Editorial Getting the most from COATS

Unfortunately, the Canadian Over-the-counter Automated Trading System (COATS), set up in 1986 to revive the moribund OTC market and bring it up to date, was working under some severe handicaps that have prevented it from reaching its potential. A recent industry-government committee looking into ways to improve the over-the-counter (OTC) market in Ontario has identified some of those handicaps and recommended changes designed to overcome them.

For one thing, COATS came into existence just when flow- through share financing was coming into its own. Unfortunately, under the Canadian Income Tax Act, a company had to be listed on a “prescribed stock exchange in Canada” to be allowed to issue flow-through shares. That in itself was a major incentive for companies to get off COATS and get on an established stock exchange.

The stock market crash of 1987 didn’t help COATS get established, either. Investor interest in the stock market dried up after the crash and, even though stock prices have fared well since Black Monday, investor interest still hasn’t bounced back. The number of new issues, which often trade actively on the OTC market just before being listed on an exchange, also declined after the crash. As a result, with revenues declining, there has not been the support in the securities industry for the fledgling COATS needed to make it fly.

Even so, the value of trading on COATS in 1988 was $670 million, 142% of that of the Alberta Stock Exchange and 20% of that of the Vancouver Stock Exchange. It also generated an operating profit for the TSE during its first full year of operation (figures for 1988 are not yet available).

In short, even though COATS has made the OTC market in Ontario much more equitable and efficient, there remains great potential to improve its role.

Part of the potential lies in COATS’ ability to be a national market, serving regions such as the Maritimes that aren’t already served by a stock exchange. One has only to look south of the border at the success of the National Association of Securities Dealers’ OTC market in the United States to see the potential. That U.S. market, however, dates back many years and its successful automated quotation system, known as NASDAQ, has been in place since 1971.

The formation of COATS, and its day-to-day operations, has been in the hand of the Ontario Securities Commission (OSC). The goal is eventually to establish COATS as a stock exchange in its own right, but without a trading “floor” such as the established stock exchanges. COATS would make use of telephone lines and computers to create a national market free of the restraints imposed by a physical trading location.

In fact, that is a key recommendation of the COATS committee: that the federal department of finance recognize a section of COATS as a prescribed stock exchange. That way, securities listed on COATS cold be issued through flow-through financings and be eligible for registered retirement savings plans among other things.

That one change alone would likely see a dramatic change in COATS’ role.

Day-to-day operations of COATS must also be taken out of the hands of the OSC. The provincial government agency has not done anything wrong in the way it has operated COATS, but being run by regulatory body is not conducive to creating an active, dynamic marketplace. For one thing, the OSC doesn’t have the staff and, even if it did, its mandate is just not suitable to what is essentially an entrepreneurial enterprise.

Ultimately, COATS would be a self-regulatory organization, but the committee recognized the lack of support for such a move given the current market environment. Therefore, it has recommended a first step that would see the OSC establish an operating committee with a mandate, and sufficient authority, to operate COATS.

The recommendations of the committee make sense and can only be supported by those who support a vibrant OTC market. The question is, will there be sufficient support to allow the OSC to act on these recommendations. Investors would probably support it if they were convinced it provided a viable and reliable place to buy stock. Junior issuers would certainly support it if their securities could be issued by flow-through financings and were eligible for RRSPs. What is in doubt is whether the securities industry itself would support it.

Can a dynamic OTC market provide a viable alternative for trading securities without cutting into the business of the established stock exchanges and the member brokers that make up the exchanges? The U.S. experience would suggest not. And if the established stock exchanges see COATS as a threat rather than a help, the OSC will have a hard time developing it into anything more than an elaborate way of recording trades in securities of companies merely biding time until they are listed on one of the established stock exchanges.

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