As regulators press forward with new rules to ensure clients know how much they are paying to invest – and what they receive in return – more clients and their financial advisors are turning to the lower-cost investment options provided by exchanged-traded funds (ETFs). At the same time, many clients are also deciding that they prefer to know exactly what their advisor is doing for them and what it costs. As a result, the use of fee-based accounts is on the rise.

Although these twin trends have been well established for some time, the cost and performance reporting rules of the client relationship model, Phase 2 (CRM2) – due to be fully implemented by July 2016 – could very well be the kerosene that fuels even greater growth for both trends.

For example, the prevalence of fee-based accounts is expected to increase as the requirements of CRM2 ripple through the financial advisory industry. “[CRM2] does drive the advisor model to more of a fee-based model,” says Howard Atkinson, president of Horizons ETFs Management (Canada) Inc. in Toronto. “I think CRM2 will encourage an even higher conversion to fee-based.”

In addition, more mutual fund-licensed advisors may be offering ETFs. At this point, with the exception of advisors with Burlington, Ont.-based Mandeville Wealth Services Inc., mutual fund-licensed advisors are unable to access a stock exchange, where ETFs are traded, and thus cannot conduct ETF transactions. But there may be a solution soon: the National Bank Correspondence Network plans to launch an online system that will allow mutual fund-licensed advisors to meet transaction reporting rules required by stock exchanges.

Banning embedded fees also may propel more clients and advisors toward fee-based accounts and low-fee ETFs: these fees have already been banned in the U.K. and Australia, and Canadian regulators have stated they may do the same.

So, with the rising emphasis on fee disclosure, new tools for trading ETFs and a murky future for embedded fees, many advisors may be considering moving to a fee-based practice, with ETFs as a significant component. As Pat Dunwoody, executive director of the Toronto-based Canadian ETF Association, notes, ETFs, much like an F-class mutual fund, can “fit in quite nicely” with a fee-based model.

Another potential driver for fee-based accounts is that if they use ETFs, these accounts may be cheaper overall than a traditional portfolio of mutual funds. For example, a fee-based advisor charging 1% of investible assets may recommend an ETF, while a commission-based advisor could recommend a mutual fund and receive a 1% trailing commission. Since ETFs typically have a lower management fee than mutual funds, a client would pay slightly less if working with a fee-based advisor.

Regulatory change is not the only factor driving the growth in fee-based accounts; they have been on an upward curve for at least 10 years. According to Toronto-based Investor Economics Ltd., 37% of assets in the full-service brokerages of the Big Six banks are held in unbundled, fee-based accounts – up from 16% in 2005. Investor Economics’ definition of “unbundled, fee-based accounts” includes discretionary advisor-managed programs; non-discretionary, separately managed account programs; and non-discretionary, fee-based brokerage account programs.

Independent, full-service brokerage accounts have 26% of their assets in unbundled, fee-based accounts, up from 7% in 2005. Independent advisors who sell mutual funds account for only 2% of unbundled, fee-based accounts.

New disclosure rules, however, do seem to be propelling ETF sales in other countries. After the U.K. implemented its Retail Distribution Review in 2012, which banned embedded commissions, among other changes, sales of iShares ETFs through BlackRock Asset Management (U.K.) Ltd., grew to £1.1 billion in 2014, up from about £620 million in 2010.

Warren Collier, managing director and head of iShares Canada with BlackRock Asset Management Canada Ltd. in Toronto, notes that the company has seen sizable growth in other countries, such as the Netherlands and Switzerland, as a result of regulatory change. “As the industry becomes more transparent in every market, we see ETFs and iShares become preferred tools of choice for advisors,” says Collier, “and I do expect that to happen here.”

Not all industry participants see CRM2 as an automatic boon for ETFs. Greg Pollock, president and CEO of the Financial Advisors Association of Canada (a.k.a. Advocis) in Toronto, views the increase in ETF assets as part of the “natural evolution” of the market. “I do think there will be some growth,” he says, “but I can’t say specifically [that fee-based advice is] going to lead to an explosive growth in the marketplace.”

Joanne De Laurentiis, president and CEO of the Toronto-based Investment Funds Institute of Canada, is unsure whether CRM2 is driving the growth in ETFs. She sees CRM2 as fostering deeper conversations with clients about their goals, making it easier to choose appropriate investment products, whether they be mutual funds or ETFs.

“What CRM2 is going to help refine [and] maybe help improve and enhance is that conversation,” she says. “And the product becomes almost secondary, but it’s an easier decision to make at that point.”

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