IFIC lays out arguments against proposed commission ban

The group is questioning the effectiveness of the CSA’s proposal

IFIC lays out arguments against proposed commission ban
In a new submission responding to the Canadian Securities Administrators’ (CSA) proposal to ban embedded commissions, the Investment Funds Institute of Canada (IFIC) said the measure would not be a reasonable response to concerns regarding conflicts of interest.

“The potential for conflicts of interest exists in all financial advisory services payment models,” the IFIC said, adding that with the recent implementation of CRM2, more investors are aware of and understand how much they pay in trailing commissions.

“The cost of any regulatory proposal should be proportionate to the harm it seeks to address,” the group said. “However the [CSA’s] paper does not provide any evidence that the risk of harm from conflicts of interest is any less, or that investor outcomes would be better, under a direct-pay fee-based compensation arrangement.”

The group also questioned the CSA’s assertion that embedded commissions in Canada are among the highest in the world. Citing a 2015 Morningstar study, it said that an apples-to-apples comparison of US and Canadian mutual fund fees “must include the cost of advice and federal and provincial tax.” Doing such a comparison, Morningstar placed Canadian management expense ratios (MER) in the top half of the lower-fee markets among 25 countries surveyed, the IFIC claimed.

“[R]esearch cited by the CSA shows asset-weighted cost of ownership in Canadian advice channels to be 2.02% of invested assets (when the impact of taxes is excluded) compared to approximately 2.0% in the US (which does not levy taxes),” the group said, suggesting that the Canadian rate is extremely competitive given the size of the investment fund market in the US ($17 trillion) compared to Canada’s ($1.4 trillion).

Furthermore, a ban would result in mass-market households falling into an “advice gap” because of increased up-front costs. Since direct fee-based arrangements are uneconomic for accounts below $100,000 in value, and 80% of Canadians have less than $100,000 in financial investments, fewer firms would choose to serve mass-market investors.

“[T]he prohibition will further concentrate the market … by favouring scale and affiliated vertically integrated financial institutions,” the group said.

As an alternative to banning embedded commissions, the IFIC proposed a “made-in-Canada” approach consisting of several reforms:
  • Control conflicted compensation – capping or standardizing embedded fees, restricting Series A units to channels where advice is permitted, and allowing DSC funds only within established guidelines;
  • Improve investors’ awareness and control of fees – including the full MER in investment cost disclosures, simplifying pricing conventions, and using standard naming conventions for fund series;
  • Reduce investor resistance to “upfront” fee costs – allowing an arrangement wherein fees to the dealer are paid out of redeemed units, with the client’s consent;
  • Require upfront disclosures of fees – mandating enhanced discussions of fees and services at account opening and prior to each purchase, or annually; and
  • Ensure new clients’ understanding of trailer fees – establish a service-level agreement regarding trailer fees at account opening

“Furthermore, IFIC believes that vigorous and coordinated compliance reviews of the current
rules combined with the strategic use of enforcement action in appropriate cases has proven to
be an effective deterrent to misbehaviour,” the group said.

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