CSA seeks input on ban of proposed fees
Canada’s market watchdogs are calling for public input on a proposal to prohibit embedded commissions and trailer fees in investment funds — the strongest indication in a years- long process that an outright ban is on the table.
The Canadian Securities Administrators, an umbrella organization for provincial and territorial securities regulators, on Tuesday published a consultation paper that outlines how a ban on embedded fees for investment funds, including mutual funds, could work and examines potential positive and negative impacts on investors.
The CSA also launched a 150- day consultation period — much longer than normal — for public comment on the paper.
This “final consultation” marks the “end of the line” of a lengthy process to examine the impact of these controversial fees, said Ontario Securities Commission chair Maureen Jensen.
“We really want to move this forward,” she said, adding that if consultation is positive a new rule could be ready for public comment “within a year.”
“What we would like to see is that any fees that (are) associated with advice are charged separately, so clients are completely aware,” Jensen said.
“And they’re not embedded in products, which incent advisers to mis- sell products or sell products to clients that aren’t suitable for them.”
The CSA has been examining the impact of trailer fees and embedded commissions — which mutual fund companies pay annually to financial advisors whose clients buy their funds — since at least 2012.
A study released in 2015 concluded that mutual fund performance is “considerably reduced” when fund companies pay sales and trailing commissions, and that an increase in trailer fees corresponds with a decrease in performance.
The CSA said in the paper it examined other solutions, such as enhanced disclosure in statements and fee caps, but ultimately viewed a ban as the best way to tackle the problem.
The investment industry has long pushed back against restrictions on embedded fees, even though t hey have already been banned in other jurisdictions such as the United Kingdom.
Investors tend to balk at upfront fees, according to a University of Calgary study, leading them to forgo professional advice and make “sub- optimal” investment decisions. This could ultimately worsen the retirement picture for Canadians, the paper said.
The Investment Funds Institute of Canada (IFIC) said Tuesday it was “disappointed” that the CSA was leaning towards prohibition.
“Eliminating the ability of investors to pay their fees through what is known as a bundled or embedded com mission could significantly disrupt access to investment advice for many investors,” said Paul C. Bourque, president and chief executive of IFIC in a statement.
“Both regulators and governments should understand whether the cost of banning embedded commissions is proportionate to the regulatory objective of mitigating conflicts of interest.”
Marian Passmore, t he director of policy and chief operations officer at Foundation for the Advancement of Investor Rights ( FAIR Canada), said their organization was pleased that a ban could be in the works.
“We think that there is an abundance of evidence that real harm is being caused to investors and market efficiency ... that require regulatory actions,” she said.
Funds that pay trailing commissions make up the bulk of mutual fund assets in Canada, CSA said in the paper. At the end of 2015, these types of funds made up 67 per cent of assets and increased by 58 per cent over the five years ending in 2015.
Any regulatory proposal to discontinue embedded commissions would affect all investment funds and structured notes, whether sold under a prospectus or in the exempt market, the CSA said.
However, that would not mean that dealers and representatives would have to switch to fee-based compen- sation arrangements, the CSA said in a release.
“Under direct pay arrangements, dealers and representatives could adopt various compensation arrangements, including upfront commissions, an hourly fee, a flat fee, a fee- based arrangement, or another suitable compensation arrangement, as long as the compensation is not embedded within the product and is paid exclusively by the investor,” it said.
The potential benefits of a ban include the entrance of new lower-cost product providers and distributors into the market, it said. “Estimates suggest that management expense ratios ( MER) for index funds offered by these new entrants could be up to 40 bps lower than average index fund costs today,” the paper said.
Canadians currently pay among the highest mutual fund fees in the world, said Passmore.
Drawbacks, however, include a reduction in access to advice for lower- wealth investors and the elimination of choice in how investors pay for financial advice, the CSA said.
Still, Jensen says this is the “best solution” to address the underlying concerns.
“This is a systemic problem, and it’s one best dealt with through a rule. ... This is a conflict of interest that can’t seem to be mitigated until today.”