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Ottawa, May 21, 2002
2002-040

Speech by the Honourable Paul Martin, Minister of Finance for Canada, to members of the Canadian Venture Capital Association and Toronto Stock Exchange

Toronto
May 21, 2002

Check against delivery

First of all, I want to thank the Canadian Venture Capital Association and the Toronto Stock Exchange for giving me this opportunity to speak to you today. I also want to commend the association for its strong leadership and its forward-looking approach to the economy as a whole.

As we meet today, it is clear that we in Canada have successfully weathered our most serious economic trial since restoring integrity to the nation’s finances. Indeed, for the first time in 30 years we have come through an economic slowdown in better shape than the United States. The Canadian economy grew at a 2-per-cent annualized rate in the last quarter of 2001, and growth in the first quarter of this year could be almost triple that pace. As a result, the International Monetary Fund and Organisation for Economic Co-operation and Development expect Canada to lead the G-7 in growth both this year and next.

Despite the global slowdown, we have a large current account surplus and rapidly falling foreign debt. Today our foreign debt, as a share of the economy, has been more than halved in less than a decade to below 20 per cent. It is now lower than that of the United States for the first time in history. As well, on the fiscal front we are the only G-7 country that will stay in surplus for the fiscal year just ended and for the current year. Given Canada's remarkable economic turnaround, it is not surprising, therefore, that Moody's has restored our Triple-A credit rating.

All of this being said, however, we cannot rest on our laurels. Why? Because we all know that we are in the midst of a sea change in the way economies operate, in how jobs are created and in how people and countries prepare themselves to succeed. And we know that to capture the benefits of this revolution, we have to be leading, not trailing, technological change; and that means duplicating and replicating the efforts of others is no longer sufficient. We have to be the first mover. Today getting to market second or third means getting to market too late. We need to hit the ground running, establishing the new products and approaches of tomorrow which other countries will have to meet.

Let there be no mistake. While the meltdown in the telecommunications sector has led many to question technology as a driver of the economy, the reality is that information technology, biotechnology, nanotechnology and environmental technology will be the engines of growth for decades to come. Technology will have a huge impact on all sectors of the economy, including so-called "old economy" industries. From traditional manufacturing to resource development to tourism, the application of new technologies and innovative ideas will increase Canada's productivity and competitiveness and open new markets. And the fact is, Canada is positioned far better than most realize to seize the opportunities these new worlds are opening up.

The question I would put to you, however, is: Does the Canadian success story cover all the elements needed for growth? In particular, to this audience, does it cover our ability not just to develop tomorrow's products, but to finance their entry into the world's marketplace? You know, someone once joked that a Canadian investor's idea of risk is an investment which is guaranteed by the government. Funny, but perhaps too close to the truth for comfort as well.

The point is, the unprecedented economic success of the United States in the 1990s was powered not simply by technology but by innovative financial risk analysis and risk taking, which allowed American entrepreneurs to get their new ideas to market faster than anyone else. Of course there were problems and of course there were failures. But the lasting legacy of that era was not only the development of innovative technologies, but the development of innovative financing.

My question to you today is, how do we create the financial instruments Canadian entrepreneurs need to move Canada to the next level of prosperity? What will it take to ensure that Canada becomes an incubator of dynamic new companies – and not merely a breeding ground of good ideas for others?

The need for innovative ways to access capital is not some obscure debate of interest only to Bay Street. The fact is that the ability to finance new ideas, new products and new services and bring them quickly to market is crucial if our economy is to improve its capacity to continually create well-paying jobs for Canadians. Quite simply, financing is the oxygen of entrepreneurship, enabling companies to move from the earliest stages of development to maturity. Of course, there are some who say that we can simply rely on our neighbour to the south. After all, our equity markets are only 5 per cent of those in the U.S. and our debt markets are only 3 per cent of theirs. Well, in my mind, this completely misses the point, and no one knows this better than you.

First, early stage funding is hands-on and proximity counts. Venture capitalists are more likely to finance something they can hop in a cab and go see than something they have to fly hours to visit.

Next, the reality is that while our largest companies might not have any trouble getting financing in the U.S., many of our smaller companies simply don’t have that option. It’s hard enough for a 10-person operation out of Waterloo to get Canadian investors to notice them, but if they have to depend on catching the eye of Americans, they might never get off the ground.

Finally, we all know the importance of clusters to the knowledge economy: they bring together a critical mass of high-performing research-oriented companies in a concentrated location and in a mutually reinforcing network. By definition, clusters build on local strengths in research, entrepreneurial talent and financial expertise. Thus, the capacity to finance growth from within becomes a self-sustaining advantage, as countries with entrepreneurial capital markets become leaders in the knowledge economy because they are better able to exploit opportunities and create new ones.

Canada is well placed to create this kind of environment, to develop the capacity to finance much more of its own future. We build from a strong base: active equity markets, well-developed bond markets and a growing number of capital pools. Moreover, we’ve made important strides in terms of capital gains and corporate tax reductions. As a result of recent tax changes, the average top capital gains rate is now lower in Canada than in the U.S. and, by next year, our corporate tax rate will be less than it is south of the border as well. And nobody knows better than you the importance of the changes we made to rollovers and limited partnerships.

Now, these are all positive developments, but they are far from the whole story. For example, over the past few years we have significantly increased Canada's capacity to do groundbreaking basic research. After all, ideas are the currency of the knowledge economy. For this reason, we created the Canada Foundation for Innovation, the Canadian Institutes of Health Research, Genome Canada and the Canada Research Chairs, among others. They have all breathed new life into research that will generate new ideas and technologies for years to come across our country.

But the question is: What kind of job are we doing in taking the innovation, ideas and imagination of our researchers and translating them into commercial successes? What kind of job are we doing at moving ideas from the lab to the market? The truth is, we need to do a better job at commercializing our research and innovation, and a critical element of that is innovative financing.

That’s why I wanted to talk to you today. You spend every day not just operating in the knowledge economy, but shaping it. You know its pressures, understand its dynamics and appreciate its potential. It is your business to look for the next great idea – the one that will transform an industry or hotwire the economy. Many of you have gone through the various stages of growing a company – from an idea in someone’s head to a product in people’s hands or a service on the market. And so you know the gaps that exist in our capital markets. You know the challenges that we have to face. And you know the rewards that await us if we get this right.

So I’m asking you, what needs to happen and what needs to change? For instance, take a marketable idea at the very beginning of its life cycle. Most entrepreneurs start off using their own money, borrowing from family and friends. But once they have exhausted their personal resources, they need to be able to tap into outside angel investors and other pools of funds that can make the difference between moving up or giving up. Yet it is here that many run into what they call the "death valley" of financing. They simply can’t find the money they need to go to the next level. And when that happens, the jobs that might have been created are lost.

Two years ago I suggested that we should aim to place among the top three industrial countries per capita in the level of new venture capital investments by 2010. We have made progress toward achieving this goal. In part, it has been a result of increased foreign venture capital interest in Canadian companies. We welcome this foreign participation, which is often done in partnership with Canadian venture capitalists, and encourage more of it. But it’s legitimate to ask whether we have done enough on the Canadian side.

Have the large pools of capital in Canada sufficiently embraced these opportunities? For example, in the United States, pension funds on average accounted for about half of all venture capital raised between 1996 and 2000. Canadian pension funds, by contrast, provided only about 12 per cent on average over the same period. Quite frankly, we need to change the prevailing mindset. We simply have to narrow that gap, and we must use every means at our disposal to do so. For instance, why are we not further advanced in the development of "funds of funds"? By their very nature venture capital investments are risky and require significant expertise. As was amply demonstrated in the United States, through such "funds of funds" institutional investors can share the costs of this expertise and invest in a diversified portfolio of venture capital.

Or again, why is there little or no performance data on Canadian venture capital available – unlike the U.S. and Europe? I understand that your association is working on providing this kind of information. When it’s ready, let’s make sure we get the data quickly into the hands of institutional investors and the investing public.

Finally, let us recognize that the financing gap in Canada is not simply one of the amount of dollars available. We also need more "smart" money that brings not only a cheque book, but skills in marketing, management, administration and finance – the types of investors that can ensure that entrepreneurs have access to the skills they'll need to prepare them for the next stage of growth, the stage of growth which requires access to a wider range of investors and a larger pool of funding.

Now, let's assume we have successfully moved through the early stages of financing and are now ready to go public. It is at this stage that companies move from the shadows to the spotlight – from enterprises that nobody’s heard of to the ones that make headlines. This speaks to the importance of initial public offerings (IPOs). Clearly, we need more IPO activity, which acts as both an entry to public financing for the company and as a critical exit for venture capital, so that it can be redeployed somewhere else. At the moment we lag far behind the U.S. In fact, we generate just about half as much IPO activity per capita as they do. This is not acceptable. There is no reason we cannot raise as many IPO dollars for growing enterprise here in Canada as American companies do per capita in the United States. Without the ability to go public, smaller companies – those with the potential to some day become industry leaders – simply won’t come to the attention of the wider pool of investors.

It is for this reason that we must support the efforts of stock exchanges in Canada, both to meet the needs of growing Canadian companies and to respond to stiff competition from abroad. For example, U.S. exchanges are aggressive in selectively seeking IPO candidates from Canada. This can be of tremendous help to the fortunate few but, let’s face it, it means less trading in Canada. As well, electronic trading systems in the U.S. are becoming increasingly prominent. In the face of this kind of competition, it is imperative that our exchanges continue to innovate and adapt. This is why the realignment, which saw the emergence of the TSX Venture Exchange and the specialization of the Montreal Exchange in derivatives, is so important. That being said, our exchanges must become more aggressive still in searching for IPO candidates and simplifying the listing process.

Now, so far we have talked about gaps in equity financing, but Canadian companies also face gaps in debt financing. If a company has successfully made its way from start-up through IPO, to a thriving, medium-sized enterprise, it is at a stage where a broader range of capital may be needed to expand – to develop the next product or enter the next market.

Canada has done well in developing a market for high-quality, investment grade debt, but we do not have a well-developed market for debt which is below investment grade – so-called "high-yield" debt. This has led to a reliance on U.S. investors – indeed, over the past five years Canadian companies issued an average of $6.5 billion of high-yield debt, and approximately 90 per cent of that was sold in the U.S. What we need to do – issuers, underwriters, banks, rating agencies and institutional investors – is to get together in order to explore the potential of high-yield debt in Canada. We need to develop the kind of data which would improve both the quantity and quality of market analysis, while also raising the comfort level of investors. We will never develop an economy fit for the 21^st century with a 19^th century concept of risk, and demanding an interest rate premium on a high-risk venture is entirely appropriate.

There are two other issues as well that affect our capital markets that I would like to touch on. The first is efficiency and the second is confidence.

In terms of efficiency, every day billions of dollars fly around the world at the press of a button. Indeed, technology has revolutionized capital markets more dramatically than almost any other part of the economy. It is within this context that we have to ask ourselves if it makes any sense that Canada has at least 30 different financial sector regulators and as many sets of rules. In that kind of an environment costs can only multiply and efficiency can only decline.

Just compare this with the situation in Australia, which has recently moved to two regulators, or the U.K. to one. Adjusting for size, Canada spends about twice as much on financial sector regulation as Australia. Twice as much! And Australia too is a federal state. Quite simply, we need a more uniform approach to regulation, particularly securities regulation, with a common set of rules and seamless enforcement across the country.

We understand the historical reasons why our regulatory system is balkanized. But the fact is, in a globalized market we simply cannot afford such fragmentation. We know that the status quo will not work and it must change. Otherwise, issuers and investors will take their money elsewhere. Let me be clear: I’m not going to prescribe what the mechanism should be, but whatever model is adopted, it must be based on today’s reality, not yesterday’s.

The last subject I would raise with you is the need to ensure confidence in the integrity of our markets. Some have said that capitalism is a system in which people who have money give it to people who have ideas. That exchange requires trust, a lot of it.

You shouldn’t have to be an accountant to understand a balance sheet. In recent years there has been tremendous innovation in how companies finance their operations. New instruments like derivatives and securitized products are coming on stream all the time, and we have to make sure that both accounting standards and disclosure practices keep up. Common sense suggests that auditors need to be independent of the corporations they audit and that there must be adequate oversight to ensure independence and the quality of the audit services provided. Clearly, industry-led solutions are preferred. But make no mistake, if these are not adequate, regulators and governments will need to act.

All of this being said, however, a key to building investor confidence is improving corporate governance. Companies need to convince investors that they are governing themselves with integrity and in the best interests of their shareholders. Some aspects of corporate governance, such as rules for audit committees, can be imposed by legislation or by regulation. More importantly, however, good governance comes from within – from corporate leaders who set the standards, demonstrate the values and develop the culture that inspires – and merits – investor confidence. For instance, I couldn’t believe it when I read that Enron‘s audit committee met 5 times in the last year, while its compensation committee met 10 times!

As a result of Enron, we know there will be changes in the United States. They will try to set a new benchmark against which the world will be measured. But let me tell you, we in Canada have to be at the forefront of this issue. All of us have in this room a stake in finding the answers that are right for Canada. All of us want to inspire confidence in our capital markets.

So let me just say that in conclusion, we should never forget that the history of our country has been one of developing the instruments we need to control our own economic destiny. Whether it was building a railroad from East to West, or constructing the vast hydroelectric projects which powered our progress, or becoming experts in financing the development of our natural resources, Canadians have always sought out the means of building their own future.

Today one of the keys to controlling our economic destiny is our ability to compete internationally, and a key to that is innovative financing. By strengthening our capacity to finance new endeavours at home, we will create the incentive for even greater entrepreneurial innovation and greater productivity, a virtuous circle enabling us, as a country in an increasingly integrated global economy, to follow our own path and preserve our own values. Our challenge today – yours and mine, private sector and public sector – is to build on our strengths, to make our capital markets work better and to seize the opportunities before us.

That is what national self-determination is all about. It’s about fulfilling our potential as an economy and as a society. It’s about overcoming obstacles and embracing change. In short, it’s about working together, proud of what we’ve achieved, but eager to do much more as we set a distinctly Canadian course to an even better tomorrow.