At the behest of Ontario Finance Minister Peter Bethlenfalvy, the Ontario Securities Commission (OSC) has launched inquiries into banks’ activities in two areas: the availability of third-party investment funds on their product shelves and the practice of tied selling to corporate clients.
In a letter sent late last month, Bethlenfalvy invoked a securities legislation provision to ask the OSC to undertake a review and report back by the end of February with recommendations.
The shelf-space issue is particularly timely, with the client-focused reforms (CFRs) due to take effect at the end of this year. The minister and regulators have raised concerns about the reforms’ unintended consequences, such as bank-owned dealers curbing sales of third-party funds in response to more onerous compliance requirements.
As Investment Executive reported in August, CIBC and Toronto-Dominion Bank have removed access to new purchases of third-party products for branch-level financial advisors, and Royal Bank of Canada will do so as of Dec. 31.
The government’s letter to the OSC stated banks shrinking their shelves “would run counter to the underlying intent of the CFRs, which is to mitigate conflicts of interest and ensure that investors have access to the products that best serve their needs.”
The Ontario government is not alone in its consternation.
At an investment industry conference in late September, Louis Morisset, chairman of the Canadian Securities Administrators and president and CEO of the Autorité des marchés financiers, said regulators are alarmed by reports that bank-owned dealers were shrinking their shelves in response to the CFRs.
“This is definitely not what the CFRs are meant to do,” Morisset said. “The CFRs are meant to increase the professionalism of registrants, and to give them more tools to do a better job for their clients. If that boils down to reducing what they can sell, we have a big problem.”
Grant Vingoe, chairman and CEO of the OSC, also expressed dismay at the banks’ actions. Speaking at the OSC’s annual conference on Nov. 23, Vingoe said he reacted “viscerally” to reports that banks had begun restricting their product shelves in response to the CFRs’ know-your-product provisions, which require reps be trained to assess the suitability of the products they sell and ensure they’re in clients’ best interest.
“With all of the technology being brought to bear and the skills of the advisor community, I couldn’t accept the proposition that bank-owned dealers couldn’t train their staff to include a reasonable range of independent products,” Vingoe said.
In response to the government’s request for a study of the issue, the OSC will undertake a compliance review of the bank-owned dealers to understand how they’ve addressed conflicts of interest in distributing proprietary products.
In particular, Vingoe said, the commission will look at how shelf construction has been carried out and the extent to which bank-owned dealers are limiting access to third-party products.
“We have to examine the consequences to investors … and also to the entire ecosystem that squeezes out new and emerging — and really valuable alternatives — to clients,” Vingoe said. “If the shelves are unduly constricted, over time it seems almost inevitable that costs to investors will increase because of the monopolization effect — so we have to examine the short- and long-term effects.”
The OSC contacted firms on Dec. 6 and expects responses by Jan. 6, 2022.
Whether the regulators can get banks to change course is unclear. “I am not aware of any direct authority that could be relied on to require banks to sell ‘non-proprietary’ products,” said Jean-Paul Bureaud, executive director of the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada). “However, [the regulators] might explore imposing indirect requirements or restrictions.”
For example, Bureaud suggested, regulators could consider prohibiting bank employees from holding themselves out as “advisors” if they only sell proprietary products.
This probably would require comprehensive rule-making and potentially conflicts with efforts underway in a few provinces to restrict the use of the “advisor” and “planner” titles based on proficiency.
The Ontario Capital Markets Modernization Taskforce’s January report recommended stepping up oversight of product-shelf issues, issuing guidance and increasing disclosure to investors about whether or not they are receiving independent advice. The report also called for independent fund companies to report to the OSC when their products are excluded from a bank dealer’s shelf and for dealers to be required to report on the mix of proprietary and third-party products sold each quarter.
Still, these measures may not move the needle for independent products.
On the issue of tied selling, regulators are probably on firmer ground, given that various provisions already address the problem. For example, the mutual fund sales practices rules prohibit banks from making any lending (including mortgages) contingent on an investor also buying mutual funds. Coercive tied selling also is prohibited in banking legislation.
Tied selling “is squarely within [regulators’] authority,” Bureaud said. “The real problem lies in finding the best solution or tool to address the fundamental problem, which is often difficult to uncover, let alone prove.”
The OSC’s consultation paper on tied selling indicates the regulator is seeking evidence and analysis from dealers, issuers and others to determine whether anti-competitive tied selling is occurring — and, if so, to what extent. In addition, the OSC stated it will review a sample of initial public offerings to determine whether anti-competitive behaviour occurred.
At the OSC’s November conference, Vingoe said if the big banks are using their lending power to unfairly dominate the underwriting business, that kind of anti-competitive behaviour would increase costs to both issuers and investors, and could squeeze out small investment dealers, “which would have an undesirable effect in Canada.”
Ontario’s task force made several recommendations for addressing tied selling concerns, including strengthening existing restrictions, requiring independent underwriters in certain offerings be introduced and banning “restrictive clauses” from underwriting agreements.
Yet, as the OSC noted in its consultation, these measures could have unintended consequences of their own: potentially restricting issuer choice; harming capital-raising; and possibly benefiting foreign dealers at the expense of domestic firms.