PrefBlog

In the 2023 Fall Economic Update, the Government of Canada announced:

Dividend Received Deduction by Financial Institutions – Exception

The Income Tax Act permits corporations to claim a deduction in respect of dividends received on shares of other corporations resident in Canada. Budget 2023 proposed to deny the dividend received deduction in respect of dividends received by financial institutions on shares that are mark-to-market property.

The 2023 Fall Economic Statement proposes an exception to this measure for dividends received on “taxable preferred shares” (as defined in the Income Tax Act). This exception, along with the rest of the measure, would apply to dividends received on or after January 1, 2024.

So the fears previously expressed that property insurers would stop buying (and maybe even sell! They’re about 12% of the market!) can be laid to rest. Until next time.

Thanks to Assiduous Reader Jason for bringing this to my attention! And thanks to peet for foreshadowing this announcement!

Update, 2024-5-16: See also: https://www.budget.canada.ca/fes-eea/2023/report-rapport/FES-EEA-2023-en.pdf

https://www.theglobeandmail.com/business/article-insurers-preferred-shares-tax-change/

On May 16, the Globe published a piece titled Property insurers warn proposed federal tax change to preferred shares could hurt the sector that has caused a fair amount of comment on the web and interest from Assiduous Readers. According to the Globe:

Louis Marcotte, Intact’s executive vice-president and chief financial officer, told The Globe and Mail that the company has been a significant investor in Canadian dividend-generating securities for decades, and is encouraging the government to “consult widely” on the proposed change to ensure it is supporting its “local market champions.”

“Most Canadian equity investments held by Canadian insurers like Intact Financial Corporation, are held for the long term with a view of providing a safe return for policy holders and investors,” Mr. Marcotte said in an e-mail. “The loss of the dividend deduction could have a knock-on effect on premiums but also on the availability and diversity of funding sources for Canadian corporations.”

The loss of income from the dividends deduction would effectively raise Intact’s tax rate by almost two percentage points, the company said.

“It also would increase the tax imbalance for us but also all Canadian insurers when facing their foreign counterparts,” Mr. Marcotte added.

Canadian property and casualty (P&C) insurers hold at least 12 per cent of all outstanding preferred shares in Canada – about $6-billion, according to a recent report by SLC Asset Management, Sun Life Financial’s asset-management division.

I discussed the proposed taxation change in the post Dividend Capture by Banks Now Less Profitable, but only in the context of dividend capture trading strategies. The Globe article highlights further-reaching possibilities.

So what are the implications of a potential exodus? I don’t think prices will be immediately affected: right now the market is extremely depressed – there hasn’t been much new issuance in the last three years, and that tells you something right there – and the institutions aren’t going to have a fire-sale of perfectly good assets just because the tax situation has changed unfavourably. What might happen is that any future ascent in prices gets slowed down because the holders sell into market strength, but I don’t think they’ll sell otherwise.

Liquidity will be adversely affected; but much more in the world of block-trades (more than 10,000 shares on a single ticket) and the dealer market (the proprietary traders at the big firms who make a significant portion of their paycheques by arranging these trades for their clients). At the retail level, which dominates the market so much that the average daily trading value for the universe is a mere $100,000, not so much.

A more insidious effect, I think, is that there will be some capital exiting the business. A decline in block trading will be a direct hit to dealer profits and the firms will react by reducing the amount of capital available to their proprietary desks. We saw this writ large during the Credit Crunch, when the prop-traders basically stopped doing business due to lack of capital and as a result there were enormous intra-day price swings, $1.00 gaps between successive trades, up to $2 range on a single day. Those days were glorious for those among us who supply liquidity to the market in our modest way: to some extent I see this happening again.

Another source of liquidity in the market that may be affected is ETF arbitrage. There are a few players who spend a great deal of time exploiting the equation “ETF-1 + ShareBasketA – ShareBasketB = ETF-2” and trading accordingly. A decline in liquidity will disproportionately hurt them and if they can’t make any money with a fully hedged position they’ll have to find some other market to play in.

A decline in liquidity and a shortage of big buyers will also mean that issue sizes will tend to shrink. We’ve seen some massive issues over the past decade – e.g., TRP.PR.K, $500MM, 2016, redeemed in 2022; TD.PF.H, 1,000MM, 2016, redeemed in 2021; TD.PF.G, $700MM, 2016, redeemed in 2021. I don’t think we’ll be seeing that kind of size very often if 12% of the market takes its ball and goes home.

And really, that’s all I got. Our illiquid market will become a little more illiquid, helped along by OSFI’s determination to create an OTC preferred share market (dealt a blow by the proposed tax change?) for institutional investors (see this comment). But there should be no adverse price effects relative to the current subterranean levels; perhaps a slower ascent on the way back up; and probably a greater degree of intra-day volatility.

I hadn’t been aware of the following wrinkle, brought to my attention by the 2023 Federal Budget : Tax Measures : Supplementary Information:

The Income Tax Act permits corporations to claim a deduction in respect of dividends received on shares of other corporations resident in Canada. These dividends are effectively excluded from income. The dividend received deduction is intended to limit the imposition of multiple levels of corporate taxation.

The mark-to-market rules in the Income Tax Act recognize the unique nature of certain property (“mark-to-market property”) held by financial institutions in the ordinary course of their business. Under these rules, gains on the disposition of mark-to-market property are included in ordinary income, not capital gains, and unrealized gains are included in computing income annually (in addition to when the property is disposed of). Shares are generally mark-to-market property when a financial institution has less than ten per cent of the votes or value of the corporation that issued the shares (“portfolio shares”).

The policy behind the dividend received deduction conflicts with the policy behind the mark-to-market rules. Although the mark-to-market rules essentially classify gains on portfolio shares as business income, dividends received on those shares remain eligible for the dividend received deduction and are excluded from income. The tax treatment of dividends received by financial institutions on portfolio shares held in the ordinary course of their business is inconsistent with the tax treatment of gains on those shares under the mark-to-market rules.

To align the treatment of dividends and gains on portfolio shares under the mark-to-market rules, Budget 2023 proposes to deny the dividend received deduction in respect of dividends received by financial institutions on shares that are mark-to-market property.

This measure would apply to dividends received after 2023.

It seems that Dividend Capture has been very profitable for trading desks! The revenue impact of this change is estimated at about $800-million per year. I have updated my post Research: Dividend Capture.

Update, 2023-5-18 I have clarified on FWF that:

I mean basically the same thing as you do by dividend capture, although I do not insist that the sale be executed on the very next day. When I read of the tax change though, it was this type of trading that occurred to me as being much more profitable than I had previously thought, since the dealers have been making untaxed revenue on the dividends but (I presume – I’m not a tax guy) still being able to claim the (hopefully lower) capital loss. Nice business!

The $800-million figure refers to the incremental tax income for the entirety of dividends affected (including portfolio shares held by insurers), not just those resulting from the Dividend Capture strategy and the source is the federal budget

This is very old news at this point, but better late than never!

Canoe Financial has announced (on 2020-4-9) that it:

reached an agreement under which Canoe Financial will acquire the rights to manage all of Fiera Investments’ retail mutual funds listed below (the “Mutual Funds”), representing approximately $1.14 billion in assets. The transaction is expected to close on or about the end of the second quarter of 2020, subject to receipt of all necessary approvals.

Regulatory approval was granted 2020-6-17:

The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.

The decision of the principal regulator under the Legislation is that the Approvals Sought are granted.

As a result “Fiera Canadian Preferred Share Class” was merged into “Canoe Preferred Share Portfolio Class”, a new Canoe Portfolio Class Fund to be created prior to the Merger Date consisting of Canoe Preferred Share Class and units of Canoe Trust Fund.

Accordingly, the acquisition closed on 2020-6-26.

The new fund has been assigned a page on the Canoe Financial website with an inception date of July, 2020.

The Federal Reserve has announced:

The coronavirus outbreak has harmed communities and disrupted economic activity in many countries, including the United States. Global financial conditions have also been significantly affected. Available economic data show that the U.S. economy came into this challenging period on a strong footing. Information received since the Federal Open Market Committee met in January indicates that the labor market remained strong through February and economic activity rose at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although household spending rose at a moderate pace, business fixed investment and exports remained weak. More recently, the energy sector has come under stress. On a 12‑month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation have declined; survey-based measures of longer-term inflation expectations are little changed.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The effects of the coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook. In light of these developments, the Committee decided to lower the target range for the federal funds rate to 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals. This action will help support economic activity, strong labor market conditions, and inflation returning to the Committee’s symmetric 2 percent objective.

The Committee will continue to monitor the implications of incoming information for the economic outlook, including information related to public health, as well as global developments and muted inflation pressures, and will use its tools and act as appropriate to support the economy. In determining the timing and size of future adjustments to the stance of monetary policy, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

The Federal Reserve is prepared to use its full range of tools to support the flow of credit to households and businesses and thereby promote its maximum employment and price stability goals. To support the smooth functioning of markets for Treasury securities and agency mortgage-backed securities that are central to the flow of credit to households and businesses, over coming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion. The Committee will also reinvest all principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Open Market Desk has recently expanded its overnight and term repurchase agreement operations. The Committee will continue to closely monitor market conditions and is prepared to adjust its plans as appropriate.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Randal K. Quarles. Voting against this action was Loretta J. Mester, who was fully supportive of all of the actions taken to promote the smooth functioning of markets and the flow of credit to households and businesses but preferred to reduce the target range for the federal funds rate to 1/2 to 3/4 percent at this meeting.

In a related set of actions to support the credit needs of households and businesses, the Federal Reserve announced measures related to the discount window, intraday credit, bank capital and liquidity buffers, reserve requirements, and—in coordination with other central banks—the U.S. dollar liquidity swap line arrangements. More information can be found on the Federal Reserve Board’s website.

The last cut, by 50bp to a range of 1.00-1.25%, was announced on March 3. Well, nobody can accuse them of not taking the coronavirus seriously!

I will leave consideration of the question of whether this announcement is well suited to the Ides of March to the reader.

Update: They later announced technical measures to improve credit availability under the headings:

• Discount Window
• Intraday Credit
• Bank Capital and Liquidity Buffers
• Reserve Requirements

… and coordinated Central Bank action:

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements.

These central banks have agreed to lower the pricing on the standing U.S. dollar liquidity swap arrangements by 25 basis points, so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 25 basis points. To increase the swap lines’ effectiveness in providing term liquidity, the foreign central banks with regular U.S. dollar liquidity operations have also agreed to begin offering U.S. dollars weekly in each jurisdiction with an 84-day maturity, in addition to the 1-week maturity operations currently offered. These changes will take effect with the next scheduled operations during the week of March 16.1 The new pricing and maturity offerings will remain in place as long as appropriate to support the smooth functioning of U.S. dollar funding markets.

The swap lines are available standing facilities and serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses, both domestically and abroad.

If one searches on SEDAR for “Manulife Preferred Income Class Apr 25 2018 16:25:30 ET Material document – English PDF 94 K” (as usual, the Canadian Securities Administrators prohibit me from linking to the document directly) one will find notification that Manulife Preferred Income Class has been terminated and merged into Manulife Dividend Income Class, effective as of the Close of Business, April 20, 2018.

There was a chaotic close in the preferred share market on April 20; it would be interesting to know if these two incidents were related!

The preferred fund had previously absorbed the poorly performing Manulife Preferred Income Fund, which was originally the AIC Preferred Income Fund.

According to the public document that I am not allowed to link to, “Manulife Preferred Income Class Mar 14 2018 14:27:09 ET Management information circular – English PDF 481 K”, the fund had 1,450 security holders and paid Manulife about $390,000 in management fees in 2017. According to another unlinkable document, “Manulife Preferred Income Class Jul 28 2017 07:55:29 ET Audited annual financial statements – English PDF 1191 K”, the NAV of the fund was about $27.2-million as of April 30, 2017.

Sic transit gloria mundi! As shown on the MAPF Performance Review for March, 2018 the fund was not a terrible performer (provided the absorbed fund is forgotten!) but was nothing special, returning +3.29% annualized in the three years to March, 2018, compared to +4.45% for the BMO-CM “50” Preferred Share Index and +2.76% for TXPR.

I have one pair of Toronto Rock Lacrosse playoff tickets to give away!

The Toronto Rock won their last regular season game:

The Toronto Rock (9-9) defeated the Buffalo Bandits (6-12) by a score of 19-15 and got the help they needed on Saturday night as the Vancouver Stealth defeated the New England Black Wolves in OT, meaning the Rock will now host the Black Wolves on Saturday, May 6 at 7pm at Air Canada Centre.

So I have an excellent pair of tickets for Saturday’s East Division Semi-Final at Air Canada Centre on Saturday, May 6 at 7 p.m. If you want them, entry deadline is 4pm, Monday May 1, which will allow me to post the tickets to the lucky winner in time for the 5pm pick-up time at my local post office box. Simply eMail me with your address if you want the tickets … preference will be given to clients and those who will be taking a kid who plays lacrosse to the game, but anybody can win. Determining the winner is not a mechanical scoring process, but it’s not completely random either! Let me know if I may announce your name if you win.

The games are a lot of fun. One thing that has impressed me is that these guys’ technical skills are so good they can concentrate on strategy … there are a lot fewer loose balls than I remember from my days of box lacrosse at age 10!

There will be more tickets next year!

I have no more pairs of Toronto Rock Lacrosse tickets to give away!

The fifth lucky winner, who got the tickets for March 25 against the Vancouver Stealth, was Jeremy Tabarrok.

Giveaways this year were:

The games are a lot of fun. One thing that has impressed me is that these guys’ technical skills are so good they can concentrate on strategy … there are a lot fewer loose balls than I remember from my days of box lacrosse at age 10!

There will be more tickets next year!