Mutual fund dealers may face culling

Specifically, the results of this consultation indicate that if this IIROC move happens, most independent mutual fund dealers believe they would be out of business; that clients’ access to advice would be reduced; and that the viability of the MFDA would be imperilled.

These conclusions aren’t new, though. They stem from consultations that were carried out in the summer and autumn of 2014, but the discussion is as relevant ever – because the idea of allowing investment dealers to house mutual fund reps is up for debate once again.

In November 2015, IIROC issued a white paper that proposes doing away with the requirement that mutual fund reps who work at IIROC firms must upgrade their qualifications to full investment rep status within nine months of joining the firm; IIROC also would permit all reps to utilize personal corporations. In effect, these proposals would allow investment dealers to deploy both full-service reps and mutual fund reps on a single platform.

The idea has been kicking around for several years and caught real traction after IIROC granted an exemption to one of its licensed dealers in 2013, providing that firm with relief from the so-called “upgrade requirement.”

In the wake of that decision and the subsequent policy debate that developed, the Canadian Securities Administrators (CSA) tasked both the MFDA and IIROC with assessing the views of their member firms regarding the implications of allowing investment dealers to employ mutual fund reps. The MFDA and IIROC, both self-regulatory organizations (SROs), reported back to the CSA in the autumn of 2014; in March of 2015, IIROC decided to revoke the exemption.

Yet, that wasn’t the end of the debate. Indeed, IIROC’s white paper, which seeks to explore more fully the issues raised by the prospect of eliminating the upgrade requirement and allowing reps to use corporate structures, follows from what the SRO heard from its survey, which drew responses from 41 of its 160 dealer members. (See sidebar at right.)

The stakes clearly are higher for mutual fund dealers. The MFDA took the issue to its members through a survey, a series of focus groups and one-on-one meetings; 80 dealers out of 101 member firms participated. The MFDA has released the results of those consultations, which reveal some serious concerns among its member dealers in the face of the new IIROC proposal.

For example, the MFDA report indicates that most stand-alone mutual fund dealers believe they will either go out of business or be forced to merge with an IIROC firm if the upgrade requirement is eliminated.

At the same time, survey participants warn that smaller-producing reps also will be forced to exit the business, that lower-value clients are likely to be left without access to service or advice and that the anticipated erosion of the MFDA membership will raise regulatory costs on the remaining firms to an unsustainable level.

For so-called “dual platform” firms – mutual fund dealers that also have an IIROC affiliate – the consultation found that some of them believe they would enjoy cost savings and gain operational efficiencies in an environment that allows IIROC firms to field their own dedicated mutual fund reps.

In addition, the MFDA report states that some dual-platform firms also believe this change would enhance their ability to compete with the bank-owned investment dealers and other IIROC firms.

However, the report also notes that some dual-platform firms don’t expect to see much benefit, and others suggested that they would face added costs (both technological and regulatory) in migrating their mutual fund business to the IIROC platform.

The anticipated impact of the proposed change on clients is mixed, according to the MFDA report. Although there are concerns that smaller clients and clients in smaller communities could see their access to services and advice reduced amid the resulting investment industry consolidation, some hope was offered that clients may benefit from greater choice in products and services; that eliminating the need for separate IIROC and MFDA platforms would reduce client confusion; and that transferring clients from the mutual fund dealer world to the full-service environment would be easier.

The SRO landscape also would be affected, the MFDA report suggests. Indeed, the anticipated consolidation among dealers would probably lead to SRO consolidation.

According to the MFDA report, there’s some resistance to this notion among mutual fund dealers, indicating that overhauling the SRO structure should be a result of efforts to enhance investor protection or to address regulatory concerns rather than caused by a policy change designed to help firms save on operating costs.

Other firms noted that any SRO reform should proceed from a fundamental rethink of the appropriate regulatory structure rather than as a response to a single rule change.

The one aspect of the current debate is that mutual fund dealers do appear to support a policy change that results from rule reform rather than simply granting exemptions.

The concern with making the change via exemption is that the process of applying for an exemption is not transparent and doesn’t allow for all the possible implications to be considered. The regulatory rule-making process, at least, includes an opportunity for public comment and the chance for full contemplation of potential implications.

The firms that participated in the IIROC survey shared this sentiment, indicating that such a policy change should go through the full rule-making process – not simply by exemptions – to ensure regulatory consistency, a level playing field for firms and a transparent consultation process.

Feedback on IIROC’s November 2015 paper is due by March 31.

DEALERS SEE EYE TO EYE

The white paper and accompanying consultation that the Investment Industry Regulatory Organization of Canada (IIROC) launched in November 2015 (see story at left) follows from a survey of IIROC member firms, which found that most weren’t interested in employing mutual fund representatives unless those reps can utilize personal corporations (PCorps).

IIROC’s white paper contemplates two fundamental changes: eliminating the requirement that mutual fund reps employed by IIROC dealers must upgrade their qualifications to full-service status within nine months of joining that dealer; and allowing all IIROC reps to utilize the PCorp structure that’s widely used on the mutual fund dealer platform, on which reps are allowed to flow their commissions through a corporate structure to receive tax advantages and other benefits.

The proposal to allow IIROC reps to use PCorps in principal/agent relationships stems from a survey of its members to seek feedback on the idea of granting relief from the “upgrade requirement.” Many firms and reps responded that “simply eliminating the proficiency upgrade requirement on the IIROC platform is of limited interest unless directed commissions are also allowed.”

IIROC currently does not allow reps to use PCorps. But using this business structure also raises regulatory concerns, including whether PCorps could break the chain of liability between reps and their dealers. However, certain IIROC dealers and reps have long sought the use of the PCorp structure.

The results of the IIROC survey, detailed in the white paper, indicated that only 15 of the 41 firms surveyed are interested in an exemption from the upgrade requirement to provide “increased flexibility, operational efficiencies, reduced costs and an enhanced client experience.” The other firms support an exemption, but need more information before deciding whether they would seek it.

However, the white paper also reveals that investment dealers share many concerns with mutual fund dealers about allowing investment dealers to employ mutual fund reps. According to the IIROC paper, investment dealers that considered the impact on the industry overall, “generally highlighted the negative implications for firms.” This includes the prospect of a competitive shakeup in the industry that probably would lead to the consolidation or elimination of many mutual fund dealers and the ultimate loss of the Mutual Fund Dealers Association of Canada (MFDA).

IIROC dealers also share concerns about the implications for clients, dealers and reps, anticipating that clients would benefit from wider product and service selection and less confusion about the regulatory environment, but also may suffer from decreased competition and other transition issues.

IIROC dealers foresee an opportunity for firms to reduce costs, gain efficiencies and enhance service, with the downside including transition issues and new compliance concerns. As for reps, they would enjoy many of the same benefits as their firms, along with shifting some of their existing compliance burden onto their firms. On the downside, reps would face the challenge of competing with full-service dealers more directly and added compliance and transition issues.

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