincial gov-ernments with the single objective of maximising returns.

in other words, the public plans observe an investment-only mandate, which ensures they are not influ-enced by any non-investment objec-tives related to areas such as social or economic development, or by a home bias. “the funds are entirely agnostic in their investment strategies, and are under no political pressure to invest in Canada or in any of the provinc-es,” says David Hay, vice chairman of CiBC World Markets in toronto.

At CPPiB, which manages the assets of the Canadian Pension Plan, which is the mandatory pension plan for all Canadian workers created by an Act of Parliament in 1966, senior vice

president and chief investment strategist Don raymond emphasises how inviolable this code of govern-ance is. “the CPPiB Act spells out our investment-only mandate very clearly, the fact that we’re not civil servants, and that our assets can’t be co-mingled with any other gov-ernment assets,” says raymond. “An indication of how the politicians of the day were thinking is that they made the Act very difficult to change. to ensure that future politi-cians could not use the plan’s assets for anything other than paying pen-sions, they made the Act more dif-ficult to change than the Canadian Constitution.”

A governance code emphasising independence from government has had a number of important by-prod-ucts which have kick-started a virtu-ous cycle at the funds. one of these, says Hay at CiBC, is that from the outset they have been able to attract professionals from the private sector to shape their management style and investment strategy.

When Gerald Bouey, former gover-nor of the Bank of Canada, became the first chairman at teachers’, one of the first things he did was hire Claude lamoureux as its Ceo. lamoureux, who has spent the previous 25 years at Met life of Canada, was recruited — according to otPP — specifically to “run teachers’ like a business”.

Sticky and secureApplying a private sector manage-ment style to the public pension funds from their inception has been pivotal to ensuring that they have been able to attract and retain top quality investment professionals. So too has the predictability of the funds’ long term cashflows. “Part of the reason people are attracted to us is the fact that our capital is sticky,” says James Donegan, president and

chief executive officer at omers Capi-tal Markets in toronto. “the envi-ronment is very different to a hedge fund, where large investment losses can lead to withdrawals of capital that puts job security and possibly the business at risk.”

Being able to offer relative job secu-rity is an important consideration in a highly competitive but relative-ly restricted market for talent. So too is a compensation policy that allows the funds to compete with banks and other fund managers for the ablest people. “our governance structure allows us to pay competitively,” says Donegan, adding that the low turno-ver rate in personnel at omers is com-pelling evidence that the pay struc-ture is appealing.

Donegan is echoed by raymond at CPPiB, which has the added attraction of being one of the fastest growing pension funds in the world. According to projections made by Canada’s Chief Actuary, CPPiB’s assets will reach $275bn by 2020 and over $500bn by 2050, compared with $183.3bn at the end of 2012. “if your sole objective in life is to make as much money as is humanly possible, this is not the best place to work,” says raymond. “But there is an element of self-selection in our recruitment policy, and we appeal to managers who value performance-based compensation twinned with the stability of our asset base. Know-ing that the asset base is projected to double over the next decade or so is a huge competitive advantage for us.”

Another essential component of the public funds’ success has been their strategy of managing most of their assets in-house, rather than farm-ing out mandates to external manag-ers and paying overinflated fees for the privilege. “We’ve chosen to invest largely internally because we believe the cost of investing in external funds is too high,” says Petroff at teach-

“The funds are entirely agnostic

in their investment strategies, and are under no political

pressure to invest in Canada or in any of

the provinces”

David Hay, CIBC

Fund Type of fund Assets US$bn Top 300 ranking1 CPP Public 159 9

2 OTPP Public 115 19

3 Omers Public 54 47

4 PSP Public 41 71

5 QGP Sovereign 41 72

6 Healthcare of Ontario Industry 40 74

7 Quebec Pension Public 35 86

Largest Canadian pension funds

Source: Towers Watson 2012b



ers’. “for example, investing in a typi-cal private capital fund would prob-ably cost us about 6% of our returns, whereas managing our exposure internally costs basis points.”

Infrastructure focusPerhaps the area where Canadian pension plans are regarded as the most accomplished exponents of the direct investment model, however, is infrastructure. According to the oeCD’s comparison of Canadian and Australian pension funds, the share of Canada’s institutional participation in infrastructure via direct investment (as opposed to via funds) is the high-est in the world.

At omers, which has the largest exposure to infrastructure among the public funds in terms of percentage allocations ($9.8bn, or 14.8% of assets), Donegan says that the emphasis on internal management of the plan’s net assets of $60.8bn (as of the end of December 2012) is one of the most important pillars of its governance model. “our structure is the exact opposite from the US where pension plans are provided with a budget from the state treasury to manage their funds, whereas in Canada the funds themselves pay for the management,” he says.

the effectiveness of this model, he says, has led omers to focus on increasing the internally-managed component of its assets. the plan ended 2012 with 88% of the portfolio managed in-house, compared with 74% five years ago. the long term goal, says Donegan, is to increase the share of the internally managed com-ponent of the portfolio to 95%.

the broad focus on internal rather than external management is clearly paying off in terms of overall cost sav-ings. According to the BCG analysis, the average cost of managing assets at the top 10 Canadian funds is about

0.3% of assets. “this level is compa-rable to passive index exchange-trad-ed funds (etfs), much lower than the 1.5%-2.5% (or higher) charged by many other managed funds, and lower than the 0.3%-1% average for many other Canadian pension funds,” notes BCG. its report attributes these minimal costs to the balance between internally and externally managed assets, which BCG puts at 80/20.

the public pension plans’ govern-ance framework also gives them very considerable freedom and flexibil-ity to formulate investment strate-gies and asset allocation models that aren’t restricted by pre-determined geographical parameters or ratings limits.

Freedom mandateindeed, the Canadian pension plans are probably even freer than a num-ber of sovereign wealth funds, some of which are prevented from investing in their home market. As CPPiB’s ray-mond says, Canada’s pension plans used to be subject to similar restric-tions, and until 2005 were allowed to invest a maximum of 30% of their assets outside Canada. today, they are free to invest where they choose, with CPPiB having increased its over-seas exposure from 30% in 2005 to 63% today. raymond explains that this growth in the international com-ponent of CPPiB’s portfolio has been important for several reasons.

“the first is the size and structure of the Canadian equity market, which accounts for about 2% of the global market and is very highly concen-trated in a small number of sectors,” says raymond. “there’s very little in industries like healthcare and tech-nology, which restricts the diversifica-tion of Canadian equity portfolios.

“More specific to us,” he adds, “is that because we are the national pen-sion fund, diversifying internationally means we rely less on the Canadian economy to fund future pensions.”

Another reason why internation-al diversification has been especial-ly important for Canadian pension funds is that their sheer scale means that opportunities in the domestic infrastructure sector have been lim-ited. like their Australian counter-parts, Canadian pension funds are recognised as being among the most sophisticated infrastructure investors in the world.

Unlike the Australian funds, how-ever, which have a roughly equal exposure to domestic and internation-al infrastructure, Canada’s pension funds have a small exposure to the local market.

“We’re not averse to investing in Canadian infrastructure,” says ray-mond. “in fact, our largest infrastruc-ture investment, which is a 27% stake in the 407 toll road, is in Canada. But we need scale in our infrastructure investments, and social infrastruc-ture assets such as $10m hospitals and schools — which is where much of the emphasis has been in Canada — don’t give us the scale we require.”

CPPiB’s target for infrastruc-ture investments is in the range of $500m-$2bn equity participation per transaction, although it is able to invest up to $4bn in single invest-ments.

More broadly, says raymond, the flexibility and independence of CPPiB’s governance code has allowed the plan to maintain what he describes as a forward-thinking investment strategy. “We start with a reference portfolio which is 65% equi-ties and 35% bonds, which reflects our risk appetite and satisfies our fiduci-ary mandate,” he says. “As of April 1, 2006, we’ve overlaid an active man-agement approach where we aim to outperform the reference portfolio by diversifying into a wider range of asset classes and geographies.”

raymond says that CPPiB has done so by applying what it calls a “total Portfolio” approach. “this allows us to displace public equities and bonds with assets with similar risk char-acteristics but greater risk-adjusted return potential,” he explains. “if we buy an office building for $100m, for example, which we regard as riskier than bonds but less risky than equi-ties, we would sell $60m of bonds and $40m of equities to finance the acqui-sition. We thereby maintain the over-all risk profile of the fund and hope-fully add value at the same time.”

Gruesome crisisNeither their governance framework nor their innovative investment style, however, has made them capable of the sort of alchemy that would have been needed to insulate Canada’s pen-sion plans from the impact of severe market dislocations. in terms of per-formance there have been some grue-

“To avoid political meddling, they

made our Act more difficult to change

than the Canadian Constitution”

Don Raymond, CPPIB



some years. None more so than 2008, which was especially grim for teachers’, which saw its total assets tumble from a previous record of $108.5bn at the end of 2007 to $87.4bn 12 months later. While few investors anywhere came away from 2008 unscathed, teachers’ investment return was minus 18% compared with a fall in its compos-ite benchmark of 9.6%.

over the longer term, howev-er, the performance of Canada’s leading pension plans has generated demonstrable added value for their members, generally making quick work of recovering from the trauma of 2008. According to data published by the toronto-based CeM Benchmark-ing, in 2011 teachers’ absolute and value-added returns were the highest among its peers globally, for example. in 2012, it delivered a 13% return, gen-erating $2bn above its benchmark.

Among the other largest toronto-based plans, omers has posted aver-age annual investment returns in the four years since the crisis of 8.9%, and over the last decade of 8.24%. CPPiB, meanwhile, generated a 10.1% return in fiscal 2013, bringing its 10 year annualised rate of return to 7.4%.

As CiBC’s Hay says, however, assessing the relative performance of Canada’s largest public pension plans is like comparing apples and oranges because each have very different pay-out profiles which has a direct impact on their growth rate and scale. CPPiB, for example, is an accreting fund which will be collecting excess con-tributions until 2021. longer term, it will see its total assets grow more than five-fold between now and 2050.

Growth is of course beneficial in

that it allows CPPiB to adopt a very long term investment strategy, con-structed around the mantra that it aims to deliver performance for its members not over a quarter of a year, but over a quarter of a century. As raymond says, because the plan is still seeing net inflows, short term price declines need not be detrimental to long term performance. “We focus a lot on markets like Brazil, india and China, all of which have been under pressure in recent months,” he says. “But that’s not necessarily a bad thing because it allows us to buy at lower prices. Market dislocations can pro-vide opportunities because when oth-ers are fleeing for the exits, we can be building long term positions.”

true enough, although growth will also bring challenges, reducing the share of the portfolio that can be man-aged actively and potentially mak-ing some publicly traded markets too small and illiquid for CPPiB.

Ageing processothers are in a very different position. teachers’, for example, is a mature fund, meaning it has a declining num-ber of active members contributing to the asset pot. in a speech delivered in

April, president and Ceo Jim leech said that 2,800 of the plan’s members were aged over 90 and 107 were over 100.

As a mature fund, teachers’ faces a very different fundamental chal-lenge from CPPiB, as Petroff explains. “We have an annual payroll to retired teachers of about $4.9bn and we only receive contributions of about $2.9bn — $1bn split equally from the gov-ernment and $1bn from the teach-ers themselves,” he says. “So unlike a plan like CPPiB, we start every year knowing we’re going to be down by about $2bn. that means we need to be careful about the risk we take.”

this perhaps explains why teach-ers’ makes very active use of deriva-tives to hedge its interest rate expo-sure, and why it has historically had a weighting of 45% equities in its port-folio, which is lower than other pen-sion plans. it has indicated recently, however, that it will now be looking to increase its exposure to emerg-ing markets in general and emerging market equities in particular. At the end of 2012, teachers’ had lifted the net share of equities in its portfolio to 47%.

As well as influencing the pen-sion plans’ investment philosophies, their relative scale and growth rate also informs their approach to asset-gathering. While the last thing CPPiB needs is to turbocharge its already very rapid expansion by adding exter-nal assets, for a number of other funds the emphasis is on growth. Since 2009, for example, omers — which had an actuarial deficit of $9.9bn at the end of 2012 — has been permit-ted to manage third-party assets on behalf of smaller Canadian pension funds.

“We’ve been very deliberate about finding strategic partners, which we have done by establishing innovative capital-raising initiatives,” says Done-gan. “one of these is the Global Strate-gic investment Alliance (GSiA), where we have co-invested in infrastructure alongside a number of strategic Japa-nese investors.”

“one of the attractions of acquiring third-party capital is that investment returns can be enhanced if we can buy bigger assets,” he explains. “if you can write a cheque for a billion dollars rather than chase assets worth $100m or $200m, competition tends to be less intense.” s

“If you can write a cheque for a billion dollars rather than

chase assets worth $100m or $200m,

competition tends to be less intense”

James Donegan, Omers

Asset mix of Canadian pension funds

Source: PIAC (asset mix of plans of sponsor organizations represented by members)

100

Asset mix of Canadian pension funds

Source: PIAC (asset mix of plans of sponsor organizations represented by members)

%

9080

70

60

50

40

30

20

10

0‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08 ‘10 ‘11

Public equity

Private equity

Fixed income

Real estate

Infrastructure

Other

Infrastructure fInance


When a respected think-tank wrings its hands in despair about “spine-jarring streets and highways”, “mind-numbing and catastrophical-ly wasteful traffic jams” and “unre-solved waste treatment problems and countless boil water orders”, it is obvious that something is very seri-ously awry.

“For at least the past 20 years, alarms have repeatedly been raised about deteriorating public infra-structure in canada and the threat it poses for the living standards of cana-dians in the future,” is how this think-tank — the canadian centre for policy alternatives — begins its analysis.

readers from some of the world’s fastest-growing and congested cities may wonder what all the fuss is about. commuters in Mumbai and Bangkok, after all, could tell canadians a thing or two about sitting in mind-numb-ing traffic jams. But toronto-based bankers and investors also argue that there is nothing unusual about can-ada’s infrastructural shortcomings. “I don’t see canada’s infrastructure gap as being materially worse than many other industrialised countries,”

says cliff Inskip, managing director and head of infrastructure and pro-ject finance at cIBc World Markets in toronto. “Like many other devel-oped economies, we built much of our social infrastructure in the 1950s and 1960s and this is now coming to the end of its natural life cycle.”

that may be. But the centre for pol-icy alternatives report, entitled Can-ada’s Infrastructure Gap — Where it came from and why it will cost so much to close, makes unsettling reading not just for the taxpayers who have to endure these infrastructural defi-ciencies. some say it also has alarm-ing implications for the prospects

for inward investment into canada, although there does not seem to be much evidence that lack of infrastruc-ture is deterring foreign direct invest-ment (FdI).

On the surface, canada compares reasonably well with its peers as a destination for FdI. In 2011, it ranked sixth out of 16 in the Inward FdI per-formance Index, according to the conference Board of canada. that was behind australia but ahead of the UK, the Us, France and Germa-ny. the same report adds, however, that since the 1970s, canada’s ranking on FdI inflows has been slipping. “In the 1970s, canada scored an ‘a’ on its ability to attract FdI,” the conference Board says. “this dropped to a ‘B’ in the 1980s and to a disappointing ‘d’ average in the 1990s, rebounding to a ‘c’ only in 2011.”

canada’s share of global inward FdI stock, according to the same report, fell from an average of 13.4% in the 1970s to an average of 2.9% between 2000 and 2011. the conference Board’s report does not pin any of the blame for this precipitous fall directly on canada’s infrastructure. “Multina-tional enterprises looking for opera-tional efficiencies are dissuaded by canada’s low productivity relative to its peers,” says the report. “canada’s low productivity reflects its lower cap-ital intensity and a lack of sufficient investment in research and devel-opment (r&d) and other areas that would foster innovation.”

It may or may not be a coincidence, however, that the decreasing appeal of canada as a location for FdI has dovetailed with a sharp reduction in investment in canada’s infrastructure.

according to the centre for policy alternatives report: “the difference between the 3% of Gdp range that was typical of the 1960s and 1970s and the 1.5% range that became the norm in the late 1990s represents $24bn in missing annual investment in public

After years of neglect Canada is a long last stepping up its efforts to fill its yawning infrastructure gap. Philip Moore reports on how the private sector and the bond market are playing key roles.

Closing the infrastructure gap with P3

“I don’t see Canada’s

infrastructure gap as being

materially worse than many other

industrialised countries”

Cliff Inskip, CIBC

World Markets

Financings for Canada’s largest megaprojects, such as on the Lower Churchill River, have been explicitly government-guaranteed



capital.”“the cumulative effect of the

underinvestment characteristic of the period of the 1980s and 1990s is dramatic,” it adds. “the difference between a capital stock valued at 30% of Gdp in the early 1980s and 22% in 2011 represents missing public capital stock with a current value of $145bn.”

the decline in public sector spend-ing on infrastructure was reversed in the aftermath of the global financial crisis, when the government’s eco-nomic action plan introduced initia-tives such as the $4bn Infrastructure stimulus Fund. how effective that stimulus was in addressing canada’s infrastructure challenge is open to question, with one toronto bank-er describing its support for all but a handful of so-called shovel-ready pro-jects as “illusory”.

Decades of neglectIrrespective of its impact, the post-cri-sis stimulus package looks like a stick-ing plaster in comparison with the requirement created by several dec-ades of neglect. according to the cen-tre for policy alternatives analysis, to close the infrastructure gap by bring-ing the general government capital stock back to 30% of Gdp within 10 years would require an annual invest-ment in general government infra-structure of 4.3% — a higher invest-ment rate than was ever achieved between 1955 and 2011. “In 2013-2014, that would require an investment of approximately $75bn for general gov-ernment infrastructure alone,” says the centre for policy alternatives.

“Whether the target is an infrastruc-ture base of 25% of Gdp ($60bn in 2013-14) or 30% ($75bn in 2013-14), the annual investment in infrastructure required is… substantially higher than the $45bn annual that was allocat-

ed to general government infrastruc-ture at the peak of the recession-relat-ed stimulus programme in 2009 and 2010,” notes the cautionary report. this means that it is “in a different category altogether from the $20bn-$30bn that was being allocated annu-ally in the mid-1990s.”

Bankers say that this yawning infra-structure gap is being addressed more decisively today than it has been for many years. In very broad terms, the majority of key infrastructure pro-jects now in the pipeline in canada fall into two basic types. the first are the so-called “megaprojects”, chiefly in the energy sector. KpMG’s most recent update on these developments advises that “there are currently more than 175 megaprojects [in canada] either on the books or under construc-tion across a multitude of sectors. In total, these projects represent around Us$420bn worth of investments.”

the list of sectors is led, says KpMG, by power and utilities, which has nearly 50 projects underway with a total price tag of around $170bn. “equally prolific in terms of numbers — though slightly less costly — is the mining and natural resources sector which is expecting nearly $80bn in capital spend,” adds KpMG.

Bankers say that for the most part, financings for canada’s larg-est megaprojects have been explicit-ly government-guaranteed. take the example of key developments such as the Lower churchill river hydro-electricity projects being developed by nalcor energy, newfoundland and Labrador’s crown-owned energy cor-poration, and emera Inc of nova sco-tia.

according to the government, these projects will allow newfoundland and Labrador to source 98% of its electric-ity from renewable sources and elimi-

nate up to 4.5m tonnes of greenhouse gas emissions. this is the equivalent of taking 3.2m cars off the road.

With the projects also creating some 3,100 jobs at the construction peak, it is perhaps small wonder that the Gov-ernment of canada has committed to guarantee project-related debt of up to $6.3bn for the Lower churchill river projects.

“although they are popular with lenders, the megaprojects are typi-cally federal or provincial government risk,” says Laith Qamheiah, director of infrastructure finance at BMO capi-tal Markets in toronto. “there is no transfer of risk to the private sector.”

P3 focusthis is why Qamheiah echoes a num-ber of other toronto-based bankers when he says the more interesting batch of projects, as far as investors are concerned, are those in the public-private-partnership (ppp, or p3) space. “Unlike most of the megaprojects, these p3 projects are ones in which the private sector is genuinely shoul-dering the risk that they are not com-pleted on time and within budget,” says Qamheiah.

the rising use of p3, says the Oecd in a recent report on pension funds in canada and australia, is a relatively recent development. “despite closing some high profile projects in the early 1990s (including the confederation Bridge linking prince edward Island and new Brunswick), canada gen-erally has lagged behind in the past in the use of ppps when measured against comparable Western jurisdic-tions such as the United Kingdom or australia,” notes the report. “In recent years, however, there have been signs of a strong pick-up of the ppp mar-ket in the healthcare, road and justice systems sectors which are now con-

SettlementIssuer Sector Term Yield Amount IssueSpread LeadDate (years) (%) (C$MM) (bps) Manager(s)1

01 Nov Brookfield Renewable Kwagis Holding Power & Utilities 41 4.452% 175 205 SC23 Oct Lower Mattagami Energy Ltd Power & Utilities 5 2.228% 200 81 CIBC/BMO21 Sep St. Clair Holding Power & Utilities 19 4.881% 172 295 RBC18 Sep ABC Schools Partnership P3 31.3 4.246% 87.2 185 CIBC18 May 407 East Development Group P3 3.8/33.1 2.813%/4.473% 451/120 138/211 BMO/DESJ11 May Capital City Link General Partnership P3 34 4.386% 534.8 187 CIBC/NBF23 Apr Lower Mattagami Energy Ltd Power & Utilities 40 4.175% 225 160 CIBC/BMO1 Bank of Montreal, Canadian Imperial Bank of Commerce, Desjardins Securities, National Bank Financial, Royal Bank of Canada, Scotia Capital.

Canadian broadly marketed project/PPP bonds 2012

Source: CIBC



sidered mature and benefiting from strong competition from equity and debt participants. Opportunities in new sectors such as water, waste water and rapid transit, are also like-ly to increase in the coming years.”

Bankers echo the view that since the crisis, the emergence of p3 has had a far-reaching impact on cana-da’s infrastructural landscape. “since the financial crisis of 2008/09, the provinces have developed a very effective way of dealing with risk transfer by passing risk to the private sector after a number of contract-ing and construction landmarks have been passed,” says peter hepburn, head and managing director of infra-structure finance at national Bank Financial Markets (nBFM) in toronto. “the cost of the debt is bought down or repaid and effectively subsidised by the province or relevant government entity, following achievement of these construction milestones, and a small-er amount of private finance then sees the project through the operat-ing period, which is generally 25 or 30 years.”

a frequently used argument against a p3 structure, says hepburn, was that the provinces enjoyed low funding costs and could provide more value for taxpayers by funding projects themselves. But with many provinces committed to an accelerated deliv-ery of essential public infrastructure while balancing their books sooner rather than later, it has become nec-essary for them to explore alternative funding solutions. hence the prefer-ence for transferring risk and split-ting the financing between the public purse and the private sector.

around 200 p3 projects with a value of more than $60bn have now reached financial close across a range of sec-tors, and bankers say that by virtu-ally any yardstick, canadian p3 has

already earned its spurs. “rather than reinvent the wheel, canada has done a very good job of adapting the UK pFI and australian models, setting up dedicated procurement agencies, for example,” says Qamheiah.

Even the unionsthe results have been impressive. a conference Board of canada report published in august reports that 83% of p3 projects in canada have been completed early or on time.

the efficiency of the p3 model also appears to have won round the gener-al public. according to the conference Board, “opinion polls show that sup-port for private sector delivery of pub-lic sector of public services in partner-ship with government has increased from 60% in 2004 to 70% in 2011.”

the canadian public has not always been so keen on handing responsibil-ity for developing social infrastructure projects to private enterprise. Mistrust of the 407 express toll route (etr) highway north of toronto, leased to a consortium for a 99-year period, is one well documented example of popular opposition to private owner-ship of key transportation infrastruc-ture. “there was originally opposition to 407etr because there was a per-ception that the government was giv-ing away the asset on the cheap,” says hepburn at nBFM. “Governments

have learned the lesson that it is best to stick to projects with 25 or 30 year lives, rather than 99 year concessions where it can look as though they’re giving away the keys. there is now a much better understanding among the general public that private opera-tors and sponsors will run assets on a temporary basis and that they are handed back in good order to the gov-ernment at the end of the concession period.”

even the unions, say bankers, have abandoned their opposition to p3 pro-jects, and in some cases even invest in them via their pension plans. “the unions have recognised that these projects are creating huge improve-ments in working conditions for their members,” says Qamheiah. “Many are being moved from older hospitals to brand new, state of the art facilities as a direct result of p3.”

Foreign banks creep back inas well as being increasingly well regarded by the general public, the p3 model has become extremely popular among bank lenders. “the evolution of the canadian p3 market has created a large construction period financing opportunity for banks,” says hepburn at nBFM. “Given that most of this demand is for three to five year loans, these are ideal projects for canadi-an banks which seldom lend beyond seven years. as p3 borrowers and pro-jects are generally investment grade and the risks are well understood, there is plenty of appetite among bank lenders for construction phase lending.”

Until recently, canadian banks had most of the market to themselves. “Most of the european banks which were very active in the Us as well as in the canadian infrastructure mar-ket pulled out after the crisis and are still deleveraging,” says John Kirwan,

“The provinces have developed a very effective way

of dealing with risk transfer by passing

risk to the private sector”

Peter Hepburn, NBFM

SettlementIssuer Sector Term Yield Amount IssueSpread LeadDate (years) (%) (C$MM) (bp) Manager(s)1

20 Sep Lower Mattagami Energy Ltd2 Power & Utilities 30 4.944% 200 168 BMO/CIBC20 Sep North Battleford Power LP2 Power & Utilities 19.3 4.958% 667 205 CIBC13 Sep Arctic Infrastructure Ltd Partnership P3 33.9 5.092% 142 185 CIBC25 Feb Lower Mattagami Energy Ltd Power & Utilities 33 4.176% 275 152 CIBC/BMO22 Feb Comber Wind Financial Corporation Power & Utilities 17.7 5.132% 450 300 SC21 Jan Spy Hill Power LP Power & Utilities 23 4.140% 156.3 188 CIBC/CASG1 Bank of Montreal, Casgrain & Company, Canadian Imperial Bank of Commerce, Scotia Capital. 2 Transaction has been priced and allocated to investors.

Canadian broadly marketed project/PPP bonds 2013

Source: CIBC



the London-based managing direc-tor and global head of infrastructure finance at scotiabank Global Banking and Markets. “We’ve seen some of the european infrastructure specialists pulling out of overseas lending alto-gether, with many banks tending to focus on their home markets.”

that may be starting to change. “Overseas banks are returning to this market and lending alongside the canadians on a selective basis,” says hepburn at nBFM. “Japanese banks in particular have been more active in some of the larger facilities.”

this is having a clear impact on pricing. “We’ve seen pricing on three to four year construction period loans come in considerably over the past 12 months,” says hepburn.

Project bond successthe success of p3 in canada has also helped to nurture a highly efficient and increasingly liquid market in pri-vately placed project bonds, which are now regarded as an asset class in their own right. “When the sub-stantial completion payments have been made, what is left is a long term tranche of debt that is generally rated in the BBB+ to single-a range,” says hepburn. “dealers such as nBFM are comfortable underwriting large tranches of this debt, for which there is plenty of institutional appetite.”

“From the perspective of institu-tional investors, infrastructure is a very popular asset class,” says Inskip at cIBc. “Before the credit crisis, european banks in particular were very willing to lend up to 30 year money to canadian projects and insti-tutional investors were effectively crowded out of the market.”

“now virtually all the dBFM [design, build, finance, maintain] p3 deals are being structured as bonds which are either widely distributed or narrowly placed, mainly with life insurance companies and pension funds,” adds Inskip. “these are very attractive assets for institutions look-ing for long dated assets to match their liabilities.”

a good example of the increased institutional appetite for ultra-long infrastructure-related debt, says Inskip, was investors’ response to a recent 50 year bond issued by toronto hydro. this was priced at 152bp over the government benchmark, which was at the tight end of guidance, and

was increased from $150m to $200m in response to strength of demand.

One of the principal attractions of p3 bonds to domestic institution-al investors, says Inskip, is the stable cashflows associated with availability-based assets. In contrast to infrastruc-ture assets such as toll roads, which are subject to potentially unpredict-able passenger numbers, availability-based assets are so-called because as long as they remain available for use at no charge to the public, the govern-ment or quasi-government sponsor will continue to pay for them. In other words, as long as the asset meets basic quality and performance standards, payment for them comes from the tax base.

Canadian PF bond magica key difference between canada’s p3 bonds and those that financed european infrastructure through, for example, pFI in the UK, is that the canadian market is not supported by credit wraps.

“the recurring question that comes up at conferences about canadian finance is how the market has grown and flourished, taking on construc-tion risk without the support of guar-antees from the monoline insurance companies, and how other countries can replicate canada’s success,” says Kirwan at scotiabank GBM.

“Be it in europe, the Middle east or elsewhere, people are fascinated at how canadian projects can raise long term bond finance without third party credit enhancement,” he adds. “For many european procuring authori-ties, the holy grail is to promote demand for broadly marketed bonds

with construction risk.”Kirwan says that there are a num-

ber of explanations for canada’s suc-cess in this area. the first is that as project finance has a relatively strong and successful history in canada, domestic institutions have recognised the value of dedicating substantial resources in terms of time and per-sonnel into analysing infrastructure as an asset class. “Over time, that has allowed these institutions to become much more comfortable with the leg-islation and the structure that under-pins these projects,” says Kirwan.

this process, he adds, initiated a virtuous circle within the canadian financial community several years ago. “Five or six years ago we started to see a marked increase in interest in this asset class among dealers, driven by investor demand, deal size and the pipeline,” he says. “consequently, dealers and p3 advisors have expand-ed their underwriting commitment and deployed even more resources to managing each stage of the process — including getting transactions rated.”

as the movement snowballed, there was a conspicuous increase in the number of investors participating in the market. Inskip at cIBc says that there are now perhaps 50-60 insti-tutions that buy p3 bonds. “that is a significantly higher number than sev-eral years ago, when the project mar-ket was still dominated by banks,” he says.

Rising institutional demandrising institutional demand, coupled with the unblemished track record to date of p3 bonds, has pushed pricing down in recent years. Inskip says that

Preliminary design concept of one of the Crosstown stations, Mount Pleasant. Image supplied by Metrolinx.



typical pricing for long dated bonds has declined from a peak of around 300bp over the canada curve three or four years ago, to a sub-200bp spread today.

that compares with ballpark pric-ing of around 150bp over the govern-ment bond for 30 year issuance from the top utilities.

Given that provincial governments ultimately pay for availability-based projects, some investors may regard p3 bonds as offering quasi-provin-cial risk at an appealing pick-up. But bankers caution that p3 bonds are priced at a spread to provinces for good reason, given that they are gen-erally unrated, privately placed and are often illiquid as they tend to be held to maturity.

Besides, both in the p3 market and for many public utilities, there is no typically no explicit federal or provin-cial government guarantee. “Investors may regard these borrowers as pro-viders of essential services, but while bond issuers like toronto hydro, which is owned by the city of toronto, and hydro One, owned by the prov-ince of Ontario, they are not guaran-teed by their owner,” says Inskip.

Eglinton testBankers say that a key potential test of appetite for project bonds will be the eglinton Light rail scheme, which is still in the early bidding stages and is part of an $8.4bn project which represents the largest light rail tran-sit expansion in toronto’s history. In terms of its size, which is on a par with the so-called megaprojects, this could lift the bar in the canadian p3 market. “as it will run into several bil-lion dollars, it remains to be seen how easily the eglinton Light rail project will be absorbed by the market,” says one banker.

Its prospects appear to be good, given that p3 is becoming an increas-ingly popular funding mechanism for urban light rail systems in canada. In February, for example, the rideau transit Group (rtG) consortium closed a $440m financing on its 35 year design, build, finance and main-tain (dBFM) ppp for the confedera-tion Line in Ottawa.

total project costs are in excess of $2bn, of which the federal govern-ment, the province of Ontario and the city of Ottawa are providing the bal-ance of public funding.

the private financing tranche, meanwhile, includes a $215m loan provided by national Bank, scotia-bank, and BtMU and sMBc of Japan, alongside a $225m underwritten pri-vate placement, led by national and sunLife.

edmonton is also using the p3 model to finance the construction of its 13.2km light rail system. In March, the city announced that a private sec-tor proponent would be selected to design, build, finance, operate and maintain the new light rail transit pro-ject over a 30 year period.

Beyond the transportation space, bankers report that there is no short-age of projects in the pipeline in a diverse range of sectors. “at nBF alone, we are working on a two year infrastructure pipeline that will require total public and private fund-ing of about $30bn, and that does not include municipal projects,” says hep-burn.

Pension funds look elsewherethat pipeline, say bankers, should be digested straightforwardly enough. But they add that two groups that are not yet meaningful players in the mar-ket are foreign investors (bar a small handful of Us accounts) and — for the most part — canada’s deepest-pocket-ed public pension plans.

the good news is that canadian pension plans are prolific and very sophisticated investors in infrastruc-ture. according to the Oecd, the average allocation to infrastructure among large pension funds in canada is 7%-8%. “canadian pension funds such as Ontario teachers, caisse de depot et placements du Quebec (cdp), Omers, the canadian pen-sion plan Investment Board (cppIB), alberta Management, British colum-bia and Optrust are active investors in the infrastructure market,” says the Oecd report. “Over the years, these

investors have been able to acquire the knowledge, expertise and resourc-es to invest directly in infrastructure.”

the bad news, as far as canada’s so-called infrastructure gap is concerned, is that the local pension funds have turned much of their attention — and channelled many of their assets — into opportunities outside canada rather than into the domestic mar-ket, for several reasons. “It’s not that the largest public pension funds don’t have an interest in the local market,” says Qamheiah at BMO. “But p3 deals aren’t structured with the large equity tranches that these pension plans are looking for. they’re typically look-ing to write $500m or $1bn cheques for big-ticket projects such as airports and other similar long term transpor-tation infrastructure.”

Qamheiah adds that canadian pen-sion plans also generally look to invest in operating assets rather than green-field projects, as the funds themselves confirm. “We’re not there for altruis-tic reasons,” says neil petroff, execu-tive vice president and chief executive officer at the toronto-based Ontario teachers’ pension plan (Otpp), which had net assets of $129.5bn at the end of 2012, $9.6bn of which was in infra-structure. “We’re there to make good risk-adjusted returns for the teachers of Ontario, which is why we always have to ask ourselves if we’re being paid for the risk we’re taking. In the case of canadian infrastructure, pen-sion plans generally want to invest in existing, brownfield projects, whereas the government is aiming to attract investment in greenfield develop-ments, which carries considerable construction risk,” he says.

this does not mean that pension funds are entirely absent from the domestic infrastructure market. hep-burn says that some, such as caisse de depot et placement du Quebec, are playing an increasingly active role in the market, as are specialist investors such as Fiera axium Infrastructure and Fengate capital Management.

as far as canada’s infrastructure is concerned, the more investors the bet-ter, because as the centre for policy alternatives says, the stakes are high. “a decision to revert to pre-recession levels of investment will leave our infrastructure stuck at a crisis level indefinitely, and is clearly a recipe for disaster,” it warns. (See page 46 for separate chapter on pension funds.) s

“Some European infrastructure

specialists have pulled out of

overseas lending altogether, with

many banks tending to focus on their home market”

John Kirwan, Scotiabank

Financing the energy sector


Given the importance of the energy sector to the Canadian economy — 6.8% of GDP and 16% of total invest-ment, according to the energy Council of Canada — it accounts for a surpris-ingly modest share of the country’s corporate bond market.

According to CiBC, energy-related issuance reached $5.575bn in 2012, or 15.7% of total Canadian dollar corpo-rate non-financial issuance. Of this total, which was up from 13.7% of all issuance in 2011, $3.95bn was account-ed for by investment grade issuance, with $1.625bn in the high yield market.

By early September, total issuance in 2013 was $3.985bn, or 14.7% of the total, with the distribution between investment grade and high yield issu-ance similar to 2012. these numbers, however, refer to issuance in the entire sector, which includes energy-related infrastructure.

Sean Gilbert, managing director of debt capital markets at CiBC World Markets, says that on average, explo-ration and production (e&P) compa-nies account for between 2% and 5% of total annual issuance.

that is well below the market’s capacity. “On the investment grade side we believe the Canadian dol-lar market has the capacity to absorb between $4bn and $6bn annually of e&P issuance, and we’re nowhere near that level today,” says Gilbert.

Bankers say that the outlook for issuance in the broader Canadian energy sector is mixed. “in terms of access to capital, i would divide the industry into the e&P or upstream sector on the one hand and the infra-structure or midstream sector on the other,” says Derek neldner, manag-ing director and head of the Canadian energy group at RBC in Calgary.

“For e&P companies, the capi-tal intensity of the Canadian energy industry has continued to increase. At the same time, with commodity prices under pressure and the sector out of favour in the capital markets, for many

companies access to the debt and equity markets has been challenged.” the result, he says, is that much of the sector has been reliant either on cashflow, bank debt, or asset sales to underpin its financing requirement.

Randy Ollenberger, managing director and head of the oil and gas research group at BMO Capital Mar-kets, agrees that while capex plans at the largest companies remain exten-sive, little of this is likely to feed through into capital market issu-ance. “Five years ago there were many more oil sands projects in the pipeline than there are today,” he says. “today, the investment plans are much more concentrated among the larger companies such as Sun-cor and imperial Oil. these compa-nies are still spending tremendous amounts of money, and oil sands probably represents about $25bn a year of capex for each of the next five years. But this will largely be funded by cashflow, with a small amount of incremental debt and not much in the way of equity.”

Living within their meansthat may reflect the inherent conserv-atism of large sections of the Canadi-an corporate sector. “in the large cap sector the mantra is of companies liv-ing within their means,” says CiBC’s Gilbert. “the funding requirements of these companies will be relatively modest and focus chiefly on refinanc-ings. While they won’t look to shrink their aggregate debt, these companies are wary of increasing it, especially in the gas-weighted sector.”

there is certainly little sign of any immediate refinancing pressures in the Canadian energy sector. According to DBRS: “Liquidity, defined as cash balances and available credit facilities, decreased slightly but still remained well above historical norms for the sector in Q1 2013.” Cash balances, says the DBRS report, reached $200bn in the first quarter of this year.

the DBRS analysis adds that “on average, maturities are well spread out, with no concentration of matur-ing debt.” With more than 45% of debt maturities due in 2018 and beyond, says DBRS, “refinancing risk remains low across the sector.”

DBRS advises, however, that “for some smaller operators, there is slight-ly greater refinancing risk, as available liquidity is often in the form of credit facilities as opposed to cash.”

CiBC’s Gilbert agrees that relative external funding requirements may be higher in the non-investment grade sector than they are among the largest companies. “On the high yield side, we may see companies increase budgets, because the smaller you are, the more important it is to maintain and grow production levels,” he says.

Midstream potentialGilbert and other bankers say, how-ever, that a more vibrant area of the capital market may be bond issuance from companies in the infrastructure or so-called midstream sector of the energy industry. “there is a continual shortage of transportation pipelines and rising demand for gas treatment, processing and gathering companies,” says Gilbert. “the midstream sector has emerged as a source of about $3bn of supply a year, which is double the size of the market five years ago.”

At RBC, neldner agrees. “there are a lot of growth projects underway in the energy infrastructure sector call-

With exploration and development energy companies reliant on cashflows, bank debt or asset sales, capital markets bankers are finding more joy in the infrastructure or so-called midstream sector. Philip Moore reports.

Midstream sector offers most potential for capital markets

“The Canadian dollar market has the

capacity to absorb $4bn-$6bn annually

of E&P issuance, and we’re nowhere near

that level today”

Sean Gilbert, CIBC

Financing the energy sector


ing for a significant amount of funding. the energy infra-structure organiza-tions have very strong access to financing, which is the polar opposite to what we’re seeing in the e&P sec-tor,” he says.

Rising issuance in the energy infrastruc-ture sector, says Gilbert, has dove-tailed with growing demand among local institutional investors, especial-ly at the long end of the yield curve, where infrastructure requirements are highest. the most extreme example was the issue in July 2012 of a $100m 100 year transaction by enbridge Pipe-lines, which was the first 100 year issue from a Canadian borrower for 15 years. the ultra-long enbridge deal, led by BMO nesbitt Burns, was bought by a single insurance company, and priced at a coupon of 4.1%, or 185bp over the Canadian government curve. the company said at the time that this represented no more than a modest premium over what it would have paid for a 30 year bond.

“the Canadian market is evolving towards longer dated and larger deals,” says Gilbert, who points to two recent issues in the energy infrastructure sec-tor as evidence of the trend. the first of these is the $700m two-tranche issue launched in June by the Calgary-based pipeline and gas distribution utility holding company, enbridge inc, which is undertaking a $32bn five year capex programme. the enbridge issue, led by CiBC, hSBC and RBC, was split into a $450m 10 year tranche priced at 150.4bp over Canadian gov-ernment bonds, and a $250m re-opening of an existing 2042 bond, at a spread of 178bp. that, says Gilbert, made the endbridge issue a landmark transaction, given that it was the com-pany’s largest issue to date.

Another notable recent transaction, says Gilbert, was the $200m 2043 issue for the Calgary-based transportation and midstream service provider, Pem-bina Pipeline Corp, which was its first 30 year transaction. Led by CiBC and national Bank, the Pembina issue was increased from an originally planned $150m, with momentum driven by a few large reverse enquiries.

this strong demand, says Gilbert, allowed the triple-B rated Pembina

to achieve its objective of pricing at a sub-5% coupon, with the issue priced at 4.75%, which equated to a spread over the government benchmark of 235bp. “the fact that Pembina’s 30 year transaction was so well received is a strong indication of how comforta-ble the investor base has become with the midstream sector,” says Gilbert.

that investor base, says neldner at RBC, is attracted by what he describes as an almost perfect set of circum-stances. “energy infrastructure com-panies are very appealing to investors because they offer a unique combi-nation of defensive characteristics, strong organic growth prospects, and an attractive yield,” he says.

in the upstream sector, investor demand also remains strong. Limited supply, however, is opening up oppor-tunities for top quality international issuers to access the Canadian investor base. “Because e&P issuance by Cana-dian companies has been relatively quiet, the secondary market for this sector is fairly tightly bid,” says Gil-bert. “that has led companies like BP to look at the market which can absorb issues of $500m or more at very com-petitive levels.”

Equity cautionAnalysts say that while many of the top companies in the Canadian energy sector may continue to enjoy ample access to bank debt and to liquidity in the bond market, the equity market has been much less accommodating, for a number of reasons. “Concerns over global economic growth, the out-look for China and emerging markets, and implications for commodity pric-es have led investors to underweight the energy sector in general,” says neldner at RBC in Calgary. “Against this cautious background for energy globally, equity investors in the US and europe have tended to put their capital to work in their home market rather than in Canada.”

there are also a num-ber of more specific factors that have made equity investors wary of the Canadian e&P sec-tor. Foremost among these, says Ollenberger at BMO, has been the competition for inves-tors’ attention that has been created by the shale oil boom in the

US. this recently led the international energy Agency (ieA) to forecast that the US will overtake Saudi Arabia as the world’s leading oil producer. “the growth of the shale oil sector has led to a lot of new equity issuance in the US which has satisfied the appetite of US investors and displaced much of their traditional demand for Canadian equi-ty,” says Ollenberger. “there is also a perception among international inves-tors that Canada is a higher cost juris-diction than the US, when in fact the supply costs for oil sands projects are generally competitive with shale oil.”

Buffett callsinternational equity investors may, however, be missing a trick. As neld-ner at RBC in Calgary says, perhaps the strongest indication that the Cana-dian energy sector represents attrac-tive value was the recent purchase by Warren Buffett of 17.8m shares in Canada’s largest oil and gas company, Suncor energy. “Buffett has obviously done very well as a value investor and he clearly believes certain Canadian energy companies are now trading at too much of a discount,” says neldner.

“he is right to regard the sector as undervalued,” neldner adds. “We have had a strong energy sector for multiple decades, which has always been regard-ed as a global operational and techno-logical leader and has proved itself to be entrepreneurial and adaptable.”

Public equity investors’ loss may be private investors’ gain, says neld-ner. in the continued absence of much support from the public equity mar-ket, he says, a number of Canadian energy companies have been explor-ing alternative funding sources. “Com-panies can only take on so much debt,” he says. “With public equity markets challenged we will see more companies trying to raise additional capital through asset sales or by bring-ing in joint venture partners or private equity investors.” s

All figures in C$m 2011 2012 2013 YTD Total C$ corporate non-financial issuance $31,024 $35,403 $27,170

Total investment grade energy related issuance $2,500 $3,950 $2,975

% of total C$ corporate non-financial issuance 8.1% 11.2% 10.9%

Total high yield energy related issuance 1,745 $1,625 $1,010

% of total C$ corporate non-financial issuance 5.6% 4.6% 3.7%

Total combined energy related issuance $4,245 $5,575 $3,985

% of total C$ corporate non-financial issuance 13.7% 15.7% 14.7% 1 Includes all C$ energy infrastructure and oil and gas offerings in the Canadian market as of Sept 4, 2013.

Canadian energy related issuance1

Source: CIBC Internal Database.

HigH grade Corporates


In Canada’s bond market, 2013 has been a year of strong investment grade issuance, especially in the cor-porate sector. Firms have pulled off numerous refinancings, liability man-agement exercises and, more exciting-ly, merger and acquisition financings.

Four bonds to finance M&a have been issued this year, totalling C$3.9bn — far ahead of 2011’s full year record of C$1.582bn, according to dea-logic.

“The Canadian high grade market has been very happy to finance acqui-sitions in 2013,” says susan Rimmer, managing director and head, debt capital markets — corporates and financial institutions at CIbC. “The domestic M&a calendar has been quite robust this year and we have seen bridge takeouts in the bond mar-ket, for example the escrow deal for sobeys, which is buying Canada safe-way, terming out the bridge for the benefit of the acquisition.”

supermarket chain sobeys bought more than 200 safeway stores in west-ern Canada for C$5.8bn in June. To finance the deal it issued C$1bn of 2018 and 2023 bonds in July, along-side an equity offering by sobeys’ par-ent Empire, a sale and leaseback and a loan.

“over the last 12 months we’ve seen some household Canadian brands make transformational acquisitions, both domestically and abroad,” says sean st John, co-head of fixed income at national bank Financial in Toronto. “Having the likes of [retailer] Loblaw, sobeys, [telco] bCE and [convenience store chain] Couche-Tard all finance these acquisitions in the Canadian market speaks volumes about the depth and breadth of the investor base.”

The growth of the Canadian bond market in the past few years has given Canadian companies access to domes-tic capital they have not had before, which st John believes is fuelling

growth in the Canadian economy.The average deal size has risen,

partly driven by investors’ desire for liquidity, according to Greg Greer, head of debt capital markets at sco-tiabank in Toronto. “as a result, transactions are sized according to demand, while giving considera-tion to the issuer and its needs,” he says. “In addition, the potential to print larger deals attracts global bor-rowers, borrowers that are active in other debt capital markets, to the Canadian market.”

The largest non-financial corpo-rate deal of 2013 so far was the C$1.7bn bond for Telus, the telecoms and satel-lite TV group. The C$1.1bn 11 year and C$600m 30 year notes were an exam-ple of companies using liability man-agement to take full advantage of low interest rates. These larger deals cater for Canada’s growing investor base.

“In a typical investment grade deal, around five years ago, you would have had 40-45 buyers; today you have 100-plus buyers,” says st John. “Given the growth of the number of investors and the money available in fixed income, the market has been able to deal with more supply, bigger size and more diverse issuance.”

This has not only come from Cana-dian companies. around C$4bn of bonds have been issued this year in Canada’s resurgent Maple market, among them European heavyweights bHP billiton and anheuser-busch Inbev.

“We saw significant Maple bond supply this year, as issuers were look-ing to broaden their investor bases into Canada,” says CIbC’s Rimmer. “and issuers were able to do so at a cost of funds that was competitive with global markets.” (See page 60)

US bid keener for long bondsCanadian investors will buy bonds with maturities from three to 30 years and in some cases longer, but at the

moment there is keen demand in the five to 10 year belly of the curve for corporate paper, with continued interest for long dated utility bonds.

at present, Canadian firms want-ing 30 year debt may be better off in the Us market, according to Patrick Macdonald, co-head of dCM at RbC in Canada.

Rogers Communications, the tele-coms and cable TV group, sold $500m 10 year and $500m 30 year bonds with 3% and 4.5% coupons in February.

“Certainly, one of the reasons a Canadian issuer would look south of the border would be to take advantage of attractive pricing at 30 years and to take advantage of the depth of that market,” says Macdonald.

Rogers needs Canadian dollar pro-ceeds, so any Us issuance was prob-ably swapped, but other Canadian firms have a natural need for Us dol-lars.

“For the borrower the questions are, what is my most economic source of funding, what is the optimal term of my financing, and what would I need to do to bring the proceeds back into my currency of choice,” says amery dunn, head of Us dCM and syndi-cate at RbC in new York. “some of the Canadian corporates have a strong preference for Us dollars because of the nature of their industries, be it commodities or mining, but in general issuers look across jurisdictions for the best funding opportunities.” s

A surge in corporate mergers and acquisitions in 2013 has been fed by a record total of M&A-related investment grade bond financings. With C$27bn of total corporate issuance so far this year, bankers think 2013 could prove to be the Canadian market’s busiest year yet. Stefanie Linhardt reports.

Lively bond market eager forM&A deals, corporate Maples

“We saw significant Maple bond supply this year, as issuers

were looking to broaden their

investor bases into Canada”

Susan Rimmer, CIBC

HigH Yield


Since 2009, with the resurgence of the high yield bond market in cana-da, speculative grade companies have been spoilt for choice. they can raise money in the fast-paced and vigorous US high yield market, where $10bn of deals can easily be printed in a week. But there is also the domestic cana-dian market, which allows issuers to raise capital in canadian dollars, if not in the same amounts.

high yield issuance in canadian dol-lars has reached c$2.8bn from a dozen deals this year. And there is a good pipeline until year end, says Susan Rimmer, managing director and head, debt capital markets — corporates and financial institutions at ciBc.

Some say full year issuance could surpass last year’s record of c$5.2bn and maybe even reach c$6bn.

Sean St John, co-head of fixed income at national Bank Financial, is more doubtful. “the bulk of natu-ral high yield issuers came out of the gate in 2009-2011, and now there isn’t the massive number of potential high yield issuers,” he says. “the market is going to have its bigger years and soft-er years, depending on where we are

in the refinancing schedule and with M&A-related special situations. i think we are going to finish the year light in high yield issuance.”

issuance compared to the mighty US market still looks tiny, but it stacks up better compared with the $11.2bn (c$11.6bn) of US dollar high yield bonds sold by canadian issuers so far this year.

“there are things that make the two markets separate and distinct, but there is a lot of bleed-over between the US and canada,” says Kete cockrell, group head of high yield capital mar-kets at RBc capital Markets. “it is best for investors and issuers not to think

of it as silos but look at it as one larger, broader north American market.”

Many issu-ers in the canadian mar-ket have previ-ously issued in the US. One such is Vid-éotron, the Quebec-based integrated tel-ecoms com-pany owned by Québecor Média. it used to be an active Yankee bond

issuer before turning to canada.“Vidéotron and Québecor Média are

longstanding issuers in the US high yield market that have now successful-ly included canadian dollar high yield bond offerings in their funding mix,” says Rimmer.

Vidéotron issued its first bond in the US as a $150m 10 year investment grade issue in 1992. it returned as a high yield issuer in 2003, but since 2010 has been active in the canadian market. its last bond was a c$400m 12 year issue in June this year.

“we are now entering a cycle of refi-nancing of canadian dollar high yield bonds, which demonstrates the devel-opment of a sustainable market,” says Greg Greer, head of debt capital mar-kets at Scotiabank in toronto.

Like Vidéotron, many former US high yield issuers are now choosing canada over the US.

Size matters, so does currency“historically, a number of canadian issuers accessing the US high yield market were forced to go into an unnatural currency for their debt capi-tal requirements, with expensive cross-currency swaps they needed to overlay or take currency exposure, so having an avenue into high yield in canada is much more attractive to them,” says Richard Sibthorpe, head of canadian DcM at BMO capital Markets.

those that still prefer the US mar-ket either naturally need US dollars to finance their businesses, like mining and energy companies, adds Sibthor-pe, or want to raise larger amounts.

the biggest high yield bond ever in canada was Athabasca Oil’s c$550m five year deal in november 2012.

“companies value that the canadi-an market gives them an alternative to doing a massive deal in the US, which they have to swap back into canadi-an dollars,” says Mark MacPherson, a director at BMO. “they can now print paper in canadian dollars and do it in a smaller size, without having to pay

It is a luxury, being a speculative grade-rated company in Canada. With the vast North American market on its doorstep, a Canadian issuer can choose between the mother of all junk bond markets, the US, or the steadily evolving Canadian high yield market. Stefanie Linhardt reports.

Canadian high yield issuers: spoilt for choice in funding

“There is demand in

both the Canadian and US high yield

markets for the other currency”

Sean St John, National Bank

Financial

Canadian high yield issuance: at home and in the US

Source: Source: CIBC (domestic) / Dealogic (US market)

0

2

4

6

8

10

12

14

16

18

20 C$bn

2009 2010 2011 2012 2013 YTD

Canadian high yield issuance: at home and in US

Source: CIBC (domestic ) / Dealogic (US market )

Canadian HY issuance in domestic market

Canadian HY issuance in US market

HigH Yield


up — minimum deal sizes in the US are in the $200m range but in cana-da, we can do deals in the c$100m-c$125m range for the right name.”

the possibility of small trades ben-efits smaller issuers. even companies with an ebitda of as little as c$30m could access the canadian market, as long as leverage does not rise too high.

On the other hand, if an issuer wants a larger size, it can go to the US or split its deal across the border.

the $740m-equivalent dual tranche transaction for tervita, the energy and environmental services company, was one of this year’s best examples.

tervita, which had tapped the US market for the first time in October 2012, sold a $650m tranche with an 8% coupon and a c$200m 9% piece, both with november 2018 maturi-ties.

Lead bookrunners were RBc, Goldman Sachs, tD Securities and Deutsche Bank, with co-managers ciBc and nBF alongside Barclays, credit Suisse and JP Morgan.

“there is demand in both the cana-dian and US high yield markets for the other currency — there is plenty of US dollar demand in canada and some canadian dollar demand in the US,” says cockrell at RBc.

“however, the markets are much deeper for their native currencies. By doing both canadian and US dollars, we can garner the great-est demand and attention out of the combined markets, which often

results in superior execution for both transactions.”

Homegrown LBO bondBeing the larger and more advanced market, the US is the first choice for more challenging financings such as dividend recapitalisations, leveraged buy-outs and more geared structures.

“the canadian high yield market is primarily composed of double-B and single-B category credits,” says Scoti-abank’s Greer. “however, lower rated and unrated credits have access to the market if transactions are appropriate in terms of structure and pricing.”

A direct LBO financing in the cana-dian bond market has not yet been possible, but the investor base has become more sophisticated. “the number of canadian investors in the high yield market has increased over the past years, more than doubling since 2009,” says Rimmer at ciBc.

Bankers say a typical high yield deal used to attract around 15 buyers, now it has 35-40.

“in the next wave of development in our market — as the investor base grows and as investors become more comfortable with aggressive financ-ing structures and covenant packag-es — we expect that we will start see-ing homegrown canadian LBOs in the canadian market,” says Rob Brown, co-head of debt capital markets cana-da at RBc. “But so far our LBO experi-ence has been fairly limited.”

the canadian market does, howev-

er, finance deals from private equity-owned companies, even acquisition-related ones.

GFL environmental, a waste recy-cling business in toronto, issued a c$200m 7.5% 2018 bond in June, part-ly to refinance its revolving credit facil-ity and partly for acquisitions, without indicating a target.

“GFL was an interesting deal because it was a sponsor-owned com-pany and because the proceeds of the deal were used for both refinancing and for growth,” says MacPherson at BMO. “GFL is known to have grown dramatically in recent years through acquisitions and the proceeds will help them to grow further.”

One aspect of the canadian high yield market that is both a strength and a weakness is its illiquidity. On one hand, this makes the secondary market more stable than that in the US, where inflows and outflows — especially from exchange-traded funds — cause sharp swings.

“All my traders talk about etF flows in the US and how good credits can get sideswiped by etFs, especially larger issuers that are a bigger part of the etF,” says St John at national Bank.

On the other hand, he feels there is still room for more liquidity in the canadian market. “You need all deal-ers supporting the secondary mar-ket and investors, too, can do more to provide more liquidity. there are only a handful of investors who actually trade stuff.” s

With Canadian high yield bonds of a mini-mum size of C$125m possible — as atM pro-vider directCash Payments’ seven year bond in august 2012 showed — the capital market can also be an option for medium sized busi-nesses in Canada. But for small firms, the bank is usually the first port of call.

in Canada, around 2.2m businesses have revenues of less than C$1m a year, against 350,000 with revenues greater than that, according to Peter Conrod, vice president, client and business strategy, business finan-cial services at RBC in Canada.

about 26% of all Canadian businesses are internationally active, mainly in the US, which means they either buy or sell over-seas or have an office, division or subsidiary outside the country. around 7% of Canadian businesses are looking for banking services

from a bank in a foreign country.SMEs mainly turn to their relationship

banks to access funding, Conrod says. Of-ten this is through operating lines to fi-nance receivables and inventory, and term financing or leasing to finance fixed assets. Some larger businesses take out bankers’ acceptances for their short term credit needs.

“debt capital is relatively accessible and robust and we approve around 85%-90% of all business credit applications we get,” Conrod says. “When it comes to raising eq-uity, this can be more challenging.”

however, businesses in the information and communication, life sciences and me-dia and entertainment sectors, which can convince investors they have a growth tra-jectory, can tap money from business an-

gels, venture capitalists and private equity.apart from the six big lending banks,

SMEs can also reach out to credit unions, and regional lenders, while the government also offers business loans and grants of C$1,500-C$10m. s

Canadian SMEs — financing for 86% of the businesses

“Debt capital is relatively

accessible and robust and we

approve 85%-90% of applications”

Peter Conrod, Royal Bank of Canada

MAPLE BONDS


With C$3.35bn printed so far, 2013 has already seen the second highest volume issued in the Maple market since 2007. While there is still a way to go to top the C$4.4bn of Maple bonds sold in 2012, it is by no means an unachievable target, with syndi-cate bankers hoping for a busy close to the year. the final four months of 2012 saw C$2.4bn of issuance and the closing months of the year often prove the busiest, both in the Maple and domestic Canadian market, according to syndicate managers.

“We had a loose target of C$4bn-C$6bn of issuance,” says ian White, vice president in debt products at Bank of Montreal. “We’re on target to exceed that at the moment and the market mood is constructive. Looking at Maple issuance in previ-ous years September is often very busy and this carries through to the end of the year.”

Even if year-to-date volumes fail to improve on 2012, they are still encouraging and there have been a number of developments that are leaving Maple syndicate bank-ers feeling very confident for the future.

Extending durationOne trend that bankers have picked up on in 2013 is a growing bid for long dated paper. the Maple market has traditionally been centred on bonds with a five year tenor. While five year notes have by no means fallen out of favour investors are willing to look a little further along the curve for the right issuer.

“We’ve seen two trends this year — deals have got bigger and the maturities have got longer,” says Michal Cegielski, director in debt capital markets at Bank of Montre-al. “this year we’ve seen two big 10 year deals. investors like the extra yield on offer with a longer maturi-ty, though obviously not any issuer

is going to be able to do a 10 year Maple. investors really have to be comfortable with the name.”

Belgian brewer Anheuser-Busch inBev was one such issuer, selling a hefty C$1.2bn in the first month of the year, split equally between five and 10 year tranches. BhP Billiton proved that AB inBev’s trade wasn’t just a one-off when it sold C$750m of 10 year bonds in May.

the extra maturity on offer isn’t the only thing that is increasing issuers’ attraction of the Maple market. the growing size of deals is encouraging more to spend two or three days making the trip to Canada to meet investors face to face — an element of the process that most debt capital market bankers deem essential.

“A few years ago an issuer would ask what size bond they could expect to issue on the Maple mar-ket and i’d have to look down and tell them they could sell C$300m or so,” says one DCM banker. “Now i can look issuers in the eye and tell them they can be confident of a C$500m or C$750m deal. A deal that size is what justifies the work they have to put into a roadshow and that’s what’s really changed over the last 18 months.”

More liquidityMaple bonds have suffered from a reputation for illiquidity in large part because of the predominance of financial institutions in the mar-ket in the days before the global financial crisis.

“i’ve had investors ask why they should buy Maples when they lost money on them in the past,” says a Maple DCM banker. “the problem isn’t that they bought Maples, it’s that they bought Bradford & Bingley or Bear Stearns or Lehman Broth-ers.”

however, the Maple market as

it stands today is a very different beast to its pre-crisis days. Corpo-rates make up an increasingly large share of issuance, which bankers say should lead to a more robust and healthy market. in 2007 — the Maple market’s peak — less than 1% of Maple bonds came from corpo-rates, but over 2012 and 2013 cor-porate bonds have accounted for slightly over 60% of new issuance.

Canadian investors remain keen to see new corporate issuers in Maple format, largely for the diver-sification they offer. While corporate Maple issuers tend to have bonds in a number of other currencies before selling Canadian dollar denominat-ed debt, Canadian investors have a natural preference for picking up paper in their own currency. But investors remain wary of issuers that do not already have established liquid curves in other currencies, meaning the Maple market is likely to remain fertile ground for only veteran borrowers.

“investors continue to look for attractive diversification opportuni-ties into new names with demand highly dependent on the borrower’s domicile, sector, credit ratings and regulatory landscape,” says Pat-rick MacDonald, co-head of Cana-dian debt capital markets at Royal Bank of Canada. “Well recognised corporates with solid financials and

The investor base for Maple bonds is growing, more corporate issuers are keen to visit Canada and even the yield curve is extending. Nathan Collins looks at the Maple market as it tries to shake off a reputation for illiquidity and FIG dominance.

A sweet future in store for Maple market

“Investor market-ing is still a critical

ingredient in gaining access to the Maple

market — a simple one or two day

roadshow goes a very long way”

Patrick MacDonald, RBC

MAPLE BONDS


operating performance continue to be well received. having said that, investor marketing is still a critical ingredient in gaining access to the Maple market — a simple one or two day roadshow goes a very long way.”

But Maple investors are a demanding bunch. Savvy Canadian investors baulk at any signs of an issuer looking to take advantage of cross-currency arbitrage, demand-ing that a deal be priced in line with the issuer’s other funding curren-cy. Fortunately issuers seem will-ing to accommodate them in a bid to diversify their funding base and help to develop the market reach maturity.

“issuers aren’t looking at the Maple market for opportunistic arbitrage,” says MacDonald. “Rath-er, they are increasingly recognis-ing Canada is a deep, efficient and rational market that provides issu-ers with cost-effective funding diversification, an opportunity to expand their global investor base and a very straightforward docu-mentation process that allows for expedient market access.”

Broader basethe Maple market has also ben-efited from a change in attitude towards the structure of syndicate groups. Pre-crisis Maple deals tend-ed to have less involvement from the larger Canadian banks, relying more on international institutions that were less familiar with the local market.

“trades coming to market post-

crisis tend to have syndicates with several of the larger Canadian banks involved in a meaningful way,” says Andrew Ryde, head of European DCM at CiBC. “this gives investors the comfort they need that there will be liquidity in the secondary market and that they will be able to go to a number of banks to get a price. in terms of liquidity, it is also worth noting that most deals are now much more broadly distrib-uted, several of the recent corpo-rate Maples have been placed with upwards of 50 accounts — more like domestic deals.”

MetLife — a fairly regular issuer of Maples — sold a C$300m seven year bond in July that attracted interest from around 40 accounts. Just a year or two ago the issuer would have considered itself lucky to see 25 investors participate, according to a syndicate banker involved with the deal.

Bankers in the Maple market are keen to shake the format’s reputa-tion as being something of a fair-weather friend, only open when the climate is favourable. For exam-ple, BhP Billiton was able to secure strong demand at a tricky maturity in an environment that was not par-ticularly conducive to success for miners.

“in general, Canadian investors are willing to do the necessary ana-lytical work and will support a new issue if the credit makes sense and if the relative value is fair,” says CiBC’s Ryde.

“the BhP Billiton roadshow

coincided with the start of a sharp sell-off in commodity markets, but investors still took part in large numbers. they were willing to look beyond the short term volatility to the underlying strength of the credit.”

that’s not to say that investors will buy anything — issuers from the eurozone’s troubled periph-ery are likely to have a tricky time appealing to Canadian investors but it isn’t an insurmountable obstacle, says one syndicate official.

SSAs resurgence unlikelyWhile several SSA issuers have been able to bring successful Canadi-an dollar denominated deals this year, not a single one has tapped the Maple market, opting instead for international deals. indeed, there has been only one Maple bond sold by a public sector issuer since 2007, when Norway’s Kommunalbanken sold a 10 year bond in 2011.

international investors are keen to diversify the currency mix of their holdings of SSA debt, however it remains tricky for issuers to agree with domestic accounts on pricing. Canadian investors are spoiled for choice with high volumes of issu-ance from domestic public sector entities — provinces, particularly Ontario and Quebec, are frequent issuers as is the Canada housing trust.

“investors are very comfortable with provinces and Canada Mort-gage Bonds, these are very safe and liquid investments,” said Andrew hainsworth, managing director in debt capital markets at Bank of Montreal. “A domestic investor looks at a supranational borrow-ing in Canadian dollars and wants a yield pick-up over local issuers to make up for the reduced liquidity. At the same time, these borrowers will generally price inside of Cana-dian issuers in other markets and want to do the same in Canadian dollars.”

With Canadian dollar deals from SSAs proving popular with offshore investors — KfW was able to sell C$1bn of five year paper in June — there seems little reason for issu-ers to meet the pricing demands of domestic investors and the Maple market is likely to remain restricted to private sector issuers. s

Maple volumes by year

Source: Dealogic

0

5

10

C$bn

15

20

2013 (ytd)20122011201020092008200720062005

Canada In FIGURES


Over the following pages EuroWeek provides a snapshot of Canada’s macro-economic, bond market and bank sector data, from a range of official sources, including the Department of Finance, Statistics Canada, OSFI and the leading rating agencies. For more detailed information, please refer to the websites of these institutions.

Canada in figures: an economic snapshot

Standard & Poor’s: AAA • Moody’s: Aaa • Fitch: AAA • DBRS: AAA

All Stable Outlook

Treasury Board of Canada

Bank of CanadadeparTmenT of finanCe

offiCe of The superinTendenT of finanCial insTiTuTions Canada

James flaherty, Minister of Finance

Julie dickson, Superintendent

mark Zelmer, Deputy Superintendent

andrew kriegler, Deputy Superintendent

kevin sorenson, Minister of State (Finance)

michael horgan Deputy Minister

Tony Clement, President

stephen poloz, Governor

yaprak Baltacioglu, Secretary of the Treasury Board

Tiff macklem, Senior Deputy Governor

seleCTed key offiCials

2007 2008 2009 2010 2011 2012 2013F 2014F

Real GDP (% change) 2.0 1.2 -2.7 3.4 2.5 1.7 1.6 2.6

Inflation (CPI, % change Dec/Dec) 2.5 1.2 1.3 2.4 2.3 0.9 1.6 1.9

Gen. Gov. Financial Balance/GDP (%) 2.6 0.9 -3.1 -3.4 -2.5 -2.2 -1.6 -0.9

Gen. Gov. Primary Balance/GDP (%) 6.6 4.7 0.7 0.3 1.1 1.1 1.6 2.2

Gen. Gov. Debt/GDP (%) 53.5 57.7 68.3 69.6 70.3 72.5 72.1 69.9

Gen. Gov. Debt/Gen. Gov. Revenue (%) 134.7 150.1 177.8 185.1 187.5 193.0 189.3 182.7

Gen. Gov. Int. Pymt/Gen. Gov. Revenue (%) 10.2 9.8 9.7 9.6 9.5 8.8 8.5 8.1

Current Account Balance/GDP 0.8 0.1 -2.9 -3.5 -2.8 -3.4 -3.9 -3.4

Source: Moody’s

key eConomiC indiCaTors

Canada In FIGURES


Current account balances

$bn, seasonally adjusted

Source: Statistics Canada

2.0

15

10

5

0

-5

-10

-15

-20

2008

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2009 2010 2011 2012 2013

Goods Other current account Total

CurrenT aCCounT BalanCes


Major Rating Factors

Strengths:

• Extremely effective, stable, and predictable policymaking and political institutions

• A highly resilient economy

• Better-than-average fiscal and external indicators

• Extremely strong monetary flexibility

Weaknesses:

• High dependence on U.S. economy and U.S. financial conditions

Rationale

The ratings on Canada reflect Standard & Poor’s Ratings Services’ opinion of the country’s relatively diversified and resilient economy and its effective and predictable policymaking and political institutions. Canadian authorities have a strong track record in managing economic and financial crises and delivering economic growth. During the recent global financial crisis and recession, no Canadian financial institution required a government injection of capital and Canadian real GDP per capita growth exceeded U.S. growth in almost every year of the 2007-2011 period. Canadian governments have demonstrated an ability and willingness to implement reforms to ensure sustainable public finances over the long term. We expect Canadian institutions and the broad direction of Canadian policies to remain stable over time, ensuring the predictability of responses to future crises.

Underpinning Canada’s monetary flexibility are the sovereign’s free-floating exchange rate regime, its well-established monetary policy credibility, and monetary transmission mechanisms that are strong and stable.

Our view of Canadian fiscal flexibility reflects the government’s ability to run countercyclical policies, and reduce increases in general government debt, which have been 6%-7% of GDP annually since 2008, to below 2% of GDP over the next few years. As a result, we expect net general government debt to peak at about 54% of GDP this year and to fall below 50% in 2015.

Canada’s external flexibility reflects the Canadian dollar’s status as an actively traded currency, low current account deficits, and a net external liability position of about 50% of current account receipts. More than half of the gross external liabilities are related to foreign direct investment and portfolio equity, which are less burdensome in most circumstances. External debt, net of reserves and other liquid external assets, has risen to slightly more than 80% of current account receipts this year, but we expect it to ease, as receipts gradually recover with the U.S. economy. The greatest potential risk to Canada’s external position would be deterioration of the Canadian financial sector’s domestic or foreign loan book that could raise external funding costs. We view this risk as small, given Standard & Poor’s credit ratings on the large, internationally active Canadian financial institutions, all of which are in the ‘A’ or ‘AA’ categories.

Canada’s economy is highly dependent on the economy of the U.S. (unsolicited ratings AA+/Negative/A-1+). About three-quarters of goods exported and about half of goods imported are traded with the U.S., and Canadian financial markets are also deeply interconnected with U.S. ones. Many of the trade linkages are intra-firm, contributing to stability of flows and somewhat mitigating this concentration risk.

In addition, despite several elevated measures of Canadian household indebtedness and house prices, including household credit market debt to disposable income of 162% in 2011, we continue to view Canada’s contingent liabilities as limited. We view micro- and macro-prudential factors as stronger than in many peer countries at the time of their housing market corrections.

December 31, 2012

sTandard & poor’s opinion

Canadian Recovery is Weak, but Favorable Compared with Global Peers

Canadian & global peers: Real GDP growth & unemployment rate, Moody’s 2013 forecast

Source: Moody’s

Canada

France

Germany

Italy

Spain

Australia

United Kingdom

United States

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

0% 5% 10% 15% 20% 25% 30%

Rea

l GD

P g

row

th

Unemployment rate

Canada and gloBal peers: real gdp growTh & unemploymenT raTe, moody’s 2013 foreCasT

Source: Moody’s

2009–10 2010–11 2011–12 2012–13 2013–14 Actual Actual Actual Projected PlannedTreasurybills 176 163 163 181 149Marketablebonds 368 416 448 466 477Retaildebt 12 10 9 8 7Foreigndebt 8 8 11 11 15CPPbonds 0.5 0 0 0 0Totalmarketdebt 564 597 631 665 648Note:Numbersmaynotaddduetorounding.

Source: Department of Finance Canada

Change in ComposiTion of markeT deBT (C$bn)

Canada In FIGURES


Source: Department of Finance, Statistics Canada, DBRS

8%

9%

10%

11%

12%

13%

14%

15%

16%

17%

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

Canada: central government revenues, expenditures & fiscal balance

Fiscal Balance (% GDP, LHS)

Program Expenditures (% GDP, RHS)

Revenues (% GDP, RHS)

Source: Department of Finance, DBRS estimates

0%

10%

20%

30%

40%

50%

60%

250

300

350

400

450

500

550

600

650

700

Canada: government unmatured debt

$ Billions (LHS)

% of GDP (RHS)

P: Projected; B: Budgeted

Source: Bank of Canada, Statistics Canada

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Canada: target overnight rate and inflation

CPI

Core CPI

Target Overnight Rate


(5.0%)

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

Canada: composition of the current account (% of GDP)

Goods

Services

Income

Transfers

Current Account

TargeT overnighT raTe and inflaTion



8%

9%

10%

11%

12%

13%

14%

15%

16%

17%

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%






0%

10%

20%

30%

40%

50%

60%

250

300

350

400

450

500

550

600

650

700


$ Billions (LHS)

% of GDP (RHS)



(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%


CPI

Core CPI



(5.0%)

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Goods

Services

Income

Transfers

Current Account

CenTral governmenT revenues, expendiTures & fisCal BalanCe



8%

9%

10%

11%

12%

13%

14%

15%

16%

17%

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%






0%

10%

20%

30%

40%

50%

60%

250

300

350

400

450

500

550

600

650

700


$ Billions (LHS)

% of GDP (RHS)



(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%


CPI

Core CPI



(5.0%)

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Goods

Services

Income

Transfers

Current Account

ComposiTion of The CurrenT aCCounT (% of gdp)


Credit Strengths

Canada’s credit strengths include the following:

• Advanced industrial economy with sound monetary policy and flexible exchange rate

• Strong banking system that weathered to global financial crisis without major stress

• Political consensus on maintaining relatively low government debt levels

Credit Challenges

Canada’s credit challenges include the following:

• Still relatively high general government debt ratios, although the federal government’s position is strong

• High concentration of external economic and financial relations with the United States

Rating Rationale

Canada’s Aaa rating is based on the country’s very high degree of economic resiliency, its high government financial strength, and its low susceptibility to event risk. The economy’s resiliency is demonstrated by very high per capita income, the large scale of the economy, and its diversity. Natural resource industries, a competitive manufacturing sector, and a well-developed financial market all support the country’s resiliency.

On the public finance front, Canada’s ratios of general government debt to GDP and to revenue moved significantly downward over the decade through 2008. Thus, in facing the global crisis the federal government’s balance sheet started from a strong position. Although the crisis/recession caused a reversal of the improvement in the debt ratios, they did not deteriorate as much as in most other Aaa-rated countries. The debt levels and outlook remain compatible with the Aaa rating.

Canada’s current account balance returned to surplus in 1999 and remained there until 2008. The combination of the global recession and lower commodity prices have brought it back to deficit. Whereas in the past current account deficits had caused the country’s net external liability position to rise to a moderately high level, the period of surpluses caused this position to decline significantly. Thus, while facing the effects of the global recession, Canada was in a stronger external position than in previous downturns. The strong Canadian dollar appears to be a factor keeping the current account in deficit at present, but demand for Canadian dollar assets is strong, reducing the risk emanating from external developments.

Rating Outlook

The outlook for Canada’s rating is stable. The country was affected less than most other advanced economies by the global credit crisis and recession, and its government financial position remains comfortable.

What Could Change the Rating - Down

As an advanced industrial country with comparatively low debt ratios at the federal level, Canada’s ratings appear unlikely to move downward in the near future. The country weathered the global credit crisis better than many other advanced economies. Over the long term, should the political consensus on maintaining sound public finances erode and debt ratios rise again to elevated levels, the government’s rating could come under pressure.

Despite some pressures on government spending related to health care, in particular, such a scenario seems remote. Pressure on public finances coming from pensions is less in Canada than in some other Aaa rated countries.

July 24, 2013

moody’s opinion

Canada In FIGURES


Canada’s sovereign ratings reflect the following factors: Canada is an advanced, well diversified and high income country. Its political stability, strong governance and institutional strengths support the rating. Its overall policy framework remains strong and has delivered steady growth and low inflation.

Canada has a good track record of prudent fiscal management. Its fiscal credibility was boosted by the timely withdrawal of the fiscal stimulus implemented during the global financial crisis and the roadmap provided by the authorities to achieve a balanced federal government fiscal position by 2015/16. Prudent budgetary practices provide sufficient confidence that the consolidation path is realistic.

Fitch believes that Canada’s general government debt (GGD) has peaked and should start to decline in 2013-15 in line with fiscal consolidation. Nonetheless, at 88.2% of GDP for 2012 GGD is the second highest among the ‘AAA’ rated sovereigns, highlighting Canada’s more limited fiscal flexibility compared with peers. Mitigating this rating weakness are Canada’s strong commitment to fiscal consolidation and ample domestic financing flexibility.

Elevated household indebtedness (especially mortgages) and strong appreciation of house prices in recent years renders the Canadian economy vulnerable to adverse shocks. The authorities have taken measures to mitigate risks and the initial signals suggest some moderation in the housing market and stabilization of household indebtedness. However, external and/or domestic economic shocks can lead to a faster adjustment which would be negative for the banking system and the broader economy.

Fitch believes that the banking system is relatively well-capitalized and can absorb a potential moderate level of stress from the housing market. This is supported by a strong regulatory framework and an early implementation of Basel III which is already in effect for all banks in Canada.

While Canada’s growth has outperformed peers since 2009, consumption and construction, the main drivers of growth after the crisis are losing steam on the back of tightening credit conditions and high household indebtedness. The economy faces the challenge of rebalancing growth drivers away from consumption and construction to exports and business investment in a context of high uncertainty for the country’s energy sector as well as competitiveness issues confronting the manufacturing sector.

Rating Sensitivities

A Stable Outlook reflects Fitch’s assessment that downside risks to the rating are currently not significant. Nonetheless, the following risk factors individually, or collectively, could trigger negative rating action:

• Disorderly unwinding of household indebtedness with adverse repercussions for financial sector stability and fiscal consolidation

• A renewed and persistent rise in the general government debt/GDP ratio

• Material weakening in macroeconomic projections caused, for example, by a deterioration in the housing market

Key Assumptions

Fitch assumes that economic growth in the US (Canada’s largest trading partner) will pick up in 2014.

Fitch assumes that the Eurozone remains intact and that there will be progress in deepening fiscal and financial integration at the eurozone level in line with commitments by policy makers.

Fitch assumes that China will avoid a hard landing and that oil prices will remain at relatively high levels. Crude oil is forecast to average USD105 and USD100 per barrel in 2013 and 2014 respectively, compared with USD112 per barrel in 2012.

Fitch assumes that the housing market will achieve a soft landing and that the Canadian government will remain proactive and pragmatic in its approach to address macroeconomic and banking sector vulnerabilities. The agency assumes that the government broadly adheres to its fiscal consolidation strategy.

August 21, 2013

fiTCh opinion

20

Actual Projection

% of GDP

15

10

5

0

2000-2001

2002-2003

2004-2005

2006-2007

2008-2009

2010-2011

2012-2013

2014-2015

2016-2017

2018-2019

2020-2021

The level of re�nancing risk as a percentage of GDP is expected to decline

Source: Department of Finance Canada ?????

The level of refinanCing risk as a perCenTage of gdp is expeCTed To deCline


120

Actual Projection

$bn

100

80

60

40

20

0

-202007-2008

2008-2009

2009-2010

2010-2011

2011-2012

2012-2013

2013-2014

Gross bond issuance will decline in 2013–14

Gross bond issuance Gross bond issuance net of buybacks and maturities


gross Bond issuanCe will deCline in 2013–14

Source: Department of Finance CanadaGross domestic product and �nal domestic demand


quarterly % change, chained (2007) $

2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

-2.0

-2.5

2008

Real gross domestic product at market prices Real final domestic demand

2009 2010 2011 2012 2013


gross domesTiC produCT and final domesTiC demand


Canada In FIGURES


The average term to maturity of the market debt will gradually increase

10

Actual Projection

years

9

8

7

6

52000-2001

2002-2003

2004-2005

2006-2007

2008-2009

2010-2011

2012-2013

2014-2015

2016-2017

2018-2019

2020-2021


The average Term To maTuriTy of The markeT deBT will gradually inCrease


DBRS has confirmed the long-term local and foreign currency issuer ratings of the Government of Canada (the Government) at AAA, along with the short-term local and foreign currency issuer rating at R-1 (high).

All trends are Stable and reflect Canada’s prudent fiscal management, which continues to support a steady path toward fiscal recovery and a debt burden considered to be very manageable. A sound financial system and signs that external headwinds are subsiding add further support to Canada’s strong credit profile.

For 2012-13, preliminary results point to a central government deficit of $25.9 billion, or 1.4% of GDP. Although somewhat larger than planned in last year’s budget, this represents a slight improvement from the prior year and continues to compare favourably with most G7 peers. The budgetary deficit is expected to continue its downward trend, with a projected deficit of $18.7 billion, or just 1.0% of GDP, for 2013-14 and a return to balance scheduled for 2015-16. Despite a weaker economic growth outlook, this target remains unchanged from the previous year.

New spending initiatives are relatively modest and include funding for skills training and apprenticeships, a renewal of economic development funding and extension of tax relief for the manufacturing sector.

In addition, federal infrastructure investment through the Building Canada plan has been renewed for an additional ten years. Revenue measures are also relatively scarce and include steps to close tax loopholes and modernize certain tariffs.

Canada’s economy began to lose steam in 2012, with real GDP growth reported at 1.7%, down from 2.5% in 2011. For 2013, the budget assumes real GDP growth of 1.6%, which is slightly below the private sector consensus and latest IMF forecast. Domestic activity is expected to remain subdued due to continued fiscal restraint across all levels of government and a much-anticipated slowdown in the housing market. However, improving economic conditions in the United States and a somewhat weaker Canadian dollar should be supportive of a stronger external position and reduced current account deficit. In 2014, the Government has budgeted for rebound in real growth to 2.5%, although the latest IMF forecast is somewhat more cautious at 2.2%.

Canada has weathered the financial crisis with relatively limited impact on its balance sheet. Central government debt (as measured by DBRS) is estimated to have grown by 6.4% in 2012-13, resulting in a debt-to-GDP ratio of 37%.

As debt used to fund assets purchased under the Insured Mortgage Purchase Program (IMPP) begins to mature, the debt-to-GDP ratio is expected to fall to 34% in 2013-14 and continue a downward trend thereafter, provided fiscal recovery efforts are maintained. At this level, debt is considered to be very manageable and DBRS believes Canada is well-positioned to benefit when the global economy turns a corner.

Strengths

1) Manageable debt burden

2) Prudent, credible fiscal planning

3) Effective debt management strategy

4) Strong liquidity position

5) Sound financial system

Challenges

1) Stagnant productivity growth and aging population

2) High household indebtedness

3) Unfunded public sector pension liability

4) Challenge from low cost global manufacturers

5) Sizeable refinancing requirements

July 30, 2013

dBrs opinion

Canadian Banks Have Noteworthy Wholesale Funding Reliance

Gross loans / total deposits (X-axis) vs (market funds liquid assets) / total assets (Y-axis) for 2012

Source: Moody’s Banking Financial Metrics

Australia

Canada

Canada (1)

France

Germany

Canada (2)

Italy

Spain

UK

US

- 15.0%

- 10.0%

- 5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

60% 80% 100% 120% 140% 160% 180%

(Mar

ket f

un

ds

-liq

uid

ass

ets)

/ to

tal

asse

ts

(%)

Gross loans / deposits (%)

Note: Total deposits adjusted to exclude term business and government deposits. Market funds adjusted to include term business and government deposits.

gross loans / ToTal deposiTs (x-axis) vs (markeT funds liquid asseTs) / ToTal asseTs (y-axis) for 2012

Source: Moody’s


8%

9%

10%

11%

12%

13%

14%

15%

16%

17%

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%






0%

10%

20%

30%

40%

50%

60%

250

300

350

400

450

500

550

600

650

700


$ Billions (LHS)

% of GDP (RHS)



(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%


CPI

Core CPI



(5.0%)

(4.0%)

(3.0%)

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012


Goods

Services

Income

Transfers

Current Account

governmenT unmaTured deBT


Canada In FIGURES


High-Quality Residential Mortgages and Securities Dominate

Balance sheet composition of Canadian bank assets as of December 31, 2012 (Black outline denotes higher quality assets)

Source: OSFI

Cash and deposits 5%

Securities 20%

Other assets 5%

Reverse repo and securities borrowed 10%

Derivative assets 8%

Personal loans 13%

Corporate loans 14%

Resi mortgages insured 15%

Resi mortgages uninsured 10%

BalanCe sheeT ComposiTion of Canadian Bank asseTs as of deCemBer 31, 2012 (BlaCk ouTline denoTes higher qualiTy asseTs)

Source: OSFI

0%

5%

10%

15%

20%

25%

30%

35%

As of March 31, 2008(pre-crisis)

As of March 31, 2013(projected)

Projected medium termdebt structure

Treasury bills 2-year 3-year 5-year 10-year 30-year

Real return bonds (including inflation adjustment)

Transitioning Towards a More Even Distribution Across Instruments


governmenT deBT is BeComing more evenly disTriBuTed aCross insTrumenTs


Foreign investment in Canadian securities

$bn


40

50

30

20

10

0

-10

-20

2008


2009 2010 2011 2012 2013

Bonds Money market investments Equity and investment fund shares

foreign invesTmenT in Canadian seCuriTies


Canadian investment in foreign securities

$bn


15

20

10

5

0

-5

-10

-15

-20

2008


2009 2010 2011 2012 2013

Equity and investment fund sharesDebt securities

Canadian invesTmenT in foreign seCuriTies


Canadian Banks Have Strong

Risk-Weighted Capital Ratios but Only Average Leverage

Tier 1 capital ratio (X-axis) vs tier 1 leverage ratio (tier 1 capital / Avg. total assets) (Y-axis) for 2012

Source: Moody’s Banking Financial Metrics

AustraliaCanada

FranceGermany

Italy UK

US

Spain

1%

2%

3%

4%

5%

6%

7%

8%

9%

5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15%

Tier 1 leverage ratio - tier 1 capital / Avg. Total assets (%)

Tier 1 capital ratio (%)

Bank Tier 1 CapiTal raTio (x-axis) versus Tier 1 leverage raTio (Tier 1 CapiTal / avg. ToTal asseTs) (y-axis) for 2012

Source: Moody’s

Canadian Asset Quality is Exceptional

Problem loans / gross loans to customers for Moody's rated banks across selected systems

Source: Moody's Banking Financial Metrics

0%

2%

4%

6%

8%

10%

12%

Australia Canada France Germany Italy Spain UK US

2008 YE 2009 YE 2010 YE 2011 YE 2012 YE

Bank asseT qualiTy: proBlem loans / gross loans To CusTomers for moody’s raTed Banks aCross seleCTed sysTems

Source: Moody’s

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Canada in the Global MarketPlaCe · 36 Safe-haven credits adapt to new life after crisis ......

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