Af­ter decades of in­ac­tion, the CSA fi­nally may be de­cid­ing whether to ban these com­mis­sions

Investment Executive - - FRONT PAGE - BY JAMES L ANGTON

In­dus­try groups are not happy with the CSA’s pro­pos­als on de­riv­a­tives.

the cana­dian se­cu­ri­ties Ad­min­is­tra­tors (CSA) once again is turn­ing its at­ten­tion to­ward the long-stand­ing pol­icy dilemma of whether to ban mu­tual fund trailer fees this au­tumn. But will the CSA fi­nally put the is­sue to rest once and for all?

In Jan­uary, the CSA pub­lished a con­sul­ta­tion pa­per re­gard­ing the idea of ban­ning em­bed­ded com­mis­sions, such as mu­tual fund trailer fees, as a way of ad­dress­ing long-stand­ing in­vestor pro­tec­tion con­cerns about the prac­tice. That pa­per gen­er­ated vo­lu­mi­nous com­ments from both the in­vest­ment in­dus­try and in­vestor ad­vo­cates, re­veal­ing en­trenched, op­pos­ing views.

Now, reg­u­la­tors have em­barked on more pub­lic con­sul­ta­tions. As this is­sue of In­vest­ment Ex­ec­u­tive went to press in mid-Septem­ber, the On­tario Se­cu­ri­ties Com­mis­sion (OSC) was host­ing a round­table meet­ing to dis­cuss al­ter­na­tives. In early Oc­to­ber, the B.C. Se­cu­ri­ties Com­mis­sion will hold its own con­sul­ta­tion on the sub­ject.

Al­though the is­sue has been de­bated end­lessly, these lat­est con­sul­ta­tions will be watched keenly. In­deed, the OSC had to move its meet­ing to a larger venue when the demand to at­tend the ses­sion far out­stripped ca­pac­ity at the reg­u­la­tor’s of­fices.

One rea­son for the high level of in­ter­est is the ex­pec­ta­tion that reg­u­la­tors fi­nally will de­cide whether to ban trailer fees. The OSC in­di­cated in its state­ment of pri­or­i­ties that, fol­low­ing this lat­est round of con­sul­ta­tions, its staff will make a pol­icy rec­om­men­da­tion to both the OSC and the rest of the CSA mem­bers re­gard­ing how to deal with em­bed­ded fees by the end of this fis­cal year, end­ing March 31, 2018.

“This round­table is part of our on­go­ing con­sul­ta­tion on the op­tion of dis­con­tin­u­ing em­bed­ded com­mis­sions,” says John Moun­tain, di­rec­tor of the in­vest­ment funds and struc­tured prod­ucts branch with the OSC. “While no de­ci­sion has been made on whether to dis­con­tinue em­bed­ded com­mis­sions or pur­sue al­ter­na­tives, the dis­cus­sion will as­sist us in de­vel­op­ing a reg­u­la­tory re­sponse that will bet­ter align the in­ter­ests of in­vestors and ad­vi­sors and im­prove in­vestor out­comes.”

At this point, the reg­u­la­tors’ di­rec­tion on the is­sue isn’t clear. Al­though the lat­est CSA pa­per in­di­cates that the reg­u­la­tors have con­sid­ered, and re­jected, a va­ri­ety of al­ter­na­tives to an out­right ban — such as cap­ping trail­ers or fur­ther boost­ing dis­clo­sure — reg­u­la­tors may not be pre­pared to face down in­dus­try op­po­si­tion and sim­ply elim­i­nate trail­ers.

This dis­cus­sion isn’t merely a ques­tion of which po­si­tion the reg­u­la­tors will side with; it’s also a mat­ter of the reg­u­la­tors reach­ing con­sen­sus. Ear­lier this year, mem­bers of the CSA an­nounced they couldn’t agree on whether to adopt a “best in­ter­est” stan­dard for fi­nan­cial ad­vi­sors — an is­sue closely linked with reg­u­la­tors’ con­cerns about the use of em­bed­ded com­pen­sa­tion.

Re­gard­ing the best in­ter­est is­sue, reg­u­la­tors now agree to dis­agree, with On­tario and New Brunswick de­vel­op­ing a best in­ter­est stan­dard and the rest of the CSA mem­bers re­ject­ing the con­cept.

Re­gard­ing the trailer fee is­sue, there seems to be less scope for dis­sent among the prov­inces. Adopt­ing dif­fer­ent con­duct stan­dards for ad­vi­sors who typ­i­cally do most of their business in one lo­ca­tion is one thing. How­ever, the prov­inces adopt­ing dif­fer­ent rules on fee struc­tures for funds typ­i­cally of­fered in mul­ti­ple prov­inces would be much more dis­rup­tive.

Yet, the fact reg­u­la­tors are still wrestling with this is­sue is stag­ger­ing, given that con­cerns about trailer fees first came up in the very early days of the mu­tual fund in­dus­try.

Glo­ri­anne Stromberg’s orig­i­nal re­port on the fledg­ling mu­tual fund business in 1995, is­sued when she was an OSC com­mis­sioner, ob­served that trail­ers cre­ate fun­da­men­tal con­flicts of in­ter­est; that in­vestors are pay­ing trail­ers in ex­change for on­go­ing ser­vices that they may never re­ceive; and that clients of­ten aren’t aware that they’re pay­ing the trailer fees, and of­ten don’t un­der­stand how those fees neg­a­tively af­fect in­vest­ment re­turns.

Stromberg’s re­port noted that some in the in­dus­try viewed trail­ers as essen­tially “bribes” paid by mu­tual fund com­pa­nies to se­cure dis­tri­bu­tion: “The ad­vent of trailer or ser­vice fees has been a ma­jor con­tribut­ing fac­tor to the ques­tion­able sales prac­tices and in­cen­tives that have de­vel­oped in the in­vest­ment fund in­dus­try.”

Since these wor­ries ini­tially were raised, the mu­tual fund in­dus­try has grown to $1.4 tril­lion in as­sets un­der man­age­ment (AUM) from about $130 bil­lion in AUM. Yet, con­cerns about the im­pact of trail­ers on in­vestors, and their dis­tort­ing ef­fect on mar­ket com­pe­ti­tion, never have been ad­dressed — or gone away.

In fact, em­pir­i­cal re­search that the CSA com­mis­sioned in 2015 val­i­dated the long-stand­ing in­tu­ition that trailer fees drive mu­tual fund sales and af­fect in­vestors’ port­fo­lio re­turns neg­a­tively.

Ban­ning trail­ers is a mat­ter of reg­u­la­tors reach­ing con­sen­sus

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