Investor advocates got a surprise gift late last year when the Canadian Securities Administrators (CSA) declared that it will make 2020 the year of the ban on deferred sales charge (DSC) mutual funds.
The CSA promises to introduce rule changes this year that will effectively eliminate DSCs by banning the payment of upfront commissions to dealers from fund companies – except in Ontario.
The regulator also plans to outlaw the practice of discount brokers receiving trailer fees, ostensibly for advice those brokers can’t provide. Unlike the planned DSC ban, this policy has the support of Ontario.
The announcement on DSCs comes after more than a year of uncertainty. The CSA first declared its intention to ban DSCs in 2018, but Ontario’s Progressive Conservative government immediately declared its opposition to the idea after being elected in 2018, throwing the DSC initiative into doubt. Although the government initially promised to explore alternatives to a ban with the other members of the CSA, the regulator decided to go ahead with the ban without the country’s biggest, most important market.
That might not matter.
Investor advocates say that even if Ontario doesn’t participate in the CSA’s planned ban on DSCs, the ban still will be nationwide.
“DSC funds are now a pariah product,” says Neil Gross, chair of the Investor Advisory Panel (IAP), the Ontario Securities Commission’s (OSC) independent investor advocacy group.
“[DSC] use has been largely impossible to justify ever since many mutual funds became purchasable on a zero upfront commission basis,” Gross says. “So, even if Ontario doesn’t join in the ban, any Canadian dealer or [financial] advisor will just be courting liability risk by continuing to sell DSC funds from this point forward.”
The Canadian Foundation for the Advancement of Investor Rights (FAIR Canada) also anticipates that even if the DSC ban happens without Ontario, DSCs will eventually vanish throughout the country.
“Leading financial [services] institutions have already decided to stop selling DSC mutual funds, and more will come on board over time,” FAIR Canada states. “We believe that in time the elimination of DSCs will encompass all of Canada, including Ontario.”
Both FAIR Canada and the IAP have long supported the elimination of DSCs. The groups advocate an outright ban on embedded fees in general, including mutual fund trailers. The CSA’s approach of scrapping DSCs and discount brokers’ trailer fees reflects a more modest approach than the comprehensive ban it initially considered.
Yet, the CSA maintains that these measures will address its investor protection concerns with current sales structures.
“These expected rule changes, together with new conflict-of-interest rules that are being implemented under our client-focused reforms, will bring greater transparency to the fees paid by investors when they buy mutual funds,” said Louis Morisset, chair of the CSA and president and CEO of the Autorité des marchés financiers, when announcing the CSA’s policy plans.
Investor advocates are pleased that the CSA is taking action at all. While they would have preferred a comprehensive ban on embedded compensation structures, FAIR Canada states that DSC funds are “rife with conflicts of interest, target the most vulnerable investors and there is strong evidence of mis-selling.”
FAIR Canada further states that eliminating the DSC structure will be good for both investors and the investment industry.
“The move away from DSCs is an important step forward in simplifying the mutual fund fee structures that consumers simply do not understand. We believe that [a ban] will enhance the professionalism of the financial services industry,” says Douglas Walker, senior policy counsel with FAIR Canada.
Despite the contention that the industry will ultimately benefit from the CSA’s action, some in the industry would prefer to maintain the status quo.
The Investment Funds Institute of Canada states that although it will closely review the CSA’s policy proposals when they are released, the fund industry “would have preferred a nationally harmonized approach that preserved payment choices for investors with full fee transparency.”
The Ontario government refers to the same preference – citing a belief that eliminating DSCs will hamper access to mutual funds for smaller investors – in explaining the government’s decision not to go along with the CSA.
Says Scott Blodgett, senior media relations advisor for the provincial Ministry of Finance: “The ban on the DSC option imposed by the CSA in the rest of the country will discontinue a payment option for purchasing mutual funds that has enabled Ontario families to save toward retirement and other financial goals.”
Instead of a ban, Blodgett adds, Ontario will consider introducing restrictions on the use of DSC funds, a move that aims to address the regulators’ concerns over investor protection “while allowing for the continuation of a viable investment option for families.”
The OSC indicates that it will consider a variety of possible curbs on DSC sales – such as banning the use of DSCs with senior-age investors, outlawing the use of leverage in DSC transactions and mandating shorter redemption schedules – with an eye to preventing investor harm while continuing to allow DSC sales.
Which, if any, of these restrictions the OSC decides to adopt – and when that will happen – remains in question.
The CSA states it’s planning to introduce its final rule changes outlawing DSCs in “early 2020.” The ban on paying trailers to discount brokers will be introduced later in the year.
The OSC indicates that its focus will be on working with the other members of the CSA to finalize the planned trailer- fee ban.
The one concession the CSA is promising is a longer transition period. The regulator’s initial proposal contemplated phasing in a DSC ban over just one year. Now, the proposals will include a phase-in period of “at least two years.”
New sales under the DSC option will be prohibited immediately once the ban takes effect, the CSA states. But the regulator expects to allow existing DSC redemption schedules to run their course.
Similarly, the CSA indicates that the ban on paying trailers to discount brokers will include a two-year transition period.
Nevertheless, the writing’s on the wall for DSCs and discounters collecting trailer fees. Neither practice has much of a future in the decade ahead, and Ontario’s resistance ultimately may prove futile.