BACKGROUND

Innovative Income Trust Market

Experience shows that given a stable policy regime, the trust form of income security and public exchange compels growth of popular participation in financial markets. It also demonstrates the enhanced potential for development of a democratic exchange.

This supports a Possible Thesis for adoption by the Institute involving observations that these securities have proven that flow-through entities can provide a vital catalyst for:

INCOME
• Social security including income for retirees and returns for other investors;
• Consumer spending and savings as well as income as a base for both tax revenues and economic multipliers;
• Prudent cash management of returns by enterprise;
• Attraction of capital for investment in productive assets;

TRUST
- Investor confidence and participation in equity issues;
- Corporate disclosure and transparency;
- Potential clarity in expectations and good governance in terms of
  fiduciary duty as it is contracted in the trust indenture;

PRODUCTIVITY
- Flexibility to discern and value productive assets as investment opportunities by business managers in concert with owners;
- Reliably high levels of reinvestment as investors with discretion are provided meaningful alternatives in an efficient open market;
- Efficient allocation of investment towards discovery and
  development projects, i.e. growth opportunities;

GROWTH
- Informed investment by increasing number of investors; and so
- Net returns to Canadian businesses & investors, added market
  liquidity and global strength from local listings of securities for
  foreign companies;
- Real growth in the Canadian economy and a growing tax base.

As income trusts came to dominate the listing of new equity issues, they also attracted broad-based scrutiny of the inherent systematic risks in an exchange proliferating new listings in a drive for volume. Problems fundamental to new issues and equities were revealed with public experience in trusts providing the educational pointers:

GENERAL RISKS OF INITIAL PUBLIC OFFERINGS
- Need for precaution and due diligence on the part of underwriters,
  retail brokers and advisors in addition to buying investors;
- Distraction from value due to incentives for ill-informed sellers;
- Policy challenge when private equity holders sell out of business interests to drain investment capital from Canadian markets;

EQUITY-RELATED COSTS AND RISKS
- Merits of addressing lax accounting and prospectus standards;
- Asymmetric relationship in performance between investments in
  diversified financial products and focused enterprise;
- Volatility effect of market-weight indices on the trading versus
  investment nature of buyers;
- Need to address uncertainty of an unstable and relatively
  complex policy regime.

Learning from mistakes in other markets, the creators of Canadian income trusts have, on balance, provided a distinct asset class that adds an attractive dimension to equity markets today. Initial findings of comparative market studies further confirm that the Canadian experience shows promise in the innovative way income trusts can transform the beneficial role of financial markets in the lives and livelihood of sellers and buyers alike.

Income trusts have come to include oil and gas royalty trusts, real estate investment trusts, business trusts, utility trusts and limited partnerships and evolving forms of investment participation securities. Together, these forms of securities in Canadian markets warrant recognition for helping to reinvigorate investor trust in equities after being hurt by faith in cash-greedy issues of the "Tech Bubble", in fraudulent companies allowed to make public issues and in self-serving fund managers and brokers.

Structured income funds, particularly open-end trusts, have made the Toronto Stock Exchange the premier destination for investors of all types. Millions of people have entered the marketplace for the first time to sell, buy or trade these securities. Many buyers including retired people who require investment income have placed extraordinary confidence in their income trust investments, tending to hold units for income rather than trade in speculation or for short-term gain. Large fund managers, institutional investors, hedge funds, speculators and traders have all now entered the market as well.

Hundreds of successful new income trusts have been issued over the last five years and an increasing flow of local and international capital has sought investment in viable cash-yielding enterprise and productive assets. Yet, these issuers and investors face particular risk related to differences in accounting and audit standards, regulation & enforcement practices between Canada and more closely regulated markets.

Once the domain of sophisticated investors alone, income trusts have been made accessible and popular among an increasing proportion of the population.

Commitment Required to Realize Promise

With popularization comes pressure for all stakeholders in capital markets including regulators to both recognize the value and potential added merit of income trust securities and address the pre-existing and on-going exchange and market-related challenges revealed by trade in these issues.

Clearly, this security class, its existing and potential role in capital markets, is not yet well understood by investors, financial advisors, issuers and even sellers despite their practical capacity to market and exchange issues. Analysts are only just beginning to appreciate their returns and risks relative to the broader income and equities markets.

Income trusts are relatively new, varied, heterogeneous and relatively complex forms of securities. With the trust market, Canadians are developing a flexible and viable class of security and a distinct form of market that warrants greater understanding and support.

Key measures and standards of performance are required as the cornerstones for policies and practices that secure a stable market for productive investments.

Qualitative differences between trusts and flow-through entities can provide valuable lessons to all market participants for application in the market for this and other types of securities and public equities.

Furthermore, the relationship between the marketplace, potential investment incentives inherent in tax or regulatory policy, capital flows, economic growth, and long-term social security is not well understood by policy formulators and government officials. Recent government actions caused turmoil and confusion in the marketplace and a precipitous but temporary decline in equity values.

Access to the marketplace and trust in its integrity is fundamental to investor confidence and general participation in financial markets. So there is great potential to further strengthen and advance the quality of the flow-through market by design. But again, further research and development is required to look at the underlying principles in the context of the global market place and the Canadian environment.

The promise and appearance of leadership by Canadians in the income trust market requires research, development and further commitment to ensure that the potential is nurtured and fully realized in a visible way for the benefit of income trust sellers, investors and Canadians as well.

Conclusion

If their potential and value was better understood, income trusts might continue to evolve and grow as a unique asset class in Canadian markets and produce secondary benefits as well.

A Possible Thesis can be developed for research by the Institute.

Income trusts and their role in a dynamic market and growing economy all warrant further study.

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