Queen's Park, Ontario legislature, exterior

The financial services industry’s regulatory landscape is perpetually in flux, but 2019 may bring more than the usual amount of upheaval, given the scale and significance of challenges facing both regulatory policy and policy-makers.

Perhaps the biggest factor that will shape the industry’s regulatory environment this year has nothing to do with investor protection or market efficiency; rather, it’s politics. For one thing, there is the question of whether the provinces and the federal government will follow through on the long-running effort to create the national co-operative Capital Markets Regulatory Authority (CMRA). Second, there’s last year’s change of government in Ontario, which signals a fundamental shift in the approach to regulation in the industry’s most influential province.

Indeed, Ontario Premier Doug Ford’s Progressive Conservative government, elected in June 2018, appears likely to prompt an abrupt turn toward deregulation. The Conservatives have promised to cut regulation across the board – not just in the financial services industry – by 25% over the next three years as part of that government’s “pro-business” agenda. The Conservatives’ first salvo in this agenda targeted a range of industries, including agriculture, construction and the automobile industry. The only notable impact on financial services would be to open bank-led loan syndications to credit unions.

However, the Ford government has shown that it’s willing to interfere with regulatory policy-making directly. For example, last September, the government publicly declared its opposition to banning the use of deferred sales charge (DSC) structures by mutual funds just as the Canadian Securities Administrators (CSA) released its reform proposals for public consultation.

This type of political meddling is a hallmark of the Ford government – prompting U.S. authorities to kill a proposed merger in the hydro industry over fears about Ontario’s newfound propensity for political interference. Just how dramatically this meddling will affect regulatory policy in the financial services industry in the year ahead remains to be seen.

Although pruning duplicative, unproductive regulation surely would be welcome within the financial services industry, a sharp increase in the level of political uncertainty – and erosion of regulatory authority – could damage investor confidence.

At this point, the Ontario government has thrown the CSA’s long-running mutual fund industry reform initiative into disarray. At the same time, the Ontario Securities Commission (OSC) has signalled a shift in its approach to regulation by announcing plans for an initiative that’s geared toward lightening the regulatory burden in the province. This could be implemented through changes in both rule requirements and regulatory procedures, with an eye toward easing the cost of compliance. Just how deep these cuts will go, and what will be affected by the effort, will be a key issue to watch this year.

In some areas, though, the Ontario government has indicated that it’s not changing course. For example, it continues to support the creation of the Financial Services Regulatory Authority of Ontario – a new agency intended to replace the Financial Services Commission of Ontario as the regulator of the provincial insurance, pensions and deposit industries. Oversight of the troubled syndicated mortgage business would be transferred to the OSC.

At the same time, however, the Ford government endorses the previous Liberal government’s commitment to participating in the creation of the CMRA. Proponents of the initiative – which currently include Ontario, British Columbia, Saskatchewan, New Brunswick, PEI and the Yukon, along with the federal government – got a big boost last year when the Supreme Court of Canada (SCC) ruled that the proposed CMRA model does not violate the Constitution, overturning a decision by the Quebec Court of Appeal.

The SCC’s ruling clears a major legal roadblock to the creation of the CMRA, but the remaining political obstacles may prove more daunting. The various participating provincial governments and the federal government still must pass legislation to get the new agency up and running. Numerous other statutes also will probably have to be amended. The proposed new authority’s rules have yet to be finalized. A critical mechanism for dealing with the provinces that don’t plan to participate, particularly Alberta and Quebec, must be developed.

Even then, the project could face further legal challenges if ongoing concerns about respecting provincial jurisdictions resurface among the holdout provinces.

Of course, none of these obstacles is insurmountable. But overcoming them will require significant political will. And that determination is often in short supply when it comes to securities regulation. Governments typically have other priorities. And, in the case of financial services regulation, when changes may not produce a decisive, meaningful improvement in the lives of voters, there’s not much incentive for governments to dedicate much time, attention or political capital to the issue.

Nevertheless, with the SCC decision out of the way, the year ahead may prove crucial in demonstrating whether the CMRA is going to come to fruition or fall victim to political indifference and neglect.

In the meantime, the regulators that are in place have no shortage of key policy issues on their plates. For the retail investment industry, the question of what’s going to happen with mutual fund DSC structures is near the top of the list of issues – and that’s where political uncertainty looms large.

There isn’t likely to be much appetite among the rest of the CSA’s members to go ahead with a ban on DSCs without Ontario’s participation. Although Ontario’s government has stated it’s open to discussing alternatives to an outright ban, what those alternatives could be is not clear, given that the regulatory experts have determined that the elimination of DSCs is the measure that’s most likely to resolve concerns regarding investor protection.

Those concerns include difficulties in aligning client and dealer interests under the DSC structure. The regulators also have found there are several long-standing problematic practices associated with the use of DSCs. They can incentivize churning, for example, and can lead to promoting unsuitable leveraging strategies and poor suitability assessments – particularly for senior investors, who may find themselves locked into lengthy redemption schedules.

Moreover, the need to finance the upfront commissions that accompany DSC structures raises funds’ costs, reducing unitholders’ returns.

The regulators’ concerns are backed up by their compliance and enforcement experience, investors’ complaints, academic research and market research conducted among retail investors, all of which has led regulators to conclude that a ban on DSCs is the best way to resolve these concerns. In reaching that policy decision, regulators explicitly rejected alternative approaches – such as beefing up disclosure or enhancing suitability guidance – as being inadequate to address the significant investor harm associated with the use of DSCs.

Whether regulators can circle back and devise a policy approach that both addresses their investor protection concerns and salves Ontario’s newfound opposition to an outright ban on DSCs will be a key issue to watch this year.

The outcome of this policy battle is important – not just for the parts of the fund industry that are determined to cling to DSCs, but also for what the outcome could reveal about the sanctity of regulatory independence and the future direction of financial sector policy-making overall.

The future of the CSA’s proposed DSC ban also is tied closely to a series of so-called “client-focused reforms” that the CSA proposed last June in advance of its policy action on DSCs, which wasn’t unveiled until September. The impact of the client-focused reforms would go beyond the mutual fund industry in an effort to combat conflicts of interest in the securities industry overall. As part of that initiative, regulators are considering measures to bolster suitability and “know your client” requirements, introducing new “know your product” requirements, enhancing disclosure to prospective clients and requiring that conflicts that can’t be avoided are to be resolved in favour of clients.

As with the proposed DSC ban, the underlying thrust of these reforms is enhancing investor protection, which also inevitably means increased constraints and higher compliance costs for the industry. The Ontario government has yet to take a public stand on these reforms, but its approach to the DSC proposals and to regulation in general suggests the CSA is likely to face political challenges on these matters as well.

Similarly, the momentum for some of the CSA’s longer-term reform objectives – such as reviewing industry proficiency requirements and overhauling financial advisors’ use of titles and designations – also may slow in the face of the shift in regulators’ priorities from investor protection to reducing regulatory burdens.

When regulatory staff must devote their limited time and resources to rooting out inefficiencies and redundancies, the policy-making process inevitably is disrupted, even if the overarching objective of improving investor protection remains undisturbed.

The rise in political uncertainty among the provincial regulators may trickle down to the self-regulatory organizations (SROs). Projects such as the client-focused reforms would involve the SROs directly, but initiatives such as the Mutual Fund Dealers Association of Canada‘s exploration of expanding mutual fund cost disclosure (a.k.a. CRM3) could be affected. Although government approval isn’t required for SRO rule changes as it is for securities rule changes, a change in approach at the provincial regulators may filter down to the SROs’ policy work as well.