Novel pro­pos­als on fees

In­dus­try views di­verge widely on the fu­ture of em­bed­ded fees

Investment Executive - - FRONT PAGE - BY JAMES L ANGTON

there has been a del­uge of feed­back in the Cana­dian Se­cu­ri­ties Ad­min­is­tra­tors’ (CSA) ex­tended con­sul­ta­tion on em­bed­ded com­mis­sions, which in­cludes a pos­si­ble ban. Although the in­tense in­ter­est was an­tic­i­pated, reg­u­la­tors may not have been ex­pect­ing the range of novel po­si­tions ev­i­dent in writ­ten sub­mis­sions from in­vest­ment in­dus­try play­ers.

The in­vest­ment fund in­dus­try is, in gen­eral, dead set against a ban on em­bed­ded com­mis­sions and a move to “di­rect pay” ar­range­ments. That po­si­tion is de­tailed in a con­sul­ta­tion pa­per that was pub­lished in Jan­uary by the CSA. How­ever, that ba­sic op­po­si­tion is not unan­i­mous, even within the in­vest­ment in­dus­try.

There is sup­port for the ban from some firms that sup­port the con­cept that the ex­ist­ing struc­ture con­sti­tutes a bar­rier to new en­trants. For ex­am­ple, low-fee pi­o­neer Van­guard In­vest­ments Canada Inc.’ s sub­mis­sion ar­gues that em­bed­ded com­mis­sions should be out­lawed. That sub­mis­sion ar­gues that ban­ning em­bed­ded com­mis­sions would en­hance trans­parency, im­prove cost

com­pe­ti­tion and im­prove in­vestor ac­cess to low-cost in­vest­ment prod­ucts.

Sup­port for a ban also is strong from a Mon­treal-based trade group that rep­re­sents small fund port­fo­lio man­agers, pri­mar­ily in On­tario and Que­bec, known as the Emerg­ing Man­agers’ Board (EMB). The EMB’s sub­mis­sion ar­gues that em­bed­ded com­mis­sions es­sen­tially func­tion as a tar­iff im­posed by deal­ers in ex­change for ac­cess to dis­tri­bu­tion to in­vestors to the dis­ad­van­tage of small, up­start fund man­u­fac­tur­ers.

“The ex­is­tence of this de facto tax con­tin­ues to sti­fle the de­vel­op­ment of an i nde­pen­dent as­set-man­age­ment in­dus­try and re­duce com­pe­ti­tion, to the detri­ment of both Cana­dian in­vestors and firms — par­tic­u­larly newer ones — look­ing to raise cap­i­tal,” the EMB sub­mis­sion states. By elim­i­nat­ing these struc­tures, the sub­mis­sion states, ex­ist­ing fund port­fo­lio man­agers’ rev­enue should rise and new firms will be able to join the mar­ket.

Although com­mer­cial self-in­ter­est ap­pears to be driv­ing some sup­port for a ban, a sub­mis­sion from in­dus­try re­search firm Morn­ingstar Canada states that em­bed­ded com­mis­sions should be elim­i­nated for the sake of in­vestors: “By in­duc­ing com­pe­ti­tion and l ow­er­ing costs, i mprov­ing trans­parency and ac­count­abil­ity, and driv­ing tech­no­log­i­cal in­no­va­tion, Morn­ingstar be­lieves in­vestors will be well-served by dis­con­tin­u­ing em­bed­ded com­mis­sions.”

Sup­port for a ban is harder to find on the dealer side, although it does ex­ist. The sub­mis­sion from Van­cou­ver-based wealth­man­age­ment firm Cre­den­tial Fi­nan­cial Inc. favours the elim­i­na­tion of em­bed­ded com­pen­sa­tion struc­tures. How­ever, the firm has con­cerns about whether a ban will lead to a so-called “ad­vice gap” — that is, leav­ing lower-value clients un­able or un­will­ing to ac­cess ad­vice if they must pay for it di­rectly.

The prospect of an ad­vice gap is a cen­tral rea­son cited by many op­po­nents to an out­right ban. The CSA’s orig­i­nal pa­per stated the reg­u­la­tor doesn’t sup­port the con­tention that a ban would nec­es­sar­ily lead to a sig­nif­i­cant ad- vice gap. To the ex­tent one does emerge, that pa­per sug­gested the in­dus­try will move in to fill it through new mod­els, such as on­line ad­vice or through ex­ist­ing bank-based ad­vi­sors.

Still, much of the feed­back from the in­dus­try con­tin­ues to warn that a ban would cre­ate a mean­ing­ful ad­vice gap, thus harm­ing lower-value clients in par­tic­u­lar.

This ar­gu­ment has found lit­tle trac­tion among ad­vo­cates for re­form, such as in the sub­mis­sion from the in­de­pen­dent In­vestor Ad­vi­sory Panel (IAP): “[Re­gard­ing] an ad­vice gap, let’s be very clear: no in­dus­try should ad­dress the con­cerns of peo­ple who do not want to pay for a ser­vice by charg­ing them any­way and hid­ing the costs. This is not a healthy busi­ness model and it should not be ac­cept­able in the Cana­dian in­vest­ment in­dus­try. It is not trans­par­ent nor is it fair.”

The IAP sub­mis­sion ar­gues that the CSA should ban all forms of con­flicted com­pen­sa­tion, not just em­bed­ded com­mis­sions: “The only ad­vice gap that needs to be urgently closed is the one be­tween in­de­pen­dent and com­pro­mised ad­vice — the CSA is in a po­si­tion to do that.”

An­other “ad­vice gap” skep­tic is the Cana­dian Ad­vo­cacy Coun­cil for Cana­dian CFA In­sti­tute So­ci­eties (CAC). It sup­ports dis­con­tin­u­ing em­bed­ded com­mis­sions, along with com­ple­men­tary re­forms to en­hance client/ad­vi­sor reg­u­la­tion. If reg­u­la­tors aren’t pre­pared to go ahead with a ban, the CAC pro­poses al­ter­na­tives.

For ex­am­ple, the CAC’s sub­mis­sion sug­gests lim­it­ing the va­ri­ety of fund se­ries and fee struc­tures and do­ing away with front-end and back-end load op­tions. That sub­mis­sion also sug­gests ex­plic­itly di­vid­ing reps into “sales­peo­ple” and “ad­vi­sors,” based on the type of ser­vice they of­fer.

Such a dis­tinc­tion would give in­vestors a truer pic­ture of con­flicts and the ser­vices each type of rep of­fers, the CAC’s sub­mis­sion states. Al­ter­na­tively, it sug­gests im­prov­ing fee trans­parency fur­ther “by re­quir­ing prod­uct man­u­fac­tur­ers to com­pre­hen­sively dis­close all costs, for ex­am­ple, the amounts paid to deal­ers.”

This would as­sist in help­ing in­vestors to seek “answers as to whether a riskier rec­om­mended fund has higher fees as­so­ci­ated with it,” the CAC’s sub­mis­sion states.

Other al­ter­na­tives pro­posed by the in­dus­try in­clude cap­ping trailer fees, elim­i­nat­ing de­ferred sales charges (DSCs) and set­ting new ser­vice stan­dards for deal­ers and reps who col­lect trail­ers. Although there are plenty of sug­ges­tions for al­ter­na­tives to a ban, there’s lit­tle con­sen­sus on the form they should take.

For ex­am­ple, the In­vest­ment In­dus­try As­so­ci­a­tion of Canada sup­ports the elim­i­na­tion of DSCs, but the sub­mis­sion from the In­de­pen­dent Fi­nan­cial Bro­kers of Canada (IFB) states DSCs should re­main (al­beit with shorter redemp­tion sched­ules). The IFB’s sub­mis­sion also sug­gests that em­bed­ded fees be stan­dard­ized to elim­i­nate pos­si­ble in­cen­tive con­flicts among funds, along with other mea­sures.

A num­ber of these ideas have been con­sid­ered, then dis­missed by the CSA.

The CSA’s con­sul­ta­tion pa­per con­cludes that an out­right ban is likely to be the most ef­fec­tive route to ad­dress­ing the reg­u­la­tor’s con­cerns with in­dus­try fee struc­tures. With the lat­est con­sul­ta­tion pe­riod now com­plete, the CSA hopes to reach a pol­icy de­ci­sion within a year.

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