Awaiting a decision

Hopefully, the industry finally will get an answer this year on whether regulators are prepared to go forward with a ban or will be content to adopt more modest reforms.

Following yet another year of consultation by the Canadian Securities Administrators (CSA) on the issue, regulators are expected to finalize a policy direction on embedded commission structures this year.

Indeed, the Ontario Securities Commission (OSC) promises to provide its recommendations regarding a ban on embedded commissions in its current fiscal year, which ends on March 31. Other members of the CSA have signalled that they anticipate a verdict will come sometime in the spring.

Still, despite the prospects for such a critical, long-awaited policy decision from regulators, speculation over just what they will do remains just that. Investor advocates continue to call for regulators to follow through with a ban. In contrast, investment industry trade groups still are against the idea. Meanwhile, regulators have yet to declare a clear direction.

The Alberta Securities Commission, the B.C. Securities Commission and the OSC all held further public consultation sessions concentrated on possible alternatives to an outright ban this past autumn. These included: eliminating the deferred sales charge (DSC) option, but allowing trailer fees to remain; capping or standardizing trailers; or simply enhancing disclosure.

A year ago, regulators seemingly had dismissed these alternatives, which were first considered in 2012 along with a ban, as possible ways to address concerns regarding investor protection and market failure.

The CSA issued a consultation paper in January 2017 that zeroed in on the idea of banning embedded commission structures and requiring investment and mutual fund dealers to adopt direct-pay arrangements with their clients as the clearest, most effective way to address regulators’ concerns with existing industry practices.

The CSA didn’t declare its intention to ban embedded commissions definitively in that paper.

Rather, that CSA consultation focused on ways to mitigate the possible side effects of scrapping embedded commissions structures and move toward more upfront payment arrangements. Regulators also indicated at that time that the industry would have to produce compelling new evidence to maintain the status quo instead of recycling standard arguments to sway the policy debate.

To date, the industry continues to oppose such a ban, repeating long- standing arguments that banning embedded commissions structures will reduce the availability of advice, curb investor choice and disrupt industry business models – arguments the CSA continues to dismiss as unpersuasive.

Evidence in favour of the ban includes research by York University professor Douglas Cumming in 2015, which highlighted the negative impact of the trailer fee structure on investor outcomes. In addition, there were a series of regulatory no-contest settlements over the past few years involving some of the industry’s largest firms regarding systematic client overcharging, often in mutual funds that utilize embedded fee structures.

Nevertheless, the CSA is keeping its policy options open. The latest public consultation revives the debate surrounding possible alternatives to a ban, such as eliminating DSCs and capping or standardizing trailers – leaving both the industry and investors guessing about just what the regulators are going to do on this issue.

Still, an imminent ban is unlikely. Even if regulators do determine now is finally the time to eliminate embedded commissions, that will not happen overnight.

Should the CSA decide that a ban is warranted, the regulators then must craft specific rules to implement that decision. Those rules, in turn, must go through the usual rule-making procedure, which involves extensive public comment.

For such a fundamental policy move, this process often takes years, while regulators agonize over every detail of the final rules. Even then, major rule changes also often are accompanied by an extended transition period.

Moreover, lack of conviction from regulators indicates that they’re not keen on rushing to implement a ban. In contrast, the CSA’s move to outlaw binary options trading was implemented relatively quickly last year – by CSA standards, at least. But regulators continue to be much more cautious regarding embedded commissions.

Realistically, any policy direction the CSA signals in 2018 is likely to require considerable time before having direct impact on industry compensation structures.

At the same time, the CSA is working on a set of so-called “targeted reforms” to revise the rules in several areas – including suitability requirements and conflict-of-interest rules – that may address some of the concerns regulators have cited with mutual fund fee structures. Indeed, regulators have been considering the issues raised by mutual fund fee structures alongside the issues underlying the targeted reform recommendations for several years now.

Yet, here again, even if the CSA does decide to go ahead with these targeted reforms – which all of the members of the CSA support, despite their disagreement over whether a “best interest” standard should be included – this initiative still must go through the rule-making process. This means that the actual implementation of any changes on the ground is some way off.

Regulators even could choose to keep kicking the embedded fee question further down the road by deciding that the second phase of the client relationship model (CRM2) reforms need to be given more time to work before a final decision is made about banning trailer fees or not.

In any case, although the investment industry may finally get its answer this year on whether securities regulators believe the time to get rid of embedded fee structures has arrived, any concrete impact on the industry is unlikely to materialize this year – if at all.