Opposition to fund governance grows voluable

Rebecca Cowdery, manager of investment funds regulatory reform at the OSC, is also heading up the CSA project. She calls the response from various commentators “very gratifying” — even though the tone in many of the comments is decidedly negative.

It’s not unusual for industry to disagree with the regulators’ plans, but in this instance, many of the comments have been more caustic than usual. Rather than simply accepting the proposed rules as inevitable and trying to make them more palatable, as is often the case, usually accommodating industry players are attacking the premise of the regulators’ proposals and the validity of its cost/benefit analysis.

The fund industry lobby group, the Investment Funds Institute of Canada, perhaps sets the tone for many of the negative responses with its own comments. In its letter to the OSC, IFIC says that it is “not convinced of the tangible value that the adoption of fund governance will add to investors.”

IFIC allows that a fund governance regime may have some value as good optics, but says it can’t support the initiative unless there is a quid pro quo in terms of a relaxation of the “regulatory restrictions that a system of fund governance would render either moot or redundant.”

The CSA, from the outset, has said that the rules regulating mutual funds may well be relaxed — if there is an effective fund governance regime in place. However, it has insisted that such deregulation must necessarily come after the development of improved governance. But many industry players are just as vehemently insisting that the rule relief come at least concurrent with, if not before the new governance requirements come into force. IFIC says that the CSA’s proposals will be of “no benefit” to investors “if they are simply added as layers to the pre-existing inefficiencies of our current regulatory regime.”

Some of the industry’s demand for deregulation is certainly inspired by the B.C. Securities Commission’s deregulation concept proposal, which was published in February. It recommends dropping many of the prescriptive rules for mutual funds in favour of a conduct-based approach, regardless of the governance situation.
Firms were all for deregulation when its was posited as a possible side benefit of a tougher CSA governance regime. Now that the BCSC has proposed that deregulation may make sense anyway, the industry would just as soon have the deregulation without being forced into added governance obligations. Notably, the BCSC dropped consideration of mutual funds from its latest deregulation proposal, promising to deliver something on funds later this year while it goes ahead with its plans to reform most other areas of the securities rules.

Nevertheless, the industry’s insistence on relaxed rules is not just a matter of trying to cherry-pick the slackest regulatory regime. There is a genuine and credible fear of the costs of added governance. In an attempt to address this question, the OSC has already produced a cost/benefit analysis on its proposals, suggesting $17.9 million in initial set-up costs and $65.9 million in ongoing annual costs.

IFIC and various other commentators, however, suggest that those costs are understated. IFIC says the OSC’s analysis does not account for fund companies’ costs of the added regulatory burden, capital requirements, liability concerns and recruiting costs. Prominent securities lawyer and former OSC chairman James Baillie says the analysis also fails to account for the cost of the additional time management will spend on governance. He suggests that the costs are not yet justified by the benefits. Of course, tangible benefits of a fund governance regime are very difficult to quantify.

It’s the small firms that are particularly concerned about costs. Calgary-based Mawer Investment Management, suggests the CSA’s plans would create significant costs to its funds and the firm. Mawer notes that taking the OSC’s estimates — assuming they are accurate — the expected costs represent 14.1% of Mawer’s current average management expense ratio. It also represents 46.8% of the administrative (or non-investment management) costs in its average MER. “In our mind these are very big increases,” it says in its comment letter.

“Our funds have been deliberately established and managed so as to achieve low management expense ratios, providing our clients with excellent value. Our clients are cost-conscious and would be justifiably alarmed at such regulator-imposed cost increases.”

Exchange-traded fund manufacturer Barclays Global Investors Canada Ltd. agrees that the added cost will be punitive. An additional 17 basis points in expenses would essentially double the MER of some of its funds, which, it suggests, would undermine the value of its products. It asks that the regime not apply to ETFs or to pooled funds.

Similarly, the Canadian Life and Health Insurance Association says that the rules should not be extended to cover segregated funds.

While cost-conscious firms, such as Mawer and BGI fret over the possible effects of a mandatory fund governance regime on their products and unitholders, the large firms do not share their concerns. RBC Mutual Funds, for example, expresses little concern about the added costs of governance. And it’s not just the banks, other big fund companies, such as Toronto-based AIM Funds Management Inc., do not worry about the cost in their comments, either.

AIM says that the cost of its advisory boards has not had any significant impact on MERs or fund performance. It suggests that the costs of governance pale in comparison to the potential costs of other issues, such as the move to T+1. AIM does concede, however, that its large asset base makes it easier to absorb these types of costs — giving some credence to suggestions from small firms that the proposals favour the big firms and hamper smaller firms’ ability to compete.

The other fundamental issue raised by various commentators is the necessity of a harmonized, national regime for mutual funds. IFIC calls for a more unified, national regulatory regime whether the proposed governance regime is brought in or not. Without some progress toward harmonization, regulatory simplification and functional regulation, IFIC suggests that it couldn’t support the proposals.

“Added expense and further impairment of service to unitholders is unacceptable to our members and the industry will not likely be amenable to lending its support to any proposal that is not implemented and adopted in a standardized and uniform manner across all jurisdictions in Canada,” it says.

Whether the industry will end up supporting the proposal or not, it is now back in the hands of the CSA group considering the issue. Cowdery says that it has started deliberations on the future of the proposals. And it will continue to consult with the industry, she says. The CSA particularly hopes to meet with the IFIC fund governance committee and the BCSC’s deregulation team.

The CSA will now summarize all the comments and prepare a more detailed framework, laying out its recommended approach to the issue. Cowdery says that the team is targeting late fall for a presentation to CSA chairs and the other provincial commissions.

In the meantime, there appears to be a lot of work to be done to get the fund industry onside with the regulators on the issue of mandatory fund governance. IE