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A ban on embedded commissions in mutual fund would likely affect non-bank mutual fund dealers the most and could lead to regulatory arbitrage with the insurance sector, suggests a report from the Mutual Fund Dealers Association of Canada (MFDA) published on Tuesday.

The MFDA’s report details the results of a large research exercise that examines the demographics of both mutual fund dealers that belong to the MFDA and their client base. The project is designed to give the self-regulatory organization a comprehensive data-driven view of the mutual fund dealer business and its place within the broader retail investment business, while also informing its compliance and policy work.

The report divides the mutual fund industry into firms that are controlled by deposit-takers (banks) and dealers that are either independent or affiliated with a mutual fund company or insurance firm. It finds that bank-owned firms account for the majority of financial advisors (51,000) and serve the majority of households (72%), accounting for 59% of assets under management (AUM). In contrast, the other dealers serve 27% of households but represent 39% of AUM; direct sellers account for the rest.

In terms of a possible ban on embedded commissions (which is currently under consideration by the Canadian Securities Administrators [CSA]), it’s the non-bank dealers that “are the most likely to experience an impact,” the report points out.

Read: The end of embedded commissions? How we got here

In particular, a ban on embedded compensation and a switch to direct-pay arrangements will “have a greater impact on those smaller advisors who are more reliant on [deferred sales charge (DSC)] commissions than those advisors who are currently predominantly earning trailing commissions,” the MFDA’s report points out

Approximately 56% of advisors with non-bank firms have small books and “predominantly rely on DSC commissions to finance their operations,” the report notes, adding that “Mass market clients are more likely to purchase DSC funds and, therefore, are also more likely to experience an impact from a ban of embedded compensation.”

As almost all advisors at non-bank firms are dually licensed to sell insurance, a ban on embedded compensation may mean that “clients may not in fact experience any change in their advisory relationship,” the report also points out. “Rather, advisors may decide to recommend products or services to their clients that are not subject to the same regulatory requirements.”

In addition to the concern about possible regulatory arbitrage with the insurance sector, the MFDA has “identified regulatory and investor protection concerns with other compensation arrangements, and in particular, with the sale of exempt securities and referral arrangements with portfolio managers,” the report notes.

Apart from the MFDA report’s role in informing the debate over a possible reforms, it also indicates that the data collected as part of this project represent a baseline for future research, allowing the MFDA to “identify trends or changes in such things as client demographics, industry compensation structures and asset mixes within portfolios.”

“This data provides us with an unprecedented view of retail investors in Canada and will be invaluable in performing our regulatory activities.” says Mark Gordon, president and CEO of the MFDA, in a statement. “The information obtained from our Client Research Project will be used for various regulatory purposes including identifying higher risk activities, vulnerable clients and impact of regulatory policy initiatives.”

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