The regulatory landscape for the Canadian mutual fund industry is far from static as the rules governing both mutual fund manufacturing and distribution remain in flux.
Regulators have taken a keen interest in the mutual fund industry since its early days in the mid-1990s, when mutual funds emerged as the dominant investment vehicle for ordinary retail investors. That interest persists as regulators continue to grapple with the fairness of investment industry fee structures, the adequacy of disclosure and propriety of certain sales practices.
The culmination of years of analysis and debate among regulators around some of these issues came with the publication of proposals from the Canadian Securities Administrators (CSA) in September that would ban mutual fund firms from using deferred sales charge (DSC) compensation structures and prohibit the payment of trailer fees to discount brokerages.
Those proposals are currently out for comment until Dec. 13 — although their future remains very much in doubt given the stated opposition of Ontario’s new Conservative government, particularly to the plan to eliminate DSC structures. Indeed, it’s unlikely a DSC ban will go ahead without Ontario.
Although the Ontario government has said it’s prepared to discuss alternatives with the other provinces, the CSA already has studied and debated policy options in this arena extensively before arriving at the conclusion that DSCs should be eliminated.
With the future of the proposed reforms to industry fee structures now up in the air, disclosure remains the primary method the CSA relies on to ensure the mutual fund industry treats investors fairly. Prior to the latest work on fees, the CSA concentrated on ensuring investors get clear, upfront information about the mutual funds they buy.
The focus of the CSA’s efforts in this area drove the development of Fund Facts documents, which have now replaced the traditional prospectus-based disclosure with much shorter, more accessible documents for investors that aim to ensure they understand the basic characteristics of a mutual fund before they buy.
This enhanced point-of-sale disclosure is supplemented with the second phase of the client relationship model reforms (a.k.a. CRM2), which also aim to improve disclosure by providing investors with much more detailed information about the performance and costs of their investments.
The CRM2 requirements don’t apply exclusively to mutual funds. But measures such as requiring the mutual fund industry to provide investors with the annual reporting of the portfolio assets consumed by embedded fees, in dollar terms, aim to address some of the regulators’ longstanding concerns with mutual fund structures, in particular.
Indeed, the mutual fund industry has been singled out for sales practices rules and disclosure requirements that other parts of the financial services sector have not, owing largely to the pre-eminence of mutual funds among often-vulnerable retail investors. In fact, the CSA has been particularly sensitive in ensuring that the mutual fund industry treats its customers fairly given the overall decline in pension coverage, which has shifted the retirement savings burden onto individuals.
Even with this heightened scrutiny, Canada’s mutual fund industry has continued to flourish, and currently boasts more than $1.5 trillion in assets under management (AUM). At the same time, mutual funds are facing increased competition from other retail investment products — most recently, ETFs — prompting pressure from the mutual industry to reduce the regulatory burden and level the playing field between competing, comparable products.
So, even as the CSA continues to grapple with investor-protection concerns in the mutual fund industry, it also is seeking to loosen the reins on mutual funds somewhat by rationalizing certain product rules and expanding the scope of how mutual funds can invest.
To that end, the CSA published a set of rule changes in early October that will create a new regime for “alternative mutual funds.” These rules will enable mutual fund portfolio managers to offer products that utilize tactics such as short selling and derivatives trading, which largely are out of bounds for traditional mutual funds, more easily.
These new rules, which are due to take effect on Jan. 3, 2019, also relax some of the investment restrictions on alternative funds in a bid to give fund portfolio managers greater flexibility with their strategies.
Looking ahead, the CSA is planning further proposals to trim some of the requirements mutual funds currently face, even though these proposals may not be doing much to bolster investor protection or to enhance market efficiency.
The CSA is aiming to publish proposals that would eliminate redundant disclosure requirements by next March. In addition, the CSA has longer-term ambitions to reform a wider range of mutual fund rules in the coming years, with an eye on eliminating unnecessary rules and requirements.
This is the first is a series on the state of Canada’s mutual fund industry.