Extending mutual fund regulation principles beyond funds

Although the application of the point of sale rules to seg funds was not discussed by Devlin, it’s clear that regulators want to pursue more equivalency between the two sectors in order to eliminate any potential for regulatory arbitrage. Some of the areas being considered for enhanced equivalency, Devlin noted, include suitability recommendations for segregated funds (an element of the Fund Facts regime), discipline and the churning of accounts. (In a recent report, The Canadian Life and Health Insurance Association also suggested that the sale of segregated funds be accompanied by more disclosure about fund costs when funds are sold.)

Certainly, the requirements for disclosure and suitability reviews of mutual funds have never been more comprehensive. All advisors who sell mutual funds to retail clients will be required to supply Fund Facts, a two page, double-sided document, before they close the sale.

In many cases, firms will expect their advisors to go further, taking clients through the document on a step-by-step basis, explaining key concepts such as asset type, fees and commissions and risk profiles. There are exceptions, such as clients who grant full discretion for investing decisions to others, but most advisors with retail clients will find themselves subject to the new rules.

Unlike the discussions about new rules for the insurance industry, regulators have already laid down some concrete proposals for extending the disclosure principle mandated by Fund Facts to exchange traded funds (ETFs). In June, 2015, the Canadian Securities Administrators (CSA) proposed that investment firms providing ETFs begin the process of drafting “ETF Facts” documents that will essentially track the format and content of Fund Facts.

Advantages noted by the CSA include greater transparency of costs and ease of comparison between one ETF and another. The new initiative will allow the two types of investments to be “treated more equally with respect to the disclosure available in connection with the purchase of securities,” the CSA has stated.

The proposed ETF Facts document, which regulators would like to see ready for use by 2018, will also have four pages of content, organized in an accessible, easy to understand format. Like Fund Facts, it will first be made available on the web sites of firms that sell ETFs and provided to the client within two days following the purchase of an ETF. As with mutual funds, a full prospectus will also continue to be made available to ETF investors.

However, regulators have acknowledged that ETFs differ fundamentally from mutual funds in a number of key ways, which must be taken into account in the preparation of ETF Facts. The most crucial difference is that ETFs are, like stocks, bought and sold through a securities exchange. So, rather than subscribing for mutual fund units directly from a fund management firm, purchasers of ETFs must go through a securities exchange.

As a result, ETF Facts will have to include specific information that describes how ETFs are traded and how they are priced. This may include, for instance, details such as how a market price is calculated, and the relationship of this price to net asset value.

So far, it is unclear whether or not regulators will eventually impose point of sale delivery on ETF facts. Regulators have stated that a staged approach for ETF Facts delivery, similar to Fund Facts, will be used: the goal is to assess whether or not various types of delivery are appropriate for ETFs. However, like Fund Facts, ETF purchasers who have not received the ETF Facts document within two days of purchasing the ETF will be permitted to rescind the purchase or seek damages from the investment firm.

Part one of a three-part series: Fund Facts and Point of Sale Disclosure.

Up next: Understanding the new delivery requirements.