Adding ETFs

“I know of two other MFDA firms that will be launching ETFs within the next couple of months,” says Patricia Dunwoody, executive director of the Canadian ETF Association (CETFA). CETFA, along with other industry groups, has been developing a process to help fund dealers access ETFs and comply with the related complex reporting, custodial, trade confirmation and taxation issues.

Although fund dealers are allowed under regulation to offer ETFs, which essentially are a form of mutual fund, so far only Peak and Mandeville have been able to find a way to do so. For MFDA-registered firms, the difficulty is that they need access to stock exchanges to buy and sell ETFs – and this means making an arrangement with an Investment Industry Regulatory Organization of Canada (IIROC) member firm registered to trade securities. MFDA-registered firms also must fulfil ETF back-office requirements and reps must meet proficiency standards.

“So far, there has been slow take-up by the mutual fund dealers on the ability to sell ETFs,” says Rudy Luukko, investment funds and personal finance editor at Morningstar Canada in Toronto.

Peak’s solution involves leveraging securities trading, technology and operations expertise within Peak Financial Group to develop an in-house platform enabling MFDA-licensed advisors to place ETF trades directly through Peak Investment Services.

“We have an IIROC[-registered] division and already do a lot of the work in-house [regarding] tools and systems,” says Robert Frances, chairman and CEO of Peak Financial. “We’ve been able to take what we do on that side and bring it over to the mutual fund dealer side, and vice versa. Everything is happening under one roof.”

Dunwoody says CETFA continues to work with various IIROC firms and other industry service providers that could provide the necessary stock-exchange access and back-office support to MFDA-registered firms.

Mandeville became the first fund dealer to offer ETFs in 2014, thanks to trading, settlement and custodial arrangements with Broadridge Financial Solutions Inc. and Fidelity Clearing Canada ULC (both in Toronto). However, Mandeville officially resigned its MFDA registration in mid-December. Now, the Mandeville group’s primary financial advisory business is Mandeville Private Client Inc., an IIROC-registered firm that can trade ETFs.

Sandra Kegie, president of Toronto-based Kegie Consulting Corp., as well as executive director of the Federation of Mutual Fund Dealers (FMFD; also of Toronto) and part of the group working on CETFA’s process, says information has been provided to fund dealers identifying the necessary steps. However, the bottom line is that firms need to form a relationship with an IIROC dealer and possibly other service providers to access ETFs – and meet all the accompanying administrative requirements.

At the FMFD’s next annual conference in April, Kegie anticipates that she will be able to announce a “refined” set of steps. She says members will receive more specific information on the process of accessing ETFs, as well as a list of willing service providers that dealers can work with.

“The goal of the project is to provide a flow chart, but it’s up to each fund dealer to go to the IIROC dealer or service providers of choice,” Kegie says. “We’re providing the road map for how fund dealers can access an exchange, deal with reporting requirements and satisfy regulatory concerns. But each dealer [needs] to figure out [which company] to have a relationship with.”

Kegie says finding an IIROC-registered partner isn’t the most difficult part of the process; the bigger challenge is the back-office work, and “dealers that have more control of the engineering of their back-office systems will get there sooner.”

With the regulators closely examining the fund industry’s commission practices – particularly embedded fees, such as trailer fees – there is a move away from commission-based practices and toward a fee-based model in the advisory industry. This shift – along with the implementation of Phase 2 of the client relationship model, which highlights the exact amounts of fees and commissions clients pay – is fuelling demand from fund dealer reps for access to low-cost ETFs.

“There are 82,000 advisors out there at the fund dealers who don’t like other people doing things that they can’t,” Kegie says. “There is an industry move to the fee-based way of doing business, and ETFs fit right in.”

As well, technology and robo-advisor entrants are disrupting the investment industry, and advisors need a low-cost way to access investments for their clients, Frances says. He views ETFs as being particularly suitable for fee-based accounts, although, he says, mutual funds will continue to be an important product at Peak.

“ETFs are low-cost and a great tool, and they offer more choice to the client, including pricing options,” he says.

Mutual fund dealers offering ETFs also must address new proficiency requirements for their reps. ETFs differ from mutual funds in a variety of ways, and require knowledge of intra-day trading, bid/ask spreads, market and limit orders, and liquidity issues.

The MFDA awaits approval from the Canadian Securities Administrators (CSA) on proposed ETF proficiency requirements for advisors. The MFDA’s Policy 8 endorses a handful of education options, including courses offered by the Toronto-based Canadian Securities Institute, the Toronto-based Smarten Up Institute and the Mississauga, Ont.-based IFSE Institute. Until Policy 8 is approved by the CSA, fund dealer reps must pass the Canadian securities course in order to offer ETFs.

Although most of the 455 ETFs offered in Canada will be eligible for fund dealers’ shelves, ETFs with exposure to leveraged or inverse investment strategies or commodities will not be allowed.

“Reps don’t want to be at a competitive disadvantage, and that’s the motivation for providing ETFs,” Kegie says.

“I expect fund dealers will find a way to offer them and the activity will get a little frothy in 2017.”

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