This article appears in the Mid-October 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
Having received the blessing of the dealer community, the long-awaited self-regulatory organization (SRO) merger can finally proceed, laying the groundwork for a fundamental reshaping of the retail investment business.
Merging the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) will bring governance changes, increased investor representation (with the creation of both an investor office and an investor advisory panel), and possibly expansion into other registration categories, such as exempt-market dealers, scholarship dealers and portfolio managers.
The motivation behind the merger — which is scheduled to close on Dec. 31, subject to approval from the Canadian Securities Administrators (CSA) — is to simplify the SRO landscape, leading to business model changes in the dealer industry.
To begin, existing dual-platform dealers will be able to streamline their back offices into a single legal and compliance structure. The so-called 270-day rule (which requires fund reps to upgrade to full investment rep status within 270 days) will disappear for dual-platform dealers,* freeing them up to employ as many mutual fund reps as they want. This could ramp up competition in the fund dealer space.
At the same time, mutual fund dealers may be better able to compete with investment dealers in their core retail businesses. Fund dealers will have the opportunity to venture onto investment dealers’ turf by becoming dual-registered, with easier access to selling ETFs and to enter introducer relationships with IIROC dealers, making dealing in a broader range of securities easier.
The end of the 270-day rule for dual-platform dealers, as well as newly permitting introducing/carrying broker arrangements between mutual fund dealers and investment dealers, were included in the new SRO’s initial rules issued for public comment in May.
Since then, several changes have made the merger even more appealing. According to an information circular detailing the deal’s terms, the new SRO will allow MFDA reps employed by dual-registered firms to funnel commissions through unregistered corporations. This arrangement, which allows for favourable tax treatment, has long been an advantage for MFDA reps over IIROC reps. Regulators have resisted this model for investment dealers due to concerns over investor protection and regulatory accountability, but a CSA working group is examining options for IIROC reps.
Additionally, the interim rules will do away with a requirement that fund reps at dual-registered firms pass the industry ethics course, the Conduct and Practices Handbook. The rules also will add a provision enabling firms to move clients’ accounts between affiliated dealers without completely repapering those accounts.
According to the regulators’ circular, some changes to the initial rules are interim steps that will be further addressed over time. For example, the circular indicated that the new SRO will commit to developing a harmonized approach to directed commissions. And while ethics qualifications won’t initially be required for dual-registered firms’ fund reps, the regulators said that ethics requirements will be considered when the IIROC and MFDA rule books are eventually harmonized.
After the merger, the new SRO also will adopt IIROC’s approach to rule-making. Members won’t have a vote on proposed new rules, a distinct feature of the MFDA that will be eliminated in the new SRO.
While the new SRO will develop a new fee model, firms will continue to pay existing IIROC and MFDA fees until a new funding structure is adopted. However, to help the smaller dealers, minimum fees for both IIROC and the MFDA are being cut beginning in fiscal 2024, and those lower minimums will remain in place for at least two years or until the new model is implemented.
Alongside the new fee model to finance the new SRO’s operating expenses (which will continue to be funded on a cost recovery basis), the regulator also will levy a new fee on certain firms to recoup the costs of the merger.
According to the circular, those costs are expected to come in at $25 million–$38 million. The final bill will largely depend on the amount paid in retention bonuses and severance to certain SRO employees, which isn’t expected to be known until March 2024.
While the variable portion of the integration costs will depend on staffing decisions, the deal also carries a hefty bill for legal and consulting fees, integrating the SROs’ systems, branding the new organization (its new name isn’t expected until 2023) and establishing new capabilities such as the investor office and investor advisory panel.
So far, IIROC and the MFDA have paid about $8.75 million toward these costs from their existing resources (they’ve been granted regulatory approval to tap their internally restricted funds, which are funded by enforcement penalties, to pay these bills).
The remaining costs of the merger, estimated at $17 million–$30 million, will be financed by a new fee to be levied on the firms that stand to benefit most: dual-platform dealers that will be able to rationalize their back offices under the new SRO structure. Stand-alone firms that decide to become dual-registered dealers while the integration bill still is outstanding also will have to pay the new fee.
Currently, 29 of IIROC’s 174 dealers and 26 of the 86 MFDA dealers (some MFDA firms are affiliated with more than one IIROC firm) are expected to pay the new fee, which will be in place for three to five years after the merger closes, until the integration costs are recouped.
However, if a pre-merger analysis commissioned by IIROC is accurate, the dealers that end up footing most of the bill for the SRO merger will more than get their money’s worth.
In 2020, IIROC published the results of an analysis carried out by Deloitte LLP estimating the benefits of SRO consolidation. The report pegged the likely cost savings at $380 million–$490 million over 10 years — all based on the savings generated by dual-platform dealers under a single SRO.
The savings would be chiefly from reduced technology and systems costs once firms are able to operate on a single platform. Other sources would be staffing, corporate (legal, accounting and tax expenses) and marketing costs.
Other benefits listed in the report included increased competition among dealers, enhanced choice for investors and more efficient policy development at the combined SRO, but the value of these more theoretical gains was not estimated.
*The original version of this article suggested that investment dealers would no longer be subject to the 270-day rule. In fact, the rule is only disappearing for dual-registered firms. Return to the corrected sentence.