Amid concerns about mutual fund risk ratings, the Ontario Securities Commission (OSC) is reviewing fund managers’ use of discretion in setting those ratings.
According to a new report from the OSC’s investment management division, mutual fund risk ratings are currently undergoing a continuous disclosure review, which is expected to be completed in its fiscal 2025 (ending March 31, 2025).
The review followed a report from the Ombudsman for Banking Services and Investments (OBSI) that flagged the “potential systemic underrepresentation of risk in some mutual fund risk ratings in recent years.”
The OSC said “OBSI reported that they observed many funds reducing risk ratings on the basis of the 10-year standard deviation and relatively few [fund managers] increasing or maintaining risk ratings by using upward discretion.”
The methodology that funds are required to use to devise their risk ratings allows fund managers to use their discretion to classify a mutual fund at a higher risk level than its standard deviation alone would imply, “if it is reasonable… in the circumstances.”
According to the OSC’s report, while the regulator conducted its own review of funds’ risk ratings — and “did not have the same observations as OBSI” — it has since launched a continuous disclosure review that has asked a sample fund managers about the policies and procedures they have adopted, “to determine the circumstances under which it would be reasonable to increase the risk rating of a mutual fund, and how discretion has been or has not been exercised in recent risk ratings.”
Alongside that review, the OSC’s report also reiterated that its ongoing review of ETF regulation is expected to be completed this year, and that a consultation paper detailing the results of that review— and any potential policy changes that may be proposed— will be published in 2025.
The review of ETF regulation, which was launched by the Canadian Securities Administrators (CSA) in August 2023, is examining the framework for ETFs — including the rules around the creation and redemption of ETF units, secondary market trading, and the mechanisms used to keep the trading price of funds near the value of their underlying portfolios.
It’s also considering the factors that may affect ETF liquidity and trading, and the application of the latest global regulatory standards for ETFs in the Canadian market.
“This research will be used to inform our analysis of potential gaps and enhancements to the regulatory regime for ETFs,” the OSC’s report said — adding that the regulators will seek feedback on potential reforms before formally proposing them.
This work on ETF regulation comes as the growth of the ETF sector continues to outpace mutual funds.
The OSC reported that, in fiscal 2024, prospectus filings by ETFs exceeded filings from mutual funds for the first time ever. And assets under management (AUM) in ETFs rose by 23% during fiscal 2024, while mutual fund AUM was up just 11%, resulting in a 1% shift in overall market share from mutual funds to ETFs.