Canada’s mutual fund dealer regulator is pushing back against some of the opposition it has received regarding a proposal that would allow mutual fund firms and their reps to engage in a limited form of discretionary trading.
In April, the Mutual Fund Dealers Association of Canada (MFDA) proposed rule changes that would allow fund dealers to make changes to clients’ model portfolios – enabling advisors to replace a poorly performing fund or to alter asset allocation in response to changing market conditions – without first seeking client approval.
The proposal’s 120-day comment period, which wrapped up in August, attracted considerable criticism from investor advocates and various industry factions. Responses to the MFDA’s consultation expressed concerns about the proficiency standards, oversight arrangements and conduct standards that would apply to fund dealers and reps with discretionary authority, among other issues. And comments warned about the risk of regulatory arbitrage.
Now, the MFDA – which is analyzing the comments and formulating its policy responses – is pushing back, particularly against some of the objections emanating from within the industry.
This sort of criticism is creating frustration at the MFDA, suggesting that some of the negative feedback may be motivated by competitive considerations rather than genuine concerns about investor protection. Furthermore, the MFDA complains that its proposals are being misinterpreted.
“The discretion we are proposing is very limited and will just make an existing process more efficient, which will decrease costs for everyone,” says Karen McGuinness, senior vice president, member regulation, compliance, with the MFDA. “However, this proposal is being purposely misinterpreted for political/competitive reasons.”
Efforts to reduce regulatory burden or to enhance efficiency in one part of the industry often represent a competitive challenge to other industry segments. In this case, the MFDA is concerned that its proposal is being portrayed as an effort to enable fund dealers to engage in discretionary trading under lower regulatory standards than other firms must work under.
The MFDA insists that’s not the case and maintains that allowing fund dealers to manage clients’ model portfolios directly would remove a bureaucratic, operational hurdle and not compromise investor protection.
In fact, the regulator maintains, its proposal envisions dealers (and reps) that engage in discretionary trading for clients’ model portfolios will be subject to the same standards that currently apply to portfolio managers – with the added layer of oversight from the MFDA.
Under the MFDA’s current rules, there are two ways that fund dealers can offer their clients model portfolio products. The model portfolios can be operated in-house, but dealers must get a client to approve any changes to the client’s portfolio (apart from routine rebalancing). This requirement means that making portfolio adjustments tends to be a slow, cumbersome process.
Alternatively, dealers can engage external portfolio managers, which do have the authority to operate these kinds of products on a discretionary basis. However, this approach is more costly and complex.
So, fund dealers pushed the MFDA to consider reforms that would enable the dealers to run these products in-house more easily and cost-effectively.
The MFDA’s proposal suggests two options for achieving this objective: requiring MFDA-registered dealers and reps to register as restricted portfolio managers; or providing an exemption from the registration requirements, which would be conditional on adhering to the same standards as restricted portfolio managers.
The MFDA maintains that under either model, reps exercising discretionary trading authority would be subject to the same proficiency and conduct requirements as restricted portfolio managers. The MFDA also states its proposals will not create opportunities for regulatory arbitrage.
As the MFDA notes in its original proposal, enabling dealers to operate their own model portfolios in-house simplifies accountability – ensuring that any client issues that arise are the responsibility of the dealer alone and not potentially divided between a dealer and an external portfolio manager. McGuinness notes that the discretionary activity would also be subject to additional MFDA requirements and oversight, as well as contingency fund coverage.
The provincial regulators have already signed off on these sorts of discretionary trading arrangements for certain fund dealers (firms with affiliated portfolio managers) that have sought their own exemptions from the provincial authorities.
Moreover, investment dealer firms already have an exemption enshrined in the provincial securities rules that enables the investment dealers’ reps to engage in discretionary trading. While fund dealers would surely welcome the same treatment, the provincial regulators have a lot on their plates at the moment and revising the MFDA’s rules is likely to be a more effective way to effect the change.
The MFDA indicated in its original proposal that it had considered simply requiring firms to go through the chore of seeking relief for limited discretionary authority from a provincial regulator on their own.
However, the MFDA rejected that idea, stating that this approach would “unnecessarily add costs and regulatory burden.” Such an approach also would ignore fund dealers’ requests for flexibility, the MFDA stated, and would not meet the goal of supporting responsible industry innovation.
“We were just looking for a more streamlined process,” says McGuinness.