With the exception of Questrade, most brokerages in Canada don’t permit investors to hold US dollars in their RRSP accounts. This may not seem like a big deal until you check out the currency conversion costs when trading US securities. A solution to this problem is called “washing” the trades. I recently did this and thought it might be useful to describe exactly how it is done at my discount brokerage.
Before going any further, it’s important to know that “washing trades” means something completely different from “wash trading”. Wash trading is an illegal activity where someone simultaneously buys and sells a stock to drive up trading volume and give the appearance of something big about to happen. Washing trades is a brokerage service that means eliminating currency conversion costs.
I got my trades washed recently as I continued my transition from owning individual stocks to owning index ETFs. I wanted to sell several US stocks and buy a US index ETF in my RRSP. Without doing anything special, the following would have been the sequence of events for me:
– Place the order to sell US stocks
– The order is executed and US dollars arrive in my RRSP
– US dollars get converted to Canadian dollars at CDN$1.0035 per US dollar
– Place an order to buy the US index ETF units
– Canadian dollars get converted to US dollars at CDN$1.021 per US dollar
– The buy order is executed
Note the pointless conversions in the middle from US dollars to Canadian dollars and back again. This would have cost me 1.7% of my money if I hadn’t had BMO Investorline wash the trades. At Investorline, they actually call this “exchange rate matching” because they just make the two exchange rates equal rather than actually eliminating the currency conversions.
The exact method of exchange rate matching depends on whether the total number of US dollars involved in your buy orders is more or less than the total number of US dollars in your sell orders. This determines whether you are a net buyer or net seller. If you are a net buyer, then the sell order exchange rates get changed to be equal to the buy order rates. If you are a net seller, then the buy order exchange rates get changed to be equal to the sell order rates. Either way the portions of the trades that match up in total US dollars don’t cause any losses. The excess US dollars created or consumed are exchanged at the correct rate that favours the brokerage.
A restriction on wash trading is that it only applies to trades within a single day. So, if you sell US securities one day and buy other US securities the next day at Investorline, you’ll get hit with the full currency conversion costs.
Another restriction is that you have to ask for exchange rate matching with a phone call between 3:15 and 4:30 pm. Apparently, the day’s exchange rates get set around 3:15. I tend to be a little paranoid about these things and place the call before 3:30.
There is no good reason why washing trades couldn’t be done automatically without any phone call, except that BMO makes more money if you don’t make the call. There is also no good reason why the call has to be placed between 3:15 and 4:30. Surely I should be able to call at noon to say “when the rates get set, please wash my trades.” Again, BMO makes more money if I trade in the morning and forget to call later.
So, it is possible to avoid currency conversion costs, but you have to follow the silly rules. This is yet another of life’s taxes on the unwary.