Special Feature

The end of embedded commissions? How we got here

The Canadian Securities Administrators (CSA) published a consultation paper on Tuesday in which it proposes to consult with stakeholders for an extended comment period of 150 days on the option of discontinuing embedded commissions and making a transition to direct pay arrangements.

 

The move to consider a ban on embedded fees follows research the CSA commissioned from York University professor Douglas Cumming in 2015, which showed that these compensation structures distort sales and impact investment performance.

 

Included in this special feature are the notable developments in this area over the past few years highlighting how we got to the release of the CSA's consultation paper. Photo copyright: cherezoff/123RF.

Industry News

But PMAC stands behind the CSA’s concerns with these compensation arrangements and says regulators are “taking a bold step forward”

By James Langton |

The prospect of the Canadian Securities Administrators (CSA) making a move to ban embedded commissions in Canada's retail investment business is sparking concern from some in the investment industry, which have long opposed such a move.

The CSA published a paper on Tuesday that launched a consultation on the possibility of regulators banning the use of embedded fee structures, requiring instead that dealers and advisors agree to "direct pay" compensation arrangements with their clients.

Yet, the Investment Funds Institute of Canada (IFIC) and the Financial Advisors Association of Canada (Advocis) are already pushing back against the idea, reiterating long-standing arguments that intervening with these traditional compensation arrangements would harm investors' access to advice. They also question whether the harm regulators are seeking to address warrants the upheaval that an outright ban on commissions would cause.

"Eliminating the ability of investors to pay their fees through what is known as a bundled or embedded commission could significantly disrupt access to investment advice for many investors," says Paul Bourque, IFIC's president and CEO, in a statement responding to the release of the CSA paper. "Both regulators and governments should understand whether the cost of banning embedded commissions is proportionate to the regulatory objective of mitigating conflicts of interest."

A recent review of industry compensation practices by the CSA and the industry's self-regulatory organizations shows that many of the compensation-related conflicts that regulators are worried about are already prohibited under the existing securities rules, Bourque notes.

"None of the findings of these three compensation reviews support the case for a ban on embedded commissions. If regulators have concerns about specific practices, they already have the tools they need and we encourage regulators to use them," he says.

"The industry is disappointed that the CSA has chosen not to consult on less disruptive alternatives and have limited the consultation to one option — a complete prohibition," Bourque adds.

In particular, a ban on embedded fees would likely harm smaller investors, Bourque suggests: "Wealthier investors are unlikely to feel the impact of the proposed commissions ban, but many middle class investors [those with less than $100,000 in investible assets], who make up the largest population of investors, will have to choose between paying higher fees and foregoing financial advice. Smaller investors — those with assets of less than $50,000 — may be unwilling to pay higher fees for investment advice or, if they are willing, may have difficulty finding an advisor willing to serve a small account."

Advocis echoes IFIC's concerns with the CSA paper, as it also says it's concerned a ban on embedded commissions would end up limiting access to financial advice. Specifically, the idea of banning commissions is "fundamentally flawed. It would put financial advice out of reach for middle-income Canadians at a time when they need it more than ever," suggests Greg Pollock, Advocis's president, in a statement.

"Tinkering with how advisors are compensated will do little to protect the best interests of investors. In fact, it could put the financial security of vulnerable Canadians in jeopardy," he says. "Instead, we should be focused on setting new professional standards that ensure all Canadians — regardless of their income or where they live — have access to the trustworthy financial advice they need to secure their futures."

Yet, this opposition to the regulators' proposal is not unanimous. For example, the Portfolio Management Association of Canada (PMAC) says it "applauds the CSA for taking a bold step forward" in considering a ban on embedded commissions.

"Avoiding embedded commissions is not new. Traditional investment counsel/portfolio managers follow the long-standing practice of charging fees to clients directly with these fees being clearly established from the onset of the relationship and reported when fees are deducted from a client's account," says Michael Mezei, president of Calgary-based Mawer Investment Management Ltd., and PMAC director, in a statement.

"We [at PMAC] believe that clients' interests are best served by full transparency to help them understand what they are paying for, and the more quickly we can move in this direction across business models, the better off investors and the industry will be," he adds.

PMAC indicates it understands the concerns of other players in the investment industry, but suggests it "supports the CSA's view that discontinuing embedded commissions could be complementary to recent reforms and proposals."

The CSA's paper, which is out for a prolonged 150-day comment period, does not formally propose a ban on embedded commissions; rather, it reiterates regulators' concerns about these arrangements and says that a final decision on whether to proceed with a ban has not yet been made.

"The CSA is clearly proceeding cautiously and thoughtfully to ensure it has a full appreciation of both the positive and negative consequences of moving to direct pay arrangements before making a decision," says Katie Walmsley, PMAC's president, in a statement. "PMAC applauds this approach, which should pave the way for a Canadian-focused solution that carefully considers all potential impacts on investors and the industry. The extended 150-day comment period and proposed roundtables will be beneficial to all."

"We appreciate the lengthy consultation period and will use that time to propose alternatives and assess the potential impacts on investors and the industry," Bourque adds.

Photo copyright: cherezoff /123RF