Canadian securities regulators today sent the strongest signals yet that they are moving toward banning fund companies from paying mutual-fund brokers and dealers to sell their products.
The Canadian Securities Administrators (CSA), representing regulators across the country, said in a release that it expects to issue a consultation paper this fall on a proposed ban on trailer fees and other embedded commissions.
The regulators are seeking input on how best to go about eliminating embedded commissions, rather than whether or not to do so. The CSA consultation paper, when released, will discuss alternatives to banning embedded commissions and "the reasons why those options are no longer being considered." After a 120-day comment period, the CSA said it will hold further roundtable discussions on the potential impacts of ending embedded commissions and possible transition options.
"Discontinuing embedded commissions would be a significant change for investors and the mutual fund industry," the release said. "Therefore, before considering any rule proposals on mutual fund fees, the CSA wish to consult on the impact such a change could have on Canadian investors and market participants and on the ways in which any negative impacts could be mitigated through the design and implementation of potential transition measures."
In some of its most strongly worded language yet against embedded commissions, the CSA said this prevailing form of dealer compensation in the mutual-fund industry "raises a number of investor protection and market efficiency issues that suggest a need to consider change." According to the CSA, there is "considerable scope for better aligning the interests of investment fund managers and dealers/representatives with those of the investors they serve."
While noting that disclosure initiatives under the Client Relationship Model, phase 2 (CRM2) reforms and new point-of-sale disclosure requirements for mutual funds are beneficial to investors, the CSA indicated that such measures are insufficient. "While the CSA continue to evaluate and monitor these initiatives, we have decided to consult on the further option of discontinuing embedded commissions and transitioning to direct pay arrangements."
The regulators expressed the view that unbundling dealer compensation from mutual-fund fees would directly engage investors in the dealer compensation process, deliver greater clarity on the services provided and their costs, and better align the interests of fund industry participants and investors.
The apparent decision to eliminate embedded commissions, as the United Kingdom and Australia have already done, has been several years in the making. The debate over the future of embedded commissions was sparked by to an extensive CSA discussion paper on mutual-fund fees, published in December 2012.
Subsequently, discussion forums have been held in Ontario, Quebec and British Columbia. The CSA also commissioned independent research, most notably a study of the relationship between fund fees, sales and performance, headed by finance professor Douglas Cumming of York University's Schulich School of Business.
On the basis of its extensive review, consultations and independent research, the CSA has concluded that embedded commissions have a detrimental effect on investors and market efficiency. "There is sufficient evidence to consider regulatory action on embedded commissions."
Acknowledging concerns expressed by fund companies, advice-giving firms and the Investment Funds Institute of Canada, the regulators said they need to consider the impact that discontinuing embedded commissions could have on the provision and accessibility of advice and on the business models of some product providers. These consultations will include potential transition measures.
"The consultation paper will build on our previous consultations and the important body of research we have considered to date," the CSA said. "It will assess the potential quantitative and qualitative consequences of discontinuing embedded commissions on different types of market participants and different types of investors in Canada."
Reacting to today's announcement, the Investment Funds Institute of Canada urged the regulators to reconsider their proposed ban before issuing their consultation paper. Banning embedded commissions would result in the CSA regulating fees, something it has historically been reluctant to do, IFIC said in a release.
"The concerns that regulators cite as driving the need for further reforms -- potential conflicts of interest and investor awareness of fees and performance -- are already being addressed through a number of world-leading initiatives right here in Canada," Joanne De Laurentiis, IFIC president and CEO, said.
De Laurentiis was referring to the CRM2 reforms on fee disclosure, which are being phased in starting on July 15, and the requirement for pre-sale delivery of the short-form disclosure document known as Fund Facts, which took effect on May 30.
She reiterated the trade group's position that the regulators should take time to assess the impact of these new disclosure requirements, and conclude their current consultations on enhancing client-adviser relationships, before signalling that significant reforms are needed on dealer compensation.
Disputing the regulators' conclusions concerning conflicts of interest, De Laurentiis contended that research commissioned by the CSA failed to identify any evidence that fee-based advice is any less conflicted than advice obtained through the payment of embedded fees.
