Wooden shelves on the wall with golden piggy bank, isolated on white, 3D illustration.

The prospect of bank-owned dealers dropping independent investment funds from their product lineups — which is now raising regulators’ hackles — was predicted by the industry and acknowledged by the regulators themselves when the client-focused reforms (CFRs) were being developed.

Investment Executive‘s latest Report Card on Banks found that several of the big banks have stopped selling third-party funds in light of an array of new requirements, including know-your-product (KYP) obligations, that are being adopted as part of the long-running regulatory project that aims to improve the industry’s treatment of retail investors.

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The news that bank-owned dealers have curtailed their use of independent products has now attracted the attention of the Ontario Securities Commission (OSC), which has written to the banks to voice the regulators’ concerns.

“The intention of the client-focused reforms is to give investors access to products that best serve their needs — not to cause a move to proprietary shelves,” said Kristen Rose, manager, public affairs with the OSC, in a statement.

“To reiterate this expectation, we have sent a communication to the banks to confirm how each understands and intends to approach this area,” she added.

For now, the industry’s self-regulatory organizations are steering clear of the issue.

The Investment Industry Regulatory Organization of Canada declined to comment, and the Mutual Fund Dealers Association of Canada would only say that it monitors the assets under administration at dealers with proprietary products, and assesses “their compliance with regulatory requirements.”

Yet, while regulators may be disappointed with the banks’ shrinking product shelves, they can hardly be surprised — the industry warned the rules could lead to reduced investor choice, and the regulators recognized that risk themselves during the rule-making process.

For instance, the Investment Funds Institute of Canada (IFIC) stated in a submission to the Canadian Securities Administrators (CSA) in 2018 that the proposals could result in firms tightening their product lineups.

“The know-your-product requirement to compare products on the registered firm’s product shelf with similar products in the market will cause registered firms to narrow their product shelves in order to manage the firm’s compliance obligations,” IFIC said in its submission.

“We believe that any lessening of choice, whether intended or not, does not benefit investors,” IFIC said at the time; the group also called on the CSA to “reconsider those aspects of the proposals that may have the unintended consequence of reducing investor choice.”

This possibility was also highlighted by the regulators in their public consultation.

In a regulatory impact analysis that accompanied the 2018 edition of the CFR proposals, the regulators noted that an “unintended consequence” of the rules could be dealers with mixed product shelves dropping third-party products.

“If the proposed amendments are implemented, we anticipate that a small number of firms that currently offer both proprietary and non-proprietary products but still hold a large proportion of client assets in proprietary products may determine that it makes more sense for them to move to a proprietary-only business model going forward,” the regulators said in their analysis.

Now that these unintended consequences are materializing, it remains to be seen whether the regulators can contain them.

IFIC declined to comment on the current situation.

Also read: Action needed on shrinking bank shelves