Commissions-driven compensation models for financial advisors are under increasing pressure. While competition is keeping commissions low, a regulatory movement to ban commissions that is growing overseas may yet come to Canada.
In the past couple of years, regulators in various parts of the world, including Canada, have begun expressing concern about the conflicts of interest posed by certain types of commission-based compensation models and the distorting effects these conflicts may have on investment advice. Historically, regulators in the financial services sector have been loath to intervene with compensation practices. But that reluctance has waned in some countries in the wake of various “mis-selling” scandals and the global financial crisis of 2008-09.
As a result, some regulators have begun undertaking reforms that include restrictions, or even outright bans, on certain compensation structures. In Australia, for example, as of July 1, 2013, firms must negotiate fees for financial advice directly with retail clients. Sales commissions and trailer commissions that could enable financial product manufacturers to influence advice are banned.
Under Australia’s new regime, firms can charge clients ongoing fees, but they must provide service for those fees. The agreements between dealers and their clients must be renewed every two years if such fees are involved.
Along with changes to the rules regarding advisor compensation, Australia’s reforms also include the introduction of a statutory “best interests” duty, which requires advisors to put their clients’ interests before their own.
These reforms introduce the concept of “scaled advice,” a way for clients to receive less extensive advice at lower cost. This measure is designed to ensure that clients with smaller accounts and less complex needs have access to advice.
Similarly, regulators in the U.K. have adopted their own set of reforms, which took effect on Jan. 1, 2013. These new rules require advisors to negotiate fees for advice with clients up front. While commissions aren’t banned outright, commissions received from product manufacturers, such as trailer fees, are outlawed.
Instead, clients and advisors must agree to the method of payment for advice. It could be a fee-for-service arrangement, an hourly rate or a form of sales commission. The model must be agreed upon by the client and the advisor, not set by a third party.
The U.K. measures are accompanied by other changes, such as new proficiency requirements, the imposition of a new code of ethics and the scaling of services.
Under the scaling of service, advice must be labelled as either “independent” or “restricted,” based on whether the firm is offering a full range of products and services or a more limited selection. Again, the goal of segmenting the market is to ensure that less affluent clients have access to some form of investment advice.
In the U.S., regulators have considered changes to embedded compensation in mutual funds amid concerns that clients may be paying ongoing charges for which they receive no value. The U.S. Securities and Exchange Commission proposed changes to its rules in this area in 2010 but has not yet finalized them.
Canadian regulators are grappling with many of the same issues. In a consultation paper published in late 2012, the Canadian Securities Administrators (CSA) examined mutual fund fee structures, particularly the use of embedded commissions (a.k.a. trailer fees). The CSA paper suggests that one way to deal with possible conflicts of interest created by this model would be to ban embedded commissions altogether.
Whether the CSA will pursue this path remains uncertain. In late 2013, it published an update to the paper, indicating only that regulators would continue to research the issue while considering the possible imposition of a statutory fiduciary duty on retail investment advice.
In addition, the Investment Industry Regulatory Organization of Canada has proposed new guidance regarding the compensation structures that dealers use for retail investment accounts. These proposals wouldn’t restrict dealers’ compensation models, but they would establish the considerations that firms must take into account when designing, recommending and supervising those arrangements.
Certainly, a ban on commissions in Canada doesn’t seem imminent, but the issue is on the regulators’ radar.
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