This article appears in the May 2020 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
The fallout from the Covid-19 pandemic has prompted regulators to provide Bay Street with a variety of relief measures a move that has investor advocates wondering where the help is for Main Street.
Amid the spike in financial market volatility and the introduction of government restrictions designed to curb the pandemic, the Canadian Securities Administrators (CSA) has taken steps designed to ease the pressure on investment firms.
Initially, these measures included extending filing deadlines and prolonging policy consultations. More recently, the regulator took more meaningful action, such as delaying the implementation of provisions of the client-focused reforms and doubling the cap on mutual funds’ short-term borrowing from 5% of assets under management (AUM) to 10% to ensure that the funds can meet unitholders’ redemption demands.
The CSA is not alone. Regulators around the world are relaxing restrictions to support financial services firms. Yet, investor advocates are asking what regulators are doing to help alleviate the strains on investors.
Ermanno Pascutto, executive director of the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada), says his organization has no issue with the steps that regulators are taking to provide relief for financial services firms and securities issuers. “However, we think [regulators] also need to consider relief for retail investors,” he says. “After all, the purpose of securities legislation is investor protection rather than financial industry protection.”
FAIR Canada called on the industry to waive redemption fees on deferred sales charge (DSC) investment funds and provide relief on investment loans for clients facing lost income due to the pandemic fallout.
So far, investment industry regulators are content to rely on the industry’s goodwill to deal with any cases of investor hardship. Ken Kivenko, president of investor advocacy group Kenmar Associates, is particularly concerned about DSCs. He worries that the combination of financial pressure on the fund industry due to the market turmoil and the absence of hands-on compliance (thanks to physical distancing requirements) pose an added risk of unsuitable sales.
In late April, Kenmar issued an investor alert that warned about DSC sales under the current conditions: “This is the ideal environment for hard-pressed fund dealers selling DSC mutual funds,” adding that these products provide large upfront sales commissions to investment dealers’ reps, but come with an array of investor protection concerns including that the DSC structure creates significant conflicts of interest.
Most CSA members plan to outlaw DSC funds because of such concerns. Ontario is the only province that plans to maintain DSCs, but it’s proposing a series of restrictions on their use including that DSC funds can’t be sold to investors over 60 years of age, can’t be bought with borrowed money and can’t lock in unitholders for longer than three years.
Yet, for the time being, DSC funds still are available. Kenmar’s alert warns: “Given the troubled state of the mutual fund industry, amplified by Covid-19 related fund sales reductions and redemptions, the DSC fund, which provides an outsized quick payback, is the perfect product for fund salespersons in these challenging times.”
Furthermore, Kenmar’s alert suggests the current regulatory environment is only fuelling the risk of unsuitable sales.
“The pandemic-related relaxation of regulations and internal controls and a regulatory ban of DSC funds that doesn’t come into effect until June 2022 creates a huge window of opportunity for hungry DSC salespersons to get their last crack at the DSC golden goose,” Kenmar’s alert states.
Pascutto agrees with Kivenko’s doubts about DSC funds and also raises concerns for retail investors who may have been using leverage when the market turmoil hit.
“We are concerned that retail investors who have taken out investment loans may have sustained losses of most of their savings in the current market environment,” Pascutto says.
Another area of concern for FAIR Canada is group RESPs, which may have vulnerable investors locked into payment schedules that they now can’t afford. To address that issue, Pascutto says, FAIR Canada will be asking regulators to “provide relief from penalties and forfeitures when people are unable to make scheduled payments.”
Yet, at this point, the CSA hasn’t done much that directly addresses the strains on retail investors. Instead, the regulator has focused on alleviating the obligations of firms in the investment industry, with the expectation that those policies will filter down to benefit investors.
For example, the CSA’s decision to boost the ability of mutual funds to use short-term borrowing in order to meet redemptions doesn’t target investors directly, but does aim to ensure investors can redeem their fund holdings if needed.
The latest data from the Investment Funds Institute of Canada indicate that redemption demand has been high since the pandemic took hold. Mutual funds collectively recorded $14.1 billion in net redemptions in March, with long-term funds reporting $18.2 billion in redemptions that month.
For context, this amount exceeds the redemption activity at the height of the 2008-09 financial crisis. In October 2008, mutual funds recorded $9.9 billion in redemptions ($7.9 billion in long-term funds and another $2 billion from money market funds).
Yet, back in October 2008, mutual funds had slightly more than $ 600 billion in AUM, compared wit h $1.45 trillion today. So, relative to industry assets, March’s fund redemption activity doesn’t look nearly as bad as that of October 2008.
However, redemption demand may have accelerated since then, as job losses have grown and economic prospects have become increasingly gloomy. The fact that the CSA was motivated to provide funds with relief to facilitate redemptions in mid-April suggests that’s the case.
However, although the regulators have not yet taken action to directly aid investors, investor issues are on the regulators’ radar.
“Over the past few weeks, we have moved quickly to provide market participants with relief from certain regulatory requirements, so [those companies] have capacity to focus on serving the needs of investors,” says Ilana Kelemen, senior advisor, communications and stakeholder relations, with the CSA. “We are also considering actions to support investors and ensure they are treated fairly during this difficult time.”