The mutual fund industry is girding for a fight with the securities regulators over a possible ban on embedded compensation.
The Canadian Securities Administrators (CSA) indicated today that it is considering such a ban and a requirement that firms charge clients directly. In response, the industry trade group the Investment Funds Institute of Canada (IFIC) has issued a statement declaring its opposition to the idea. “The industry urges the regulators to reconsider this proposal before issuing their fall consultation paper,” it says.
IFIC argues that the regulators’ concerns with embedded compensation will be addressed through the adoption existing reforms, such as Fund Facts, and the requirements of the second phase of the Client Relationship Model (CRM2), along with other reforms that are under consideration by the CSA as noted in a consultation paper issued at the end of April.
The trade group says that the impact of these measures should be assessed before the regulators decide whether further reform is required. “It is deeply troubling to the industry, as it should be to investors, that regulators do not appear to have a plan that shows how all of the recent and proposed reforms will fit together,” IFIC says in its statement.
“The regulators are taking the industry and investors on a bumpy ride without any kind of road map or even a clear or agreed upon destination,” said Joanne De Laurentiis, president and CEO of IFIC.
Additionally, IFIC argues that banning commissions could harm investors by raising costs and reducing access to advice. Further, it says, taking this step will result in the CSA regulating fees.
IFIC’s comments are in response to the CSA’s announcement today that it is preparing to consider the elimination of embedded commissions and a move to “direct pay” arrangements between investors and mutual fund sellers in the wake of research validating regulators’ concerns about mutual fund fee structures.
The CSA said in a notice published on Wednesday that it is going to issue a consultation paper this autumn that will explore the idea of discontinuing embedded commissions in the mutual fund industry and require firms to use compensation arrangements in which investors pay dealer firms and their representatives directly.
The CSA is considering this step in the wake of research that has led to the conclusion that “the prevailing practice of remunerating dealers and their representatives for mutual fund sales through commissions, including sales and trailing commissions, paid by investment fund managers (embedded commissions) raises a number of investor protection and market efficiency issues that suggest a need to consider change.”
There is “considerable scope for better aligning the interests” of mutual fund managers, dealers and reps with investors’ interests, the CSA notice states. Furthermore, it notes that doing away with embedded fee structures would: directly engage investors in the dealer/rep compensation process; provide greater clarity to investors on the services provided and their costs; and better align the interests of the industry and investors.
The CSA acknowledges that discontinuing embedded commissions “would be a significant change for investors and the mutual fund industry,” which is why regulators are preparing to explore the idea in yet another consultation paper rather than actually proposing new rules in this area.
Although the CSA has determined that “there’s sufficient evidence to consider regulatory action on embedded commissions … before taking any action, and while we consider related regulatory initiatives underway, we want to consider the impact that discontinuing embedded commissions could have on the provision and accessibility of advice and on certain product providers in our market,” the notice states.
The forthcoming consultation paper will “assess the potential quantitative and qualitative consequences of discontinuing embedded commissions on different types of market participants and different types of investors in Canada,” the CSA’s notice adds.
The CSA’s consultation paper will seek to: evaluate how well a move to direct pay arrangements would alleviate the regulators’ investor protection and market efficiency concerns; assess the potential impact of discontinuing embedded commissions on market structure, business models and the availability of advice to investors; and identify options for transitioning to direct pay arrangements that would mitigate any negative side effects of the move.
The consultation paper will also explain why the CSA has decided to pursue the elimination of embedded commissions rather than other policy options that were proposed in the CSA’s initial paper on this issue in 2012, such as capping trailers, or mandating the provision of minimum service levels by dealers.
When the CSA releases its consultation paper, it will go out for a 120-day comment period. In addition, the CSA says it will hold more roundtable meetings to discuss the potential impacts of discontinuing embedded commissions.
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