Securities regulators are like sharks: if they stop moving forward, they may perish. Fortunately for regulators, the financial services sector’s vision of its future includes plenty of unexplored regulatory territory.
This year the Ontario Securities Commission‘s (OSC) annual conference – Dialogue with the OSC – highlighted a slew of looming challenges for the regulators. There’s a sense that the reform effort that has preoccupied the retail investment business over the past couple of years, and will continue into 2016, is far from the end of the story. (This, of course, refers to the client relationship model [CRM] reforms that are intended primarily to improve transparency for retail investors.)
In fact, the sector is already looking far beyond CRM – and it sees much bigger changes coming, including the elimination of trailer fees, a greater shift toward fee-based business, lower costs and higher standards of care. The regulators already have some of these things under consideration, although they’ve yet to take a position on whether further reforms are needed.
Still, there’s a feeling that this is the future of the financial advisory business in Canada.
That future includes an end to embedded compensation, such as mutual fund trailer fees. Speaking at the conference, James Norris, managing director of international operations with Pennsylvania-based Vanguard Group Inc., suggested that within a decade, none of the major markets in the world will be using embedded compensation structures: “This is coming because it is a better model for the advisor. And we know it’s a better model for investors because the all-in cost of investing goes down.”
Although some countries, such as the U.K., have effectively regulated embedded fee structures out of existence, Norris noted that the financial services sector in the Netherlands moved that way voluntarily – fundamentally transforming the business.
Not only do investors face lower costs when embedded compensation is eliminated, Norris continued, but they also enjoy greater product access because financial advisors will embrace a wider range of investment vehicles. In addition, he noted, it’s generally the manufacturers that bear the brunt of decreased investor costs because distributors tend to maintain their margins when they must charge explicitly for advice.
The Canadian Securities Administrators (CSA) are, of course, still studying the issue of embedded compensation and are expected to render a decision early next year. At the same time, the CSA is also considering the related question of whether to require a higher duty of care, such as a fiduciary duty, or “best interests” standard, from advisors.
Although the financial services sector has largely opposed the idea of adopting such a standard, this view may also well be evolving as the sector considers the long-term future for retail investment.
“We really do need clear rules on fiduciary duty vs suitability,” Howard Atkinson, president of Toronto-based Horizons ETFs Management (Canada) Inc., told the conference.
Whether a mandated fiduciary duty is the way to go, it stands to reason that financial advice should be in clients’ best interests, Atkinson suggested: “If we’re looking for a school for our kids, do we want a suitable school or the best school for them? If we’re looking for a home for our parents, do we want a suitable home or the best home? Why wouldn’t we want our money managed the same way?”
These issues of embedded compensation and fiduciary duty are already on the regulators’ radar, but there are other topics that have yet to be touched, says Doug Steiner, partner at BEworks Inc., a Toronto-based behavioural economics consultancy. In particular, he suggests that there are plenty of critical investor protection issues that regulators have yet to tackle, mostly in the fixed-income and foreign-exchange markets.
“We have a bond market in this country where we don’t have prices” Steiner says. “We have a foreign-exchange market where dealers make 20 or 30 times as much money trading for retail clients. So, why are we so focused on the equity market? Why don’t we look at the equities-linked [guaranteed investment certificates] market, in which customers get completely ripped off?”
Although Steiner would like to see the regulators push for much greater transparency, he also says policy-makers must realize that the average person probably is never going to understand finance well enough to make sound investment decisions.
As a result, Steiner suggests that policy-makers have to start being “a bit more dogmatic” and force people to save more for their retirements, while also creating a regulatory environment that enables people to invest much more cost-effectively than they can in the current investing environment.
So far, the big banks have served as the primary source of basic investment advice and products, and they’ve come to dominate the mutual fund industry as a result. However, this sort of captive distribution is a top concern for some in the business.
At the OSC conference, Peter Intraligi, president and chief operating officer with Invesco Canada Ltd., suggested that regulators should be looking to clamp down on practices that provide added incentives to sell proprietary products, including tied selling.
Furthermore, he suggested, regulators could help reduce investor costs by exploring the idea of a regulatory passport arrangement between Canada and the U.S., which would facilitate the sale of products in both countries and, thereby, avoid needless duplication and the costs required in the current system.
The regulators are preparing to confront many of these issues. Indeed, Rhonda Goldberg, director of the OSC’s Investment Funds and Structured Products Branch, says that regulators are thinking about what comes next, beyond simply improving disclosure.
“We do have to take a step back and ask, ‘What else [is needed] in our market?'” Goldberg says. “Do we have a concern about proprietary tied selling? Do we have a concern about limited distribution of certain types of products?”
The regulators must arrive at their own vision for the Canadian market, Goldberg points out.
“Then, we’ll really be able to pinpoint which targeted reforms in Canada will be most impactful. We’re not just talking about unbundling commissions; we’re looking more broadly at all the incentives that may motivate advisor behaviour [and] investor behaviour.
“So, there’s not one magic bullet in all of this.”
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