Its skyscrapers and icy winters might seem at odds with the stereotypical image of an offshore hedge fund centre, but Toronto is building on a thriving domestic alternative investments market and a well-resourced financial infrastructure to provide a relatively inexpensive option for administering western hemisphere hedge fund managers, as the increasing interest of global service providers attests.
It may not boast the palm-lined beaches and sultry climate of the Cayman Islands, the sheer concentration of French restaurants of Luxembourg or the pubs of Dublin's Temple Bar, but Toronto is emerging as an alternative to the hedge fund servicing centres clustered in the offshore jurisdictions in and around the Caribbean and in Europe.
The new focus on Toronto is being boosted by a variety of factors: the existence of a burgeoning hedge fund manager industry centred on Canada's financial capital that is also attracting attention abroad, a well established administration sector catering to traditional long only funds, a low cost base compared with many other hedge fund servicing centres, and the ready availability of well-educated and experienced staff.
Toronto has a long-standing tradition of hedge fund administration, including State Street's servicing of the Soros funds, dating back to the days when funds that wanted to escape the ambit of US taxation had to satisfy the authorities of their adherence to the so-called '10 commandments' specifying administrative and marketing functions that had to be carried out wholly or largely outside the United States. These requirements were relaxed nearly a decade ago, but industry members in Toronto say there remain various practical reasons why US-based managers may still find it preferable to use administrators in Canada.
That's certainly the thinking behind the decision of UBS, which administers a global total of more than $100bn in hedge fund assets, to set up a Toronto office this year to take on part of its western hemisphere business currently handled in Grand Cayman.
The dynamism of the sector is also seen in the recent merger between the fund services business of Royal Bank of Canada and the Belgo-French Dexia group, creating a new industry powerhouse with hedge fund administration operations in Dublin, Luxembourg, Cayman, Jersey and Guernsey as well as Toronto.
UBS and RBC Dexia Investor Services are among a mix of domestic and global players in a keenly contested marketplace, with international names including Citigroup and Citco competing alongside specialist local firms such as Felcom Data Services, which focuses on start-up and smaller funds that are often overlooked by the bigger service providers, according to Ron Landry, Felcom's executive vice-president and chief operating officer.
He says: 'It's a fairly competitive market, consisting of a handful of very large American-based service providers like Citigroup and IFDS, and a number of smaller companies like ourselves. As well as size,service providers also differ in their approach to the market and who their target client is. Generally you can tell from a client's focus which provider would fit best. If their concern is purely the bottom line of what they're going to spend, they may be more appropriate for one particular provider, whereas if they're more concerned about the service quality they're receiving it might be a different one.' Says Mark Purdy, chief investment officer with Toronto-based fund of funds manager Arrow Hedge Partners: 'There is a legacy of good administrative back office business in Toronto dating back to the 10 commandment days with firms like State Street and Citco, and in addition several of the global players are strengthening their hedge fund administration business.
From a prime brokerage standpoint, there's been a big push recently from the local banks in response to the growth in hedge fund managers setting up shop in Canada.' In contrast to the administration sector, few of the leading global prime brokers have made a serious push into the Canadian market, leaving the field open to the country's leading domestic banks such as RBC, Toronto Dominion and Scotia. According to Lionel deMercado, managing director and global head of equity finance with TD Securities, for the time being the domestic hedge fund market is not large or lucrative enough to justify the kind of investment required for the global players to match the market experience and insider knowledge of the local institutions.
At present the Canadian market targeted by the prime brokers consists of more than 200 single-manager funds. Although the country's sizeable community of fund of funds managers have traditionally made significant allocations outside Canada, deMercado says they are starting to show greater interest in the homegrown market as a result of the success of domestic managers over the past few years.
Up to date figures on Canada's hedge fund industry are hard to come by, but in June 2004 Toronto-based research firm Investor Economics estimated conservatively that assets totalled some C$26.6bn (US$22.7bn), consisting of C$10.9bn in pension plan assets, C$14.1bn in domestic hedge fund products (of which as much as half consisted of principal-protected structured products aimed principally at the retail market) and C$1.6bn in offshore funds run by Canadian managers, largely targeted at European investors.
Although modest measured against a global hedge fund industry whose assets have been estimated as high at US$1.5 trillion, these figures represent rapid growth for the Canadian market, with domestic hedge fund assets growing six-fold between 1999 and the end of 2004. Arrow Hedge chief executive Jim McGovern cautions, however, that because much of the current growth in hedge fund assets is flowing to the offshore vehicles of Canadian managers, domestic service providers may not gain the full benefit. He says: 'A lot of the new capital flows that they're getting are actually coming from international investors investing in their offshore funds, domiciled in Cayman, BVI or Bermuda.'
According to deMercado, the strategy adopted by many managers is to establish a track record in the domestic market and then to set up an offshore fund to market to international investors. He says: 'We find that many managers who have offshore accounts have a domestic administrator for their onshore business and an offshore administrator in somewhere like the Cayman Islands.'
Managers and service providers are unanimous that Toronto can hold its own with the best in terms of the skills it can provide in hedge fund servicing and their cost. Adds deMercado: 'Growth in the services sector has benefited not only administrators but firms offering audit and legal services, and providing structuring for hedge funds.' The city's broad-based financial services industry is a ready source of qualified staff with many of the skills required by the hedge fund sector. Says Sean Flynn, managing director and head of UBS Hedge Fund Services: 'Toronto has a good supply of qualified and experienced labour for the fund administration business."
'There are already a number of playerswho have been active for many years in the traditional fund administration business, as well as a small but growing number of hedge fund administrators, but there is also a skills pool coming from traditional business who can easily be retrained into the hedge fund business. There is a good supply of accountants coming out of the Big Four professional services firms.' According to a local adage, 'Americans love to make money and Canadians love to audit it', and McGovern says: 'There is a very strong infrastructure here for managing and administering funds.' Mark Fieldhouse, director of technical sales and relationship for global products with RBC Dexia Investor Services, notes that Toronto has one of the highest levels of new Chartered Financial Analyst qualifications of any city in North America.
Members of the industry note that while Toronto may look pricey to Canadian eyes, it is certainly competitive on cost with its rivals for hedge fund servicing business. Says Felcom Data's president and chief executive Kevin Beatson: 'Toronto is expensive by comparison with other Canadian cities except maybe Vancouver, but from a global perspective it can offer considerable savings. Any administrator in one of the offshore island domiciles would find it profitable to outsource back office work to Toronto.' Adds McGovern: 'Not only is this is a very competitive place for recruitment, things like wages and other staff costs, rental costs and operating expenses are substantially lower here than in other jurisdictions. There's also a level of comfort from the fact that there's a bigger infrastructure here in terms of the legal and accounting professions.'
Toronto offers a very viable alternative to other leading financial centres, Fieldhouse says. 'If anything it would be toward the low end of the cost scale compared with alternatives in the US, although it has probably been affected by the strength of the Canadian dollar over the past 18 months to two years,' he says. 'RBC Dexia has a global presence and I would say Toronto is in the middle of the pack when it comes to cost structure.'
These factors are likely to encourage other service providers to follow the lead of UBS and look beyond the domestic Canadian market to broader opportunities throughout the Americas. Says Fieldhouse: 'With the trend on the part of institutional investors to adopt hedge fund or hedge-like strategies and the overall institutionalisation of the hedge fund market, we can see Toronto growing as a key hub for all of North America. We expect these trends to produce double-digit growth over the next one to two years.'
Depending on their specialisation and strategy, providers differ on the importance of the domestic market in boosting business growth. For instance, it is not currently a high priority for UBS, which has always conceived its Toronto operation as internationally focused. Says Flynn: 'At this point in time Canada is not a significant market. There is a growing hedge fund business, but at the moment the major market is clearly the US, and that's the market we are looking to service.' By contrast, the outlook for prime brokers like TD Securities is rosy, according to deMercado: 'We continue to see new business and we're always in dialogue with new managers for new mandates,' he says. 'We pick up a substantial amount of new business based on our reputation in the marketplace and referrals from other clients, and I see no sign of it stopping any time soon.'
The new business, he says, is coming from a combination of existing managers setting up offshore funds, the growth in assets of managers that have been performing well, and the departure of traders and analysts from established institutions to set up their own funds. 'There's no question that over the next 12 to 18 months we will continue to grow and to increase the range of services we offer to funds,' de Mercado says, 'and perhaps to a broader geographical range of funds.'
Beatson believes that increasing numbers of managers outside Canada will add to the flow of business, even for administrators that are currently focused mainly on the domestic market. Arguing that UBS's decision to set up an administration business 'speaks well for Toronto and where they see it going', he adds: 'One of the great advantages that we bring to the table is Toronto's experienced and educated workforce.
'We've seen that one of the ways we can move forward in some of these offshore markets is providing back office services for some of the administration companies there. They are dealing with the client directly as the face of the relationship, but they have a shortage of skilled employees, so they can outsource the actual work out to us. But we also expect to see growth from the established domestic market too.'
The increasing international spotlight on Toronto might bring more competition into the market from the leading global hedge fund administrators, but Beatson argues that they may not have things all their own way. He says: 'We've seen in the past that US service providers have come to Canada with the approach that they can set up a small shop doing the same thing they do
'Some of them have been through very difficult times coming to terms with the differences between the two markets. You find that Canadian companies and the professionals working in them have, generally speaking, a higher level of exposure to what's happening worldwide, and Canadians are generally very well versed in offshore product and what's happening in that market. There's a certain global awareness among Canadians that you might not find in other places.'