Since 2008, Canada has acquired a new lustre in the eyes of
international investors, as the market that remained resilient
when global financial markets fell off the cliff. The usual
explanation is Canadians’ general financial
conservatism, including a much more cautious approach to credit
With a lot less leverage in the system, there was much less to
Royal Bank of Canada, Bank of Nova Scotia, Toronto Dominion
Bank, Bank of Montreal, and Canadian Imperial Bank of
Canada’s five large banks, came out with barely a
feather ruffled, and are newly prominent around the
But this does not translate into Canada being a hotspot for the
derivatives industry," says Aaron Fennell (pictured), senior
market strategist and portfolio manager at Lind-Waldock, a
division of MF Global Canada.
Regulatory barriers that deter foreign firms from moving in,
and even make things difficult within Canada, are partly to
blame – as is that conservatism.
Many in the market would like to see reforms, but all agree
that, with or without them, Canada is still a derivatives
market with vast tracts of unexploited potential.
Montreal on a roll
It’s been a good year for the two Canadian
derivatives exchanges. The minnow of the pair,
Winnipeg’s ICE Futures Canada, offers canola and
barley derivatives (see box).
About 2,400km to the east is Montréal Exchange,
dominated by interest rate and equity derivatives and owned by
TMX Group, which also runs the Toronto Stock
First half volume on the exchange is up 32% – a sure
sign that something is going right. MX may even recapture by
December its record annual trading volume – set with
42.7m contracts in 2007.
Boosted mainly by foreign investors, interest rate derivatives
have picked up dramatically, with 13.6m contracts traded this
year, 70% ahead of the same time last year. Further growth came
from equity derivatives.
MX’s three big products are Three Month Canadian
Bankers’ Acceptances Futures, which can get
through more than 1m contracts a month in good times; Ten Year
Government of Canada Bond Futures, about 70% as active as the
short term interest rate contract; and equity
There is plenty of potential here – 1m equity options
contracts a month is little compared to the third of a billion
that flows through US markets.
But still more underdeveloped looks the equity index segment.
Futures on the S&P Canada 60 Index get about 400,000 trades
a month, while those on the iShares ETF tracking the same
benchmark add another 200,000 or so.
ICE Futures Canada: steady as
she goes, ready to expand
In case canola is not on your weekly shopping list, it
means Canadian Oil, Low Acid and is a variety of
oilseed rape that is fit for human
Canola futures are the staple product of Winnipeg-based
ICE Futures Canada. Last year, it revelled in record
trading, as 3.5m canola futures and options changed
hands. So far in 2010, canola is 14.5% ahead of last
The exchange is satisfied with the role it plays. "We
don’t have any immediate plans to launch
new products. Canada’s largest crops are
wheat and barley, but these markets are controlled by
the Canadian Wheat Board," explains Brad Vannan, CEO of
ICE Futures Canada. "Canola is our flagship product and
has been growing nicely over the last years. There is
also a domestic western Canadian product, namely feed
barley, and we are looking at how to gain more
influence in the barley market overall."
Vannan says ICE is ready to launch a Canadian wheat
contract, if regulations change to allow this. While
the Conservative government has said it would like to
reduce some of the monopolistic controls exercised by
the Canadian Wheat Board, the Conservative Party itself
does not have a majority in Parliament and the other
parties oppose changes at this time.
Nevertheless, Vannan is looking ahead. "If we look at
how well Canada has done in terms of canola, this could
be a precedent for wheat or barley contracts," he says.
"Canada is well capable of competing internationally if
selling prices of wheat and barley are no longer
negotiated by the Canadian Wheat Board."
Canada is the largest global supplier of canola by
value, so the growth in ICE’s canola
contracts has been driven by international investors in
the industry, Vannan maintains, adding that the futures
market benefits all users and converges very well in
price with the underlying commodity.
Speculators take up the
Traders on the exchange make a "good balance", Vannan
says, between industry hedgers and speculative
investors. "Much growth has come on the speculative
side, but this has balanced out the fact that the real
industry hedgers are consolidating, which reduces
liquidity. Speculative investors have put the liquidity
back in that would otherwise have left. This is
certainly a trend in barley and canola, but applies to
other agricultural commodities as well."
While ICE Futures Canada’s offering is
limited – and more so than strictly necessary
– it enjoys an enviable lack of competition.
There is none, not even from south of the border or
further afield. "We don’t compete directly
with any of the US exchanges," Vannan says. "There is a
canola contract in Europe and one in Australia, but
they both are geared towards their domestic
The exchange does not face any immediate regulatory
threats, either. Traditional futures markets like
Winnipeg have escaped the brunt of financial and
regulatory reform as they continued to play their
traditional roles through the crisis, and played them
"During the bubble, some markets became disconnected
from their underlying commodities and have undergone
contract changes to rectify this potential," explains
Vannan. "Canola did experience a brief period of wider
than normal basis levels during the peak of the bubble,
but has been showing strong convergence in the markets
following the downturn without any material changes
being made to the contract."
Being a very specialised operation serving an important
domestic and international market is not the worst
position to be in when other exchanges have to compete
for liquidity, or struggle to expand their offerings to
attract more investors.
And while small, ICE Canada continues to grow, with
access to cutting edge technology ever since its
acquisition by Atlanta-based Intercontinental Exchange
in 2007 – a move that the exchange believes
has benefited the market in Winnipeg and its
"We are quite pleased with ICE Futures
Canada’s performance and it’s
well suited to continue to grow, both as a hedging tool
and an investment option. Canola is also growing in
importance globally, so we are happy on all fronts,"
sums up Vannan.
It’s all smiles in Winnipeg.
Together, they make up less than a sixth of the
exchange’s volume. There should be plenty of room
for this to grow, especially taking into account the overall
performance of Canadian equities.
"The interest Canada has been attracting wasn’t
just from fixed income participants," explains Alain Miquelon,
president of the Montréal Exchange and group head of
derivatives at TMX Group. "Generally, a lot of foreign capital
has flooded into Canada in the last two years. This was further
underlined by Canada’s equity indices
outperforming US indices due to Canada’s strong
mining and raw materials sector. This increase in liquidity has
helped the derivatives markets."
Despite its recent records, Montréal Exchange remains
unsatisfied. "While our market share has grown and a lot of our
products have good liquidity, there are still challenges for
us," Miquelon says. "The retail sector is underdeveloped in
Canada, and we are focusing on attracting more international
players to drive more liquidity on to the exchange."
To do this, MX is diversifying. In mid-June, it launched a
cash-settled futures contract on Canadian Heavy Crude Oil. This
is based on the price of Western Canadian Select (WCS), the
benchmark blend for heavy crude in Canada.
There is certainly a disconnect between the importance of
Canada as an oil producer – among the top 10 producers
in the world, and the US’s main source of imported
oil – and the weight of oil derivatives on its
With heavy crude production expected to double by 2020, MX
hopes to skim off some of the expected growth in trading that
would otherwise go to the US exchanges and the OTC market. But
can MX compete with the huge liquidity at Nymex?
"We launched Canadian oil futures in June and are trying to
build up that product as well as other energy products," says
Miquelon. But he admits: "While we have further energy products
in the pipeline, this is largely a diversification opportunity
for us. Our core business is in interest rate and equity
derivatives, where we are seeing attractive growth and have a
unique competitive advantage, as we have the market very much
penetrated. There would be a lot more scope in indices, and
futures are also broadly underdeveloped. There is a much less
active retail market in futures, which is a reflection of the
past, as investors here are more conservative and are not
The secret of Montréal Exchange’s success?
Like ICE Futures Canada, MX has claimed its niche and fully
owns it. Its products are suited to the domestic market
– which means MX does not have to go toe-to-toe with
its big competitors in Chicago and New York.
As Miquelon puts it: "We’re developing products
that are focused on a very segmented market. These markets are
not being targeted by anybody else, and CME might not step into
such a niche as it would not be profitable for
Vital to any successful exchange nowadays is technology, and
here TMX Group has gone from strength to strength.
At the end of last year,
the Investment Industry Association of Canada chose
TMX’s Canadian Derivatives Clearing Corporation to
develop the infrastructure for a central counterparty facility
for the fixed income market.
CDCC has been the issuer, clearing house and guarantor of
exchange-traded derivatives in Canada since its inception in
1975. It has been Montréal Exchange’s
exclusive clearer since 1999.
The new multilateral, centralised clearing house for fixed
income products is meant to enhance the Canadian capital
markets and make them more attractive to domestic and foreign
TMX Group’s Sola clearing platform, launched in
June 2009, "has both the flexibility and the horsepower to meet
this challenge", according to the company.
As European traders know well, last year TMX won the mandate
from LSE Group to provide its new trading platform. Under the
multiphase contract, Sola is now in use at LSE’s
EDX London market, while the Italian Derivatives Exchange
Market should follow by the end of October.
Miquelon says the systems held up very well during
May’s high volatility and record
Divided by regulation
With Canada set up well for future growth and success, there
remain formidable challenges, and perhaps the biggest is the
"The Canadian regulatory landscape provides a very confusing
picture when it comes to derivatives regulation," explains Greg
McNab, partner in Baker & McKenzie’s corporate
and securities practice group in Toronto. "There are a lot of
inconsistencies and gaps in the existing regimen. While other
jurisdictions tend to treat different types of derivatives
consistently, Canadian jurisdictions treat certain types
One of the main problems is that Canada doesn’t
have a national securities regulator, nor a single securities
act regulating the industry. Instead, each province has its own
slightly different laws and system of oversight. Market
participants must register separately in each
Provincial regulators have acknowledged that they are applying
some principles inconsistently and are working on a national
regime. But industry experts do not predict fast
"I don’t anticipate Canadian regulation to change
all that much any time soon," says Levente Mady (pictured),
managing director, derivatives at Canadian broker Union
Securities. "Firstly, it is not a high priority of regulators
to change. Secondly, the attitude is 'let’s wait
and see what they do abroad first, then adapt what works for
Regulatory initiatives are in the works. In September 2009, a
new registration regime was introduced, intended to standardise
licensing for securities firms.
"We had hoped that this would also regulate how derivatives are
treated," says McNab. "However, due to the complexity of the
area, reform of derivatives-related licensing did not form part
of the reform project. So, right now, there hasn’t
been any progress on regulating derivatives."
In Canada the devil is, indeed, in the details. "I would
estimate that about 90% of securities regulation is the same
across Canadian provinces and territories, but the remaining
10% can vary significantly," McNab says. "In that 10%, it
depends very much on which type of security you are talking
about. While the Canadian regulators all broadly agree on
regulatory questions for, example, mutual funds, the opposite
is true for derivatives, an area in where there is a lot of
inconsistencies on how you regulate them."
And not only is there fragmentation – the individual
provincial regimes can also be complex. The crucial province of
Ontario, with 38% of the population, is one of the most
troublesome. "It has four or five different pieces of
legislation that impact the creation and distribution of
derivatives, which at times compete with each other," argues
The industry is divided on the effects of this fragmentation.
Some feel that it has shielded Canada from some of the fallout
of the global financial crisis. Others believe that what
trouble came to Canada occurred specifically because of that
fragmentation. A third group is neutral.
"While the situation was not ideal, it could also have been
much worse. While the situation was dealt with eventually,
I’m not sure that the solution can be attributed
to our sound financial and regulatory system," McNab
His fondest wish is for a uniform national regime of regulation
and legislation – one that might remove some of the
frustrations and inefficiencies he encounters.
Clients, he says, "have to do a separate analysis for every
province, and while they might get approval in three provinces,
a fourth takes them to task over something that the other three
had had no issues with. Yes, we’re good at
navigating that system, but we’re not particularly
proud that we have to do it this way."
If it ain’t broke...
Industry professionals agree that there is little impetus for
reform in Canada today.
"In terms of regulation, Canada has been a laggard rather than
a leader," says Mady – perhaps no bad thing when many
supposedly more forward-looking countries’
financial systems have come close to collapse.
Yet the minority Conservative government lacks support from the
financial industry, beyond the big banks. "There is no
political will to streamline regulation or grow the
exchange-traded derivatives industry in Canada," says
Fennell at Lind-Waldock.
In McNab’s view, the attitude seems to be 'if
it’s not broken, don’t fix
it’. "My sense is that the feeling is the players
in the market are all sophisticated and knowledgeable enough,
which means they don’t need the same protection
as, say, a retail investor that might be misled. There also is
nowhere near the same populistic clout to gain as in Europe, so
there’s very little pressure to do something about
the current structure.
"We’ve talked about reforms to securities
regulation for 30-odd years, but it’s only in the
last two or three years that this has gained any traction," the
Toronto-based lawyer adds.
Despite these obstacles, Canada’s promising market
is attracting attention from investors and international
financial services providers.
"The pattern over the last years was like this: international
firms came into the market, some of which were successful,"
explains Rod Wilmer (pictured), new CEO of Newedge Canada. "The
ones that weren’t, were very quick to leave the
market. So all the big investment banks were here, but they
left in droves 10 years ago after a bad year or two. The same
pattern was repeated two years ago."
In exchange-traded derivatives, the community of players is
described as 'very small’ and
'clubby’. Everybody knows everybody else. Some
blame offputting regulation for this insularity, yet domestic
players see the advantages in barriers that make it hard for
newcomers to break in.
"The regulatory environment is difficult," says Fennell. "This
is, of course, good for the specialised players that are
already in the market and are familiar with the futures
Compared with other countries,
Wilmer says, "Canada has much higher capital requirements and
technical trading obstacles such as fees. Generally, the cost
to clear a listed derivative is higher than in comparable
markets, and clearing is relatively slow. There is also a
certain resistance to foreigners trading, but these are
becoming less formidable over time."
"I wouldn’t want to use the term
'protectionist’, but that is what it feels like at
times," says one insider at a brokerage.
McNab disagrees. "I would have agreed that the Canadian
securities regime could have been seen to be protectionist 10
years ago," he says. "A strong push started of US electronic
trading platforms and brokers entering the market, that could
have caused a race for prices and speed. Canadian policymakers
were slow to allow those platforms access to Canadian markets,
in some cases on the basis that they had to fully understand
the models before granting access. This was sometimes seen as a
way for the Canadian regulator to protect its own
Now, he believes, market access for foreigners is a lot more
Others want more protection – or at least, the
establishment of rules that are taken for granted in the US.
Some Canadian brokers complain that US rivals are encroaching
on their territory to
serve Canadian clients accessing US or global
"I’m not even sure if that is legal
but they are doing it anyway," says Fennell. "The CFTC would be
on me in an instant if I did the same for US clients, but there
seems to be nobody to enforcme the rules against US brokers.
We’ve been fighting this for as long as I can
remember without much progress."
Adopting similar rules and especially similar enforcement could
make competition fairer, he believes: "I don’t
mind competing with US brokers, but this isn’t
really competition if there are two different sets of rules for
US brokers and Canadian brokers. This is simply no level
playing field and has nothing to do with healthy
Exchanges, of course, welcome any increase in trading.
"US investment banks have been very successful in franchising
into Canada, especially in the futures space," says Miquelon.
"From our perspective, they not only create a larger demand for
derivatives products, but they are also aiding to educate
investors on the products and opportunities, which in turn
helps develop the market, which we can only
Sources of growth
At present, the 'big five’ and vast pension funds
are prime users of Canadian derivatives, but there is a lot of
potential for smaller and non-bank investors. Participation by
retail investors and hedge funds is low, even though activity
from hedge funds is growing.
And usage patterns of investors that do use derivatives are
markedly different from those of foreign peers.
"Market participants, whether portfolio managers or asset
managers, use derivatives a lot less than their counterparts in
the US," says Mady.
And the bulk of the flow, Canadian brokers agree, goes to
exchanges south of the border.
Yet they also agree that prospects for the market are
"While the Canadian business is only a small part of our
business, it is growing," says Mady of Union Securities, which
does 95% of its futures trading on US exchanges such as CBOE or
ICE. "The US is where the liquidity is. Especially in terms of
gold futures, there is no other market to trade than the US."
Fennell at Lind-Waldock gives a similar 95%
co-head of institutional sales and trading at Newedge Canada,
says: "There is a robust business of taking Canadian clients to
international markets – what we call 'outbound
business’. In addition, the business of taking
international clients into Canada is growing
In Fennell’s view, "the dominance of the US in
Canadian derivatives is not only because the US exchanges have
the most liquidity, there is also a structural element to it.
The Canadian financial sector is fairly small and lacks the
critical mass to properly develop new futures
Yet interest in Canada as a financial marketplace is growing,
not just from the US or even European clients, but increasingly
from Asia, says Cutts, who adds that it is now seen overseas as
a more mature market than a few years ago.
"Despite the attractiveness of Canada, however, it is still
underdeveloped as far as investments go," Wilmer contends.
"Markets like these have consistently more margins. There is an
attractive business spreading Canadian pair trades versus other
markets. But there is more room to expand into."
describes Canada as "
opportunity rich, but liquidity poor", and certainly not as
liquid as other futures markets.
"If we look at open interest, the financial crisis cut that in
half," Wilmer points out. "By now, only half of that lost
volume has come back, as a lot of international banks have
pulled back. The Canadian banks are holding the majority of
positions, especially when it comes to interest rate products.
We think the market itself can handle a lot more