7th ACSDA Seminar - Trends in the Capital Markets

1. 7th ACSDA Seminar - Trends in the Capital Markets November 9, 2006 - Sao Paulo, Brazil

2. Trends in Capital Markets 1. Demographic Influences - Demands of Retail Investors - Pensions Reform 2. Buy-Side Requirements 3. Regulatory Pressures 4. Market Structure Changes 5. Implications for CSDs

3. Demands of Retail Investors • Largest transfer of wealth as boomers inherit wealth • Households 55 years+ hold 58% 68% in 10 years • Greater demand for above-market returns, professional advice, tailored products • More complex investments for income generation, principal growth/protection, tax minimization • Structured products (e.g. principal protected notes) • Hedge funds • Income trusts (until last week) • More global diversificationas result of removal of foreign content restrictions on registered plans

4. Income Trusts • Corporate structure that avoids corporate taxation by paying all taxable income and net capital gains to unitholders • Very popular investment because of high yields • 39% held by pension plans and tax-deferred registered retirement plans • 22% held by foreign investors • Risks: • Limits ability to reinvest in the business • Lack of standards for calculation of cash distributions, disclosure • More complex corporate action processing, tax reporting

5. Income Trusts Listed on the TSX Image source: Your Key to Capital Income Trusts on Toronto Stock Exchange • October 2006: $210 billion in market value, 11% of TSX by value and 16% of number of listings

6. Income Trusts • Originally used in sectors with modest but steady growth and reliable cash flows: • real estate, resource companies, utilities • Base has broadened to include manufacturers, investment/asset management firms, service companies • Two largest phone companies - Telus Corp and BCE Inc. - recently announced conversion plans • Government concerns about lost tax revenues resulted in taxation on income trusts converting after October 30 and taxation on current trusts in 2011

7. Pensions Reform • Aging populations an increasing burden on private and public pensions as they are drawn for income • States will need to implement reforms to improve sustainability of public pensions • Hard choices: increasing contributions, reducing benefits, achieving higher returns • Private pensions increasingly relying on more sophisticated asset management to meet obligations • Impact on markets as public and private sectors seek improved returns

8. Canada Pension Plan • To keep the Canada Pension Plan (CPP) viable, Canadian government implemented two reforms in late 1990s: • increased contribution rate (split equally between employer and employee): • 5.6% in 1996 • 9.9% in 2006 • 11.3% expected by 2050 • created CPP Investment Board (CCPIB) to improve returns

9. CPP Investment Board • CPPIB’s portfolio of $99 billion: • $58 billion invested in equity of 2,600 publicly-traded companies • 600 Canadian companies • 2,000 foreign companies • Expected to grow to $147 billion by 2010 • Sustainable for at least 75 years • Becoming a more active manager • $14 billion committed for investment in private equity, including infrastructure assets, with $5 billion already invested

10. Canada Pension Plan Assets

11. Buy-Side Impacts • Size of institutional trades can affect pricing • Buy-side wants more control and faster, less costly and anonymous executions • Direct market access • Enables buy-side traders to access liquidity pools and execution venues directly without intervention from a broker’s trading desk • Use the broker’s infrastructure and clear through the broker but buy-side controls the order • Algorithmic trading optimizes timing for placing orders in order to minimize impact on pricing • Dark liquidity pools that allow order crossing without displaying quotes to the market

12. Regulatory Initiatives - Canada • Regulators are adopting initiatives to reduce costs and increase efficiency and transparency of trading and settlement • In Canada, CSA proposed institutional trade matching and settlement rule (National Instrument 24-101): • Promote more efficient and timely settlement processing of trades, especially institutional trades, per STP • Registered dealers and advisers must have procedures to match institutional trades no later than prescribed times and to facilitate settlement by standard settlement time • Transition to achieve 98% matching of trades executed before 4:30 pm by 7:30 pm on T by July 1, 2008

13. Regulatory Initiatives - U.S. • Elliott Spitzer obtained changes in market practices in the investment banking, mutual fund and insurance brokerage industries • Burden of SOX has led to increased privatizations and initial offerings in foreign markets with less onerous disclosure requirements • SEC Regulation NMS (National Market System): • market centres to prevent “trade-throughs” (i.e. execution of order at a price inferior to best displayed bid or offer) • uniform market access rule to assure non-discriminatory access to best prices displayed by market centres • sub-penny quoting banned, unless security priced <$1 • changes to dissemination of market data to public

14. Regulatory Initiatives - EU • MiFID - Markets in Financial Instruments Directive to create a single market in financial services: • Establishes common conduct of business practices • Firms to obtain best execution for clients, taking into account not only price but cost, speed and likelihood of execution and settlement • Improved operation of passport approach to better enable firms to open branches in other member states and offer broader range of cross-border services • New minimum standards for regulated markets and multilateral trading facilities • Minimum standards for pre-trade and post-trade transparency

15. Regulatory Initiatives - EU • TARGET2-Securities (T2S) • Proposal issued by the European Central Bank for consultation to develop a more efficient, cross-border integrated model for securities settlement • New service of the Eurosystem for settlement of securities in central bank money on one technical platform • To only cover settlement function; CSDs to continue providing safekeeping, custody, administration, corporate actions

16. Market Responses - Investment Firms • In U.S., firms countered disintermediation threat by direct market access by buying DMA providers • Prime brokerage provides centralized trade processing, reporting, financing and servicing for hedge funds • Technology now gives traders a centralized way of seeking out liquidity and intelligently routing orders among markets • Opportunity to create partnerships among firms and exchanges, provide transparency and offer institutional traders a single point of entry

17. Market Responses - Investment Firms • Proliferation of investments in alternative trading systems (ATSs) and regional exchanges as alternatives to NYSE and NASDAQ • E.g. Block Interest Discovery Service (Bids) - Citigroup, Lehman Brothers, Merrill Lynch, Goldman Sachs, Morgan Stanley, UBS • Level ATS - Citigroup, Credit Suisse, Fidelity Brokerage, Lehman Brothers, Merrill Lynch • With an estimated 33 crossing systems in the U.S., shake-out is inevitable

18. Exchange Trade Volume Growth

19. Market Responses - Exchanges • As public companies, exchanges expected to continue growing earnings • Increase prices for transactions and market data or change pricing model • Contributor to proliferation of ATSs and firms internalizing their crossing systems • Reduce costs and counter electronic competition by replacing floor trading with electronic trading • Diversification of revenue sources by expanding asset classes: • Derivatives • Fixed income trading • Gas and electricity contracts

20. Market Responses - Exchanges • Increase alliances between markets for interlistings • E.g. MOU between TSX, TSX Venture Exchange and BOVESPA to promote broader co-operation and exchange of information to facilitate interlisting of issuers • Compete for interlistings • E.g., AIM market is marketing its less onerous disclosure requirements, deep pool of liquidity and international institutional investor base to attract U.S. and Canadian issuers • Canadian listings account for 20% of foreign firms listed on AIM • Vertical integration with CSDs, clearing houses

21. Horizontal Consolidation

22. Implications for CSDs • Ongoing pressure to reduce costs • Enhance systems and operational capabilities and risk controls to: • Process higher trade volumes and accept trades from multiple sources • Accept and process new asset classes • Process increased and more complex corporate actions • Opportunities to broaden services, market data • Establish global links to support exchange linkages, interlistings • Continued consolidation - vertical and horizontal