"Notes for an Address to The Association of Canadian Pension Management"
Merci beaucoup, Henri-Paul
Thanks also to the ACPM for inviting me to speak to you today. There are two areas I want to address this afternoon. First I'll respond to the two questions you have posed in your program and then I'll talk about the future of financial services in general.
My thesis is that the future of our country and the financial services sector are inter-linked. They face similar challenges that require that we understand realistically our competitive position. They demand the same hard-headed approach to making choices. Governments must stay the course, making Canada an attractive place to live and build businesses. Our corporate sector cannot sit back and blame the government for all our woes. Canada's business leaders will have to step up their game to assure Canada's future prosperity.
So let me begin with the two questions your program poses.
- First: Should Canada be concerned about the potential migration of their financial services industries toward major United States' centres?
- And second: Will Canadian cities have trouble holding on to existing headquarters jobs in the face of stiff competition from major United States and international players?
The answer to both of them is fairly simple
Clearly there is a risk that financial services will continue to migrate to the United States - and that will have negative economic consequences for those of us living in Canada. These are high value-added activities that pay a disproportionate amount of our taxes and generate disproportionate GNP.
The answer to the second question is that head office jobs are clearly important and unless we act will tend to migrate south. Large clusters or concentrations of head offices spawn a whole set of small businesses, the backbone of the Canadian economy. So yes, we have to be concerned about the potential loss of head office jobs.
But if I only answered those questions you would assume that I haven't paid for my lunch. Let me try to address why these situations are occurring and what we can do about it.
The heart of the issue is quite simply that we are a small country sitting on top of a very large country. If we were totally integrated into the United States, given our relative size, we might see 90% of our large organizations headquartered in other states and only 10% headquartered in Canada.
With 86% of our exports going to America and two billion dollars of two-way trade daily between our two countries, we are effectively economically integrated into the United States -- it is our only alternative.
Increasingly, Toronto, Montreal, Calgary and Vancouver have to compete with Chicago, Boston, Houston, or Seattle. We have to look objectively at how headquarters of major firms survive and thrive in those American cities. How have they competed against New York? We have to look at the successful strategies they follow -- and do better. This is a major shift in the way we think of ourselves. If we were a major region of the United States would the head office jobs stay? Would financial services companies locate here?
There are lots of reasons why we could fare worse than American cities in a head to head competition. Real forces tilt the balance of choice towards head offices choosing American rather than Canadian cities. We're not part of the United States; we're not seen by Americans to be part of the United States. We're not part of the American political process. And U.S. politics matter. Ninety percent of the North American market is in the U.S.. Sensitivity to American politics is often the reason why foreign companies choose to put their subsidiaries in the United States even if the economics of locating in Canada are slightly better.
The United States is a nationalist and often parochial country. Many of us have a tendency to react negatively to that as if there were something inherently wrong with Americans. We are insulted when they don't know the name of our Prime Minister or are hurt when we discover they follow policies that look after American interests and do not reflect a broader North American perspective
But I'd say bluntly that if we were the United States, why would we want to spend a whole lot of energy on a country to the north that has 10% of our population and perceived lower growth prospects? If you were an investment manager, why would you take the political and currency risk to invest in a Canadian institution when there are three or four American companies with the same characteristics?
The tragic events of September 11 created an American political regime that is even more inward looking and protectionist than ever before. Demographic changes will compound that trend. The population of the United States is growing faster than any other industrialized nation. This means it will continue its trajectory as one of the world's largest, most powerful and overwhelmingly most prosperous competitors. Does it need Canada's extra growth potential? Possibly not. Do we need the U.S. market? Definitely yes.
Advantages of a sovereign state
So, in some ways we have fewer opportunities than American cities and states. As we build our strategies we have to accept that reality. But the good news is - and there is good news -- there are advantages to being a sovereign state. There are things we can do. We have the opportunity to set independent tax and currency policies. We don't have the fiscal burdens of a super power. Over the long run we ought to be able to have an effective tax rate that is permanently less than that of the United States. We ought to set that as a policy goal. We have an opportunity today to make real progress on that goal if we hold on to our fiscal discipline.
The rapid economic growth in the United States doesn't necessarily make an environment that is attractive to everybody. If we want to, we have the ability to create a better package in Canada -- a better health system, a better education system, and a better way of life. We have the opportunity to create a more inclusive society and a living environment that will be attractive to people for whom quality of life matters. So net, net we should not see ourselves as significantly disadvantaged but we should be realistic about the opportunities that are available to us and what will be required to be successful.
There is no magic solution to exploiting our current position. We have to go back to the fundamentals. We have to understand the business environment in which we are operating and we have to be tough minded about following our strategy. We have to accept that the United States is not particularly interested in us. If we want to attract their attention, we have to work hard to stimulate their interest. We have to create an aura around Canada that says we are a better place -- that we have more productive and innovative industries, that we have exportable competencies and that we are more fiscally prudent. The private sector must become Canada's sales-force. Wherever it goes it must sing Canada's praises.
We have to be prepared to make tough choices -and I would make a plea that we have to make our choices much more transparent than we have in the past. In the 1970s and 1980s governments at all levels increased spending and ran large deficits. At that time no politician stood up and said -- let's destroy the health system, let's squeeze educational spending in Canada so we descend to the level of the worst states in the United States. But in hindsight that was the long-term choice we were implicitly making. We were running expenses at rates way above what our fiscal system could possibly afford -- and a day of reckoning was inevitably coming.
Governments have now done much to correct that problem, but there is a real risk that having taken the tough measures we might slide back, that we might not now hold the line and only spend on the things that matter.
What creates economic wealth? It's not very complicated. Human capital plus investment produces higher productivity. Higher productivity makes you better off. If you don't invest, you won't grow. If you don't develop your human capital you won't be able to exploit your investment. If you waste money you'll be poorer off. If you overspend as a nation you'll be poorer off.
We have to continue to run budget surpluses, to keep our current account in surplus and to make sure that we concentrate our government spending on the two things that ultimately matter - health and education.
Private sector has to take the lead
In the end though, we in the private sector have to stop saying that all the issues are government issues -- because they are not. Once government has created the right environment, once it makes sure that our fiscal house is in order, that we are investing in the future, that we have the right incentive system to reward people and a tax system that doesn't punish innovation, then it's up to the private sector to take the lead.
Poor investment decisions in the private sector are no less wasteful than poor investments in government. When we make wrong decisions we rob the country of its potential wealth. When we run our firms less efficiently than we should, we make the nation a poorer place. If our pension fund managers invest less well than their counterparts around the world, we will be worse off. If in the end Americans are better off than Canadians then we in the private sector have failed to do our jobs. Senior executives must accept that it's our responsibility to make sure that doesn't happen.
So how do we make sure we have great companies that can contribute to the nation's economic health? Again it's not very complicated. We have to start at the strategic level. Strategies have to be realistic about where our sustainable competitive advantages are.
But great strategies are not enough. As we all know, what distinguishes great companies is their operational excellence. What is operational excellence? It starts by not allowing strategic drift away from what you are trying to achieve. It's focus, focus, focus. It's creating an environment where people don't round corners, where they speak plainly and they do exactly what they say. It's backing your best people and making sure that it's in their interest to continue to grow. It's letting people who don't fit get on with their lives. It's remembering we work for our shareholders, not ourselves.
The future of financial services
You have asked me to comment on financial services. We have good banks in Canada. They give consumers and Canadian businesses world-class value and give shareholders great returns because fundamentally they are well run. Historically our different regulatory regime gave us a competitive advantage in North America, but that advantage is disappearing. American regulation now permits national banks. The resulting consolidation means Canadian banks are becoming smaller relative to our U.S. competitors.
Investors of course don't reward you for what you've been -- they want to see where your growth is going to come from. Given the banks' dominance in Canada, a large part of our growth is inevitably tied to Canada's future. So we are intensely concerned that Canada prospers. While retail banking is an excellent industry and continues to grow at the pace of the Canadian economy, super growth will depend on whether we can export some of our competencies into the United States. All Canadian banks are trying different ways to do that.
By and large we have been successful in holding the Canadian market against the best of the foreigners. This is most true in retail banking. So, to your question, I don't see much migration of jobs south in retail banking. Indeed, if we do it right, we ought to be able to create jobs here in Canada.
Wealth management is one sector where Canadian banks are not completely dominant - many independent and foreign companies are major players. We have to assume that foreign investors will continue to grow their share, as the investment business becomes more global. Their global skills are important and global firms will have the financial clout to grow in Canada. As Canadian firms we have to find ways to evolve our product capabilities to address the Canadian market's changing needs, grow our presence in the U.S., and compete internationally.
On the wholesale side there is a more dramatic trend. In the United States just five years ago 47% of the loan deals were arranged by the top five institutions. Today that number is 59% and is climbing. It will likely reach 70-75% in another five years. The mid-tier banks in the U.S., firms that have two to three times our market capitalization, have been totally crowded out by these bulge bracket firms.
So what role remains for a Canadian wholesale bank? All of us have strong domestic franchises. While it is clear that foreign firms will play a role in serving the Canadian client base I don't think it will eliminate the important role of Canadian banks in serving our corporate market. Canadian institutions go through phases where they fall in love with the American market place -- but they discover that U.S. investors never have the same degree of staying power and permanent interest as most Canadian investors. For most Canadian issuers the Canadian stock market will be the primary determinant of their share prices. The same is true in many cases in the debt market.
Often when Canadian institutions want to do transactions in the United States they will have an American adviser. But many also want a Canadian dealer at their side who understands where they are coming from, and who will be around to be loyal to the company even if the market turns sour.
All the Canadian wholesale institutions are trying to find niche investment strategies abroad. They are looking for particular areas where they can use the skills they have built up as full service dealers in Canada.
Let me try to illustrate these changes by briefly over-viewing where TD Bank is today.
We want to be a Canadian based North American player. North American in two senses - first in our attitude and performance - comparing our performance and adjusting it to match and ultimately beat the best in North America. Secondly we want to use our Canadian skills and strengths to enter the U.S. where we see opportunities for mid-tier North American players. We will not be among the largest banks in North America. Given our limitations, Canadian government policies, and the consolidation that has already occurred, that would be unrealistic. But can we be among the best-run financial institutions in North America, able to boost our inherent Canadian growth, by developing a strategically defensible position in the U.S. market? The answer is yes. So we intend to maintain Canada as our headquarters and we intend to grow in ways that make Canada better off.
Fundamentally we've made some terrific strategic moves in the last five years. We have managed to dramatically shift our earnings balance from 52% wholesale five years ago to 38% today. Over time retail will account for 70-80% of our earnings as we shift capital from wholesale to retail.
In our wholesale bank we concentrated our skills, picked a few key sectors outside of Canada and built ourselves real expertise and capacity in telecom and energy - not today's favourite sectors, but very profitable for us in the past. We moved rapidly into the world of credit derivatives and customized solutions that gave us skills in an area that is less dependent on having bulge bracket size.
We bought Waterhouse at an opportune time and then made a series of follow up acquisitions that worked, vaulting us to a top tier player.
None of this is to say that we didn't make mistakes -- and obviously we're paying for them now in our stock price. We tried to reproduce the US model of TD Waterhouse outside the United States. It didn't work. Our international network is now being reconfigured to reduce and eventually eliminate our losses there.
We rode the telecom franchise too long. Concentration in a sector sometimes means it's psychologically more difficult to accept that the market is slowing down or having problems. In future we would take a more pro-active approach to hedging using our significant credit derivative skills.
But when we step back we are not unhappy with where we are from a long-term perspective -- although in the short run we are obviously riding through a tough part of the cycle. We've redefined our wholesale strategy to deal with the issues of concentration. We have taken decisive action on our loan loss provisions to deal with the uncertainty surrounding our balance sheet. Now we have to make sure that we execute that strategy to produce steady, transparent, higher ROE, and better risk adjusted earnings by building on our Canadian franchise and having a well defined niche investment banking strategy abroad.
On the retail side we've merged TD and Canada Trust and have become the number one retail bank in Canada. We've ended up in a better financial position than we thought at the time of the acquisition. We've restored customer satisfaction and indeed have raised it well above the levels that the two networks had prior to the merger. We have retained our brand power as the customer-oriented bank. We now have to prove that our customer-centric model can actually deliver superior financial results.
We have invested in TD Waterhouse consistently and it is one of the survivors in this space. We have a clear target audience -- the self confident, self-directed investor. We have continued to refine both our marketing strategy and our operating leverage. We should now be capable of being profitable next year even at these low volumes, and we have the potential to become super-profitable when the equity market returns.
We've launched an integrated domestic Wealth Management strategy under the TD Waterhouse brand. It has unique characteristics and offers the customer choice and a better package. It should allow us to gain market share.
We have clearly defined strategies in each of our businesses that put us in an excellent position for the future. We're reducing the volatility in our balance sheet and we clearly understand that our task now is to demonstrate that we can actually deliver a better bank and strong earnings momentum. I believe we can.
When I think about the elements that make a great company I'm convinced the same elements make a great nation. We have to make sure that the strategic moves we have made in Canada in the last 10 years are not wasted by repeating earlier mistakes. We have to continue to reward those who perform. We have to celebrate our winners and let the firms that can't survive go. We have to invest in our core strengths and make tough decisions. We have to recognize that as far as the United States is concerned we are small and irrelevant and if we want to play in that field it's we who have to convince them.
In the end success lies in execution - can we actually do what we say? Are we more productive? Do we have corporations that make more money, pay better, and deliver a better value proposition to our customers? Have we created a Canada where people want to live? This is not just government's job -- the corporate sector has to take responsibility too.
If we do all of those things we will keep and grow head office jobs in Canada, and Toronto will be a strong financial centre. The answer is in our hands. I know we have the skills. All we need is the will and the toughness it will take to get there.