Canadian Derivative Markets: Co-Existing in the Shadow of a Giant

The US and Canada are indelibly intertwined. Sharing a 5,525 mile border, acting as primary trading partners and having symbiotic economies that ebb and flow in tandem has resulted in two distinct yet highly correlated capital markets that are actively traded by global investors. Although sometimes overlooked by the US, Canada’s financial markets are substantial in their own right. The country's equity markets, with a market capitalization of $2.3 trillion, rank seventh in the world.

Many of Canada’s small- and medium-sized asset managers are just beginning to explore the potential benefits of using derivatives in investment strategies. These efforts will only expand, especially as funds compete to attract new assets through improved returns and risk management.

The wild card is the global pace of regulatory reform. As efforts to move OTC derivatives onto central clearing mechanisms and organized trading facilities begin to gain steam, the true costs associated with trading OTC instruments will become clear. When the regulatory dust settles, OTC instruments may still fit the needs of many large investors while exchange-traded instruments will increasingly appeal to smaller and mid-sized institutions looking for ways to manage risk and improve returns.

While still below the record volume peaks of a few years ago, Canada’s listed derivatives markets are poised to benefit from three major trends moving in their favor: an improving economic environment, regulatory initiatives and the return of market volatility. And although some hurdles need to be cleared, both domestic and international investors are showing signs of playing a bigger role in these markets.