This is a guest contribution by Johnny Jaswal and Brian Thomas Hall, founding Partners of Jaswal Hall. If you would like to submit a contribution please contact Bill Beatty for submission details. Thank you.
If you leave things alone, you do not leave them as they are; you leave them to a tide of change.
A recent Globe and Mail article highlighted that two of Canada’s once highly profitable independent investment banks, GMP and Canaccord Genuity, are struggling with losses, lack of deal flow, job cuts and stock trading near all-time lows in the wake of the commodities crash. Given their heavy exposure to resources and the bearish sentiment with respect to commodities, the situation as it stands does not look promising for Canada’s independent capital market participants and leads to the conclusion that they must diversify more broadly into non-resource sectors. Faced with this reality, Harris Fricker, chief executive officer of independent investment bank GMP, stated in November, “we would happily diversify the business more broadly if we felt there were sufficient non-commodity corporate targets to cover; the reality is, there aren’t.”
I found Mr. Fricker’s comments odd and, frankly, concerning on a macro level. As a Partner in an independent shop myself, his comments got me thinking. Why, in the aftermath of a commodities crash, would the head of a major independent Canadian business be in a position where his business could not pursue broader diversification into non-resource based revenue streams due to insufficient non-commodity corporate targets? Are there systemic problems that are holding our independent competitors down and, if so, is that the Canada we want? As I am looking forward to a long and prosperous run as an independent player, these are issues that matter to me. To that end, I decided to add more work to my hectic schedule in a quest to examine Canada’s seemingly uncompetitive capital markets that favour the big banks and the conditions we need to create to foster a competitive environment.
My research led to the view that the competitiveness problems in our capital markets can be attributed to a lack of government policy with respect to innovation. According to the World Economic Forum’s annual Global Competitiveness Report, Canada ranks relatively low in terms of technological readiness, business sophistication and innovation. Access to financing, inefficient government bureaucracy and insufficient capacity to innovate rank as 3 of the top 4 most problematic factors for doing business in Canada (the fourth factor is tax rates, a topic I will leave aside for another discussion). In order to explain this current state of affairs, let me take you on a ride through time. I will try to make the historical voyage brief, thanks to a review of Tom Wesson’s Canada and the New World Economic Order, so we can get to the marijuana and gambling portion of this article.
Canada’s corporate sector is the result of a curious mix of contrasts and contradictions and has its basis in poorly coordinated government policies and politically, rather than economically, motivated policy decisions. The National Policy, which was introduced by Sir John A. Macdonald’s Conservative government in 1878, was designed to encourage investment and economic growth in Canada through high tariffs on manufactured goods and an open market for foreign investment (under the National Policy, the average tariff on Canadian imports rose from 17.5 percent to 25 percent between 1878 and 1879). The purpose of the tariffs was to encourage growth in manufacturing industries in Central Canada, allowing them to reach a scale that would foster international competitiveness through greater efficiency. Macdonald’s open investment policy was based on the notion that access to capital was required to encourage economic growth. Since foreign firms that imported goods into Canada were placed at a great disadvantage by the tariffs, they saw fit to invest in Canadian subsidiaries or buy existing Canadian firms in order to produce goods for the Canadian market.
Due to Canada’s close proximity to the United States, by 1948, 72 percent of the foreign investment in Canada was by the Americans. Accordingly, the results of the Conservative policy were considered disastrous as the legacy of the Conservative policy is the introduction of branch plants in the Canadian economy; minute models of United States corporations which never became the international competitors that the National Policy was conceived to promote. Due to the fact that these branch plants were foreign owned, they had little incentive to compete internationally by improving productivity and efficiency, as to do so would be to compete with their parent companies. Accordingly, Canada was increasingly comprised of “truncated” corporations, owned by foreign firms, which centrally performed their value-added activities in their home nations to take advantage of economies of scale; leaving underdeveloped competence in Canada.
Fast-forward to present day, this historical pattern of underdeveloped competence has led to the abovementioned lack of innovation-driven corporate targets for independent banks to pursue. Competing with large banks for the existing resource-based deals becomes a one-sided battle that comes down to the ability to lend money to a client, as opposed to a competition where deals are won with innovative and intelligent ideas for innovative companies. Having worked as an investment banker at a large bank, I know this situation all too well as we won a majority of our deals based on our willingness to lend money. The pitch books, full of “great ideas” that I spent all night working on, would usually end up in the trash as reading material for Oscar the Grouch or as a coaster for the client’s beer while the real issues were discussed, lending terms. In the situations we decided to be lenders, our clients understood that we were one-stop shopping, using this more capital intensive and less profitable business of lending to secure higher margin investment banking business; quid pro quo my friend. Accordingly, where we were lender, we were also bookrunner on equity financing and adviser on transactions; effectively locking the smaller independent players out of deals.
So how do we get to an environment in which independent businesses can go toe-to-toe with the banks with great ideas and innovative advisors? Our government must clarify laws and pursue policy objectives that increase innovation and attract competitive businesses to our country; thus creating diverse, non-commodity corporate targets to cover. In recent articles, I have supported government efforts to clarify the legal grey areas with respect to online gambling, as doing so would create innovative, non-commodity businesses that attract capital to Canada. For example, with respect to online gambling, Canaccord generated approximately $60 million in revenue in 2014, primarily by virtue of its advisory role in Amaya’s US$4.9 billion acquisition of PokerStars. Despite the fact that the acquisition was legally tenuous given Amaya’s physical presence in Canada (we have discussed the foreign operator principle in previous articles), it highlights the ability of independent shops to win mandates when innovative targets compete in Canada. Given the federal Liberals have promised to allow recreational use of marijuana, the recreational marijuana industry is another example of a new and innovative market, worth up to $5 billion, that can be created through liberalization and legalization. As Canada has established a progressive regulatory environment for marijuana, we have the opportunity to be an international leader in the marijuana space; thus, similar to online gambling, creating innovative, non-commodity corporate targets that attract capital to Canada, promote innovative environments and allow capital market participants to compete by selling innovative ideas.
Though I have focused on our capital markets, online gambling and marijuana, we need innovation across the entire economy and all industries if we want to be globally competitive and maintain our current standard of living. Focusing on commodities, real estate, low interest rates or the Canadian dollar will not combat a future of slow economic growth. As discussed, what we need is liberalization with respect to industries such as gambling and marijuana, which would increase innovative goods and services and, consequently, deal flow, growth and competitiveness. Not only would this lead to better living standards for our nation’s citizens, but it creates the possibility of the emergence of strong Canadian global players, who could then expand into foreign countries, increasing the sovereign power of our nation. As the distinction between countries gets smaller and we increasingly move towards a borderless state, it is vital that Canada act and compete before the world makes the decision for us and renders us unable to emerge as the dominant nation we are.
Johnny Jaswal and Brian Thomas Hall are founding Partners of Jaswal Hall, a law firm that provides exceptional legal services and a full range of related investment banking advisory services. For more information, please visit http://jaswalhall.com/.