Despite the basic similarities of mutual funds and exchange-traded funds (ETFs), financial advisors licensed to sell mutual funds but not licensed to perform transactions on a securities exchange are, effectively, prevented from offering ETFs to their clients.

Now, a working group from the financial services sector is studying ways to remove this roadblock. This group, which counts TMX Group Ltd. and Clearing and Depository Services Inc. among its members and is led by the Canadian ETF Association (CETFA), is working on a proposal that could see mutual fund-licensed advisors offering ETFs to their clients as early as next year.

The problem facing advisors licensed only by the Mutual Fund Dealers Association (MFDA) isn’t fundamentally a regulatory one. As Rebecca Cowdery, an expert on mutual fund regulation with law firm Borden Ladner Gervais LLP in Toronto, notes: “Mutual fund dealers can sell ETFs. They have the registration to sell ETFs. But they have to get access to [a securities exchange to do so], which they don’t have.”

Sandra Kegie, executive director of the Federation of Mutual Fund Dealers in Toronto and a member of the working group, and CETFA executive director Pat Dunwoody have spent the past year looking for ways to solve this problem. Says Kegie: “We wondered if there was a way that we could functionally build a fence around ETFs, and [create] a pipeline from a mutual fund advisors’ clients through to the exchange. Is there a way we can do that and still have it be financially viable [for clients]?”

Custody and clearing of ETFs currently falls under a regime that’s foreign to mutual fund dealers. Everything from the custody of the ETF and settlement to transferring the data files is slightly different from what mutual fund dealers are used to. But the issues preventing MFDA only-licensed advisors from selling ETFs are almost entirely operational, says Dunwoody: “These issues are more about coming to an agreement on how it will work – and we are almost there.”

Both Kegie and Dunwoody have met with industry groups, including securities regulators and back-office providers, to discuss a proposal to provide MFDA only-licensed advisors with a “pipeline” that allows them to buy and sell ETFs on behalf of their clients.

In an email response to a question about such advisors potentially selling ETFs, the Ontario Securities Commission says it’s prepared to consider a proposal for more product choice as long as investor protection is not compromised.

And, as Kegie notes: “We want to make sure this is an initiative that we can do functionally, compliantly and in a cost-effective way for the client.”

The CETFA’s plan proposes using a broker supervised by the Investment Industry Regulatory Organization of Canada (IIROC) and a member of a securities exchange to conduct the actual sale or purchase of an ETF on behalf of the MFDA only-licensed advisor. The goal, says Kegie, is to make the process seamless for advisors.

The MFDA only-licensed advisor would write an ETF order and submit the order to the dealer, just as for units in a mutual fund. But instead of the order being sent to the fund company via FundSERV Inc., the order will be sent to the broker via FundSERV, which will purchase the ETF.

The working group is looking to conduct a pilot project in Ontario, with other provinces being included as the project proceeds.

There are a number of key issues that will need to be resolved before MFDA advisors move into ETF arena:

– Do mutual fund dealers know enough about ETFs? The OSC, in its email response, noted that current mutual fund courses for advisors do not contain any information about ETFs. Mutual fund dealers therefore would need to address that gap before buying and selling ETFs.

– Will the Fund Facts disclosure regime be extended to include ETFs sold by MFDA only-licensed advisors? Also, under the new Fund Facts regime, most mutual funds will have to provide a risk ranking to clients. Although this requirement does not extend to ETFs, the Canadian Securities Administrators recently asked for feedback from the investment community on the application of a similar risk rating for other types of publicly offered investment funds, particularly ETFs.

– Should mutual fund dealers provide access to a full range of ETFs or to a more limited selection? Kegie and Dunwoody intend to create a set of best practices that would be based on proficiency requirements already in place for selling mutual funds.

These would be extended to the sale of ETFs. These could include guidelines for excluding certain types of ETFs, such as very high-risk ETFs.

– How will compensation change? MFDA only-licensed advisors who want to sell ETFs may want to consider moving their clients to a fee-based model. One of the biggest challenges will be keeping investor fees low, says Kegie: “In the current structure, the price [of an ETF] is set to match the currently priced market, with all the players getting their cut. But if we are introducing another dealer into the mix, that could affect the cost.”

The CETFA and the working group are planning to launch the pilot project by the end of 2014.

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