Given the ever-increasing
cost of doing business, many traditional financial institutions see little or no attraction (read: profit) in servicing low net-worth individuals. And an important element in the high cost of serving retail clients comes from the cost of regulatory compliance. Simply put, if providing services and products to low net-worth individuals is not likely to generate a profit in the short- or long-term — and may even lead to losses — why pursue them as clients in the first place?

Devoting resources to providing services to low net-worth clients would fail to maximize shareholder value and would likely require other customers to subsidize less profitable ones. This economic fact is manifested by the decline in the number of branches of traditional financial institutions in low-income neighbourhoods and the abundance of new cheque-cashing and payday loan providers in such areas. It comes as no surprise, then, that other parts of the financial services industry are underserving the populations of these same neighbourhoods for the very same reasons.

Over the past few years, the number of mutual fund dealers in Canada has declined. One often-cited reason for this decline is the ever-increasing cost of doing business arising directly from increased compliance and regulatory requirements. As the compliance and regulatory regimes and expectations applicable to mutual fund dealers and securities dealers become increasingly similar, it would also be expected that their cost structures will also become increasingly similar even though their business models are quite different. So, what impact will this have on the availability of mutual funds to the general public — especially to low net-worth individuals?

The additional costs involved in operating a mutual fund dealer that will result from certain regulatory initiatives — including the Registration Reform and Point of Sale initiatives — will have the unintended consequence of making it increasingly difficult, if not impossible, from a profitability perspective, for mutual fund dealers to provide products, services and advice to those consumers who are often in the greatest need and have modest amounts to invest.

Many securities dealers have established minimum account sizes of $75,000 or more. Clearly, this must be seen, in part, as an attempt to establish a hurdle that ensures at least a break-even result for each account — as well as ensuring that reps don’t “waste” time with smaller accounts.

Although mutual fund dealers may have a lower cost structure, it would not be surprising to see them establish minimum account sizes that are of significant size, or impose annual account fees — each of which would dissuade individuals of modest means from investing. Many discount brokers — which arguably have cost structures that are significantly lower than many, if not most, mutual fund dealers — have implemented annual account fees to cover the costs of accounts that generate insufficient trading or other revenue.

In a market-driven economy, the typical responses when traditional service or product suppliers face increased costs are to increase prices or abandon certain markets. Often, new entrants then step in to service an abandoned market or provide similar products and services at lower prices using staff who have sufficient qualifications to perform straightforward duties that require limited training. These new providers would also take other steps to reduce costs, including narrowing service or product offerings. You need only look to the services provided by paralegals, law clerks and nurse practitioners as common examples of personnel with restricted credentials providing limited services in a fully satisfactory manner at a lower cost and in a more convenient manner than traditional providers of such services.

Even though many mutual fund dealers may find it difficult to enforce a minimum account size on a commissioned sales force that is highly mobile, many salespeople will likely self-restrict the services they provide. This could be either in terms of the breadth of service (the range of funds and other products offered) or frequency of service (number and length of customer contacts) in which the opportunity cost of servicing a small account exceeds any potential compensation.

In order to ensure that Canadians of modest means have access to basic money management services, the Canadian Securities Administrators should seek and accept input from the industry and consumer groups on how these services can be provided through distribution channels with lower operating and other costs through reduced, but satisfactory, regulatory and compliance obligations. Limiting the type of funds that can be sold through these distribution channels, for example, could be the quid pro quo for reduced compliance and regulatory obligations.

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Richard E. Austin is a counsel at the Toronto office of Borden Ladner Gervais LLP. The views expressed herein are those of the author alone.