The regulatory policy landscape for Canada’s investment industry’s has been thrown into disarray by Ontario’s new Conservative government, which declared its opposition to the Canadian Securities Administrators’ (CSA) proposed reforms to eliminate deferred sales charge (DSC) compensation structures in the mutual fund industry and ban the payment of trailer fees to discount brokerages.
On Sept. 13, the CSA published a set of proposed changes to mutual fund rules promised in June. At the same time, Ontario’s Ministry of Finance issued a statement that the provincial government doesn’t support the CSA’s proposals “as currently drafted.”
In particular, the government took aim at the proposed DSC ban, stating that it would “discontinue a payment option for purchasing mutual funds that has enabled Ontario families and investors to save toward retirement and other financial goals.”
Given that regulatory policy changes are subject to government approval, the declaration effectively kills the CSA’s proposed changes – in Ontario, at least. However, the other members of the CSA could go ahead without Ontario, as provinces often take divergent approaches to specific policy issues.
Alternatively, the CSA’s proposals could be revised to suit Ontario. Vic Fedeli, that province’s finance minister, stated that the government is prepared to work with the “other provinces and territories and stakeholders to explore other potential alternatives.”
Regulators and industry experts have spent the past six years researching, consulting and debating the alternatives to address long-standing concerns about both investor protection and market efficiency in the retail investment business. The release of the CSA’s proposals on fees was supposed to mark the beginning of the end of the policy exploration process regarding embedded commissions, which began with the release of a pair of papers on mutual fund fee structures and clients’ best interests in 2012.
Indeed, the CSA’s proposals “are the results of broad and extensive research, analysis and consultations with all stakeholders that may be impacted by the proposed reforms,” notes Louis Morisset, chairman of the CSA and president and CEO of the Autorité des marchés financiers.
This past June, the CSA an-nounced it finally had settled on its approach. At that time, the CSA proposed a series of changes to the existing rules on conflicts of interest, suitability and “know your client” requirements that would enhance the obligations of firms and financial advisors to put their clients’ interests first. These proposals, known as the “client-focused reforms,” are out for comment until Oct. 19. In addition, the CSA indicated it would release proposals to ban DSCs and to prevent mutual funds from paying trailer commissions to discount brokerages in September.
When the CSA finally unveiled its proposed changes to mutual fund fee structures, that was a win for the industry. Regulators had decided not to ban embedded commission structures completely, which seemed to be the direction in which the regulators were leaning initially.
Instead, the CSA resolved to do away with DSCs, which are seen as being particularly egregious because they provide strong incentives for advisors (hefty upfront commissions and ongoing trailers) to sell mutual funds that potentially lock clients into underperforming products for years.
In addition, the CSA pledged to prohibit mutual funds from paying trailer fees to discount brokerages. This proposal is a no-brainer, given that the bulk of these fees are supposed to compensate dealers for advice, which discount brokerages are prohibited explicitly from providing. Indeed, there are a couple of pending class-action lawsuits before the courts in Ontario regarding the practice of mutual funds paying trailer fees to discount brokerages.
Despite Ontario’s opposition, this batch of the CSA’s proposals are out for comment until Dec. 13. Morisset declined to comment on the Ontario government’s stance, noting the CSA “will carefully consider all feedback and comment letters received.”
Furthermore, Morisset says, CSA members “share a mutual commitment to work together with our governments and stakeholders to reach a successful outcome that adequately addresses the investor protection and market efficiency issues identified.”
Apart from the mutual fund fee issue, the more profound impact of the Ontario government’s stance may be on regulatory policy. Although there have been instances of regulatory proposals being quietly scuttled by governments under industry lobbying pressure, there’s no precedent for such upfront public meddling.
“The Ontario government probably will come to realize denouncing the CSA’s proposals was a mistake,” says Neil Gross, former executive director of the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) who was named chairman of the Ontario Securities Commission’s (OSC) Investor Advisory Panel in November 2017. “Those proposals were designed to help ordinary Canadians – average investors who are disadvantaged by embedded fees, especially the ones discount brokerages take unfairly for advice they can’t and don’t provide.”
Adds Gross: “The government probably also will find it’s unwise to depart from the practice of letting securities commissions develop policies free from political influence. That practice is essential for maintaining public confidence in Ontario’s capital markets.”
At this point, the OSC effectively is hamstrung because it requires the provincial government’s blessing for any rule the regulator adopts. Asked to comment on the government’s opposition to the CSA’s proposals, the OSC stated: “Our minister’s support is critically important to the OSC, and we are respectful of our government’s authority to decide whether any rules published for comment ultimately come into effect.”
Ontario’s Ministry of Finance declined to comment on the policy alternatives it has in mind for embedded fees, or whether there are other areas in which the government plans to push regulation in a different direction.
For now, regulatory uncertainty has increased in Ontario, possibly intensifying dissent within the CSA. Although the long-term fallout of this episode will play out over time, in the short term, industry lobby groups are pleased with the government’s stance.
The Financial Advisors Association of Canada (a.k.a. Advocis) stated in the immediate aftermath of the Ontario government’s proclamation that the association supports “Fedeli’s vision for investor protection and fair, efficient markets.”
The Investment Funds Institute of Canada (IFIC), which opposed a ban on DSCs, also stated it “supports the decision to preserve choice for those investors who wish to access and pay for financial advice through embedded commissions.”
But Paul Bourque, president and CEO of IFIC, declined to comment on the broader implications of the Ontario government’s decision to oppose the CSA’s proposals, saying that IFIC is “not ready to speak about these issues yet.”