The mutual fund companies that are independent from the banks want the disclosure requirements that are due to come into force on July 15, 2016 to include not only trailing commissions, but all management fees. At the heart of the problem is the fact that these fund companies pay commissions to advisors, while banks do not pay them to their employees.As part of Phase 2 of their Client Relationship Model reforms, commonly referred to in the industry as CRM2, the Canadian Securities Administrators (CSA) are requiring enhanced disclosure of investment fees. In the works since July of 2013, these reforms will come into full force on July 15, 2016.
This is the date by which firms must disclose on client statements the dollar amount of all commissions that members of the Mutual Fund Dealers Association (MFDA) have paid to the advisor. This amount is calculated for the statement period and is based on all of the client’s assets in the account. Fees that must be disclosed include trailing commissions, referral fees, and other forms of compensation.
The fund companies want to reverse this process, one which represents the final phase of amendments to National Instrument 31-103 on Registration Requirements, Exemptions and Ongoing Registrant Obligations. Concerned that similar changes will attempt to harmonize regulations and extend them to segregated funds, insurance companies are also mustering their forces.
Product suppliers in the independent advisor channel believe it is unfair that trailing commissions paid by mutual fund companies should be subject to disclosure requirements, while the full management fee ratio is not. These changes penalize investment representatives who must disclose these commissions, unlike the banks who are not required to do so because their branch distributors are salaried employees.
Mutual fund provider Invesco Canada has partnered with major competitors Fidelity Investments and Franklin Templeton Investments to meet with regulators and make them aware of the problem. As for the CSA, they prefer a full disclosure approach because it better reflects the reality of their main stakeholders, namely mutual fund representatives.
Peter Intraligi, CEO of Invesco Canada, explained his collaborative approach in a speech to the Professional Association of Financial Advisors of Quebec’s (PAFAQ) annual meeting on May 16 in Montreal. Besides addressing disclosure issues, Intraligi told the audience that there is a need to form a common front to deal with the prohibition of commissions and other issues that affect advisors, such as fiduciary duty.
Speaking with The Insurance and Investment Journal on the sidelines of the event, Intraligi said he was a strong advocate of transparency, so long as it applies equally to everyone. He indicated that he had already met with Louis Morisset, CEO of the Autorité des marchés financiers (AMF), Quebec’s financial markets regulator. He added that he would be meeting with other Canadian regulators.
AMF spokesperson Sylvain Théberge told The Insurance and Investment Journal that the regulator did meet with this group of advocates. “In this case we are considering all comments, and they will inform our thinking as a regulator,” he said.
In his presentation, Intraligi used two types funds as examples; one offered by a bank and another by a fund company, each with a management fee of 2%. The fees for a mutual fund company fund typically consist of a 1% trailing commission and another 1% fee for administrative costs, but a bank fund only has administration fees. Effective July 15, 2016, the bank funds will be said to have administration fees of 2% and 0% commission. The Harmonized Sales Tax (or Quebec sales tax) and operating costs are added to these fees.
“We are saying to the regulator this is a problem because if you have a salaried employee and he is selling your own products, there are no distribution costs to disclose. We want the fund fact sheet to have a pie chart included that would address the problem,” says Intraligi. “What we ask is, instead of just picking on the commission piece, why don’t we show the whole thing, including the management expense fees? If a dealer finds a way to disguise its payment through paying salaries and bonuses, then they’ll be exposed on the management fees side.”
Bruno Michaud, senior vice-president of administration and sales at Industrial Alliance, is concerned that this regulatory change will eventually be applied to segregated funds. This is something he would prefer to avoid, for reasons similar to those expressed by the mutual fund companies. A permanent sub-committee of members of the Canadian Life and Health Insurance Association (CLHIA) is examining the impact of regulatory changes on mutual funds. Industrial Alliance sits on this committee and Michaud notes that most insurance companies are represented on it.
“A mutual fund distributor with salaried employees who do not receive commissions from their supplier might give the impression that it has lower expenses and is less vulnerable to conflicts of interest,” comments Michaud. “If management expense ratios were equal, there would appear to be an advantage in doing business with him.”
He believes that this bias would be equally inappropriate in the segregated fund industry, and that there is a need to make regulators realize that the rules, as they stand today, would create a two-tier system. Michaud notes that the life insurance industry took the lead in disclosure by showing the client in the segregated fund prospectus the various options that are available, either with or without fees. But the subcommittee members who expressed an opinion on the July 15, 2016 regulations said they were uncomfortable with the disclosure rules as they currently stand.
Michaud believes that these regulations could end up achieving the opposite of what is intended. “The purpose of financial literacy was to make documents and financial services as simple as possible. Instead, account statements and summaries are becoming so complicated that investors no longer read them,” he says.
For the moment, the insurance industry does not know if CLHIA’s Guideline G2 on Individual Variable Insurance Contracts Relating to Segregated Funds will be changed as a result of the mutual fund regulations. The subcommittee intends to meet on this issue in September. G2 outlines the kind of documentation an insurer must provide to segregated fund customers.
While he is aware of the steps that member insurers are taking, CLHIA’s senior vice-president for Quebec, Yves Millette, emphasises that this is not a formal sub-committee of the association, but rather a members’ initiative to deal with the possibility of the CSA wanting to harmonize the rules. “This is a group that meets to carry out preparatory work,” he explained in an interview with The Insurance and Investment Journal. “They want to study segregated fund practices before taking a position on disclosure, because they differ from those prevailing in mutual funds.”
Alain Huard, vice president and regional director of sales at Invesco Canada, notes that the 2016 deadline is raising a lot of questions for advisors. “They were bowled over. Some say they are ready but others see this requirement as a wrecking ball. Those who are thinking about the possibility of switching to the management fee model know that it will mean a lot of administration for them. They are not all prepared to make the move,” he says.
“The essence of the proposed regulation is transparency. Advisors expect at least that the client will be able to see what they are paying and the breakdown between the percentage paid to the mutual fund company, the fund dealer, and the investment advisor,” comments Huard. “The bank does not allocate any percentage to the representative while its costs are just as high as those of an independent.”
As for Michaud, he has put together comparative data on the subject. For example, he points out that the fees for balanced Canadian mutual funds are comparable. Fidelity Investments offers their fund in this category with total fees of just 2.11%, second only to Scotia Bank, with 2.05%.
President of PEAK Financial Group and the PEAK Investment Services mutual fund dealer, Robert Frances prides himself on the fact he provides access to over 3,000 third-party mutual funds and that he offers no in-house products. For him, this last detail is an essential one. The bank advisor sells in-house funds and no commission will appear on the disclosure statement, but it is still possible for the bank fund to be more expensive, explains Frances.
PEAK also intends to take part in discussions with regulators, and Frances says he has sent a memo to the AMF. “We are going to recommend adjustments to the regulations,” commented Frances in an interview with The Insurance and Investment Journal. “We are telling the CSA that we still have concerns with 31-103. We are asking the CSA if one day all charges will be disclosed, and if insurers and their segregated funds will be subject to the same rules that govern mutual funds? Meanwhile our advisors will do everything in their power to explain the situation to clients.”
Frances points out that all fees have always been disclosed in the fund prospectus, but notes that the text of the proposed regulations claims that investors do not read them. “The CSA recommends that the amount of commissions be disclosed on the statement in dollars and cents but, in their research, have they have shown that doing so will produce the desired results? Those who read the prospectus are interested investors. Those who do not read it, will they read the statement instead? Will they increase their savings rate?” asks Frances.
Of course clients would like to pay less in fees, but would they invest more if fees were lower? “Often, their money is already invested. And if they invest a little less because they are confused by all this information, we are not any further ahead,” comments Frances. “It will be difficult for the advisor to explain that the $3,000 that appears on the statement does not all go into his pocket, but that he is only paid a portion of it by his firm. He also has to deduct the expenses he incurs, such as liability insurance, his office assistant, and his systems costs.”
Many advisers are incensed by the proposed changes. “The disclosure of commissions as proposed by the CSA has introduced a system of double standards,” says PAFAQ president Flavio Vani. “Mutual fund representatives must disclose all remuneration while this is not the case in other professions. Banks can give bonuses to their employees without declaring them,” points out Vani, who also owns his own financial services firm, Vani Insurance and Financial Products Inc.
“I spent 27 years building my clientèle. Pending regulations like 31-103 and 81-407 on the cost of mutual funds (possibly banning commissions) will take away its value,” he says. Vani would rather see discussions focus on the risks that advisors run in order to earn a commission. Looking for a customer is difficult, he says, and requires all of an advisor’s resources and all of his available time.
As for Leon Garneau-Jackson, vice president of sales for eastern Canada at BMO Investments, he does not understand independent advisors’ reactions. He points out that investment advisors (those with full securities licences) have long been obliged to disclose transaction costs, as are those who have chosen the management fee model, who account for about 15% of investment advisors in Canada.
As of July 15, 2014, this disclosure requirement will also apply to bonds. Up until now, it was not necessary to disclose commission information on bond sales. “Starting on July 15, this information will be disclosed to the client. Some people may have thought there were no fees. This is a big first step towards transparency,” comments Garneau-Jackson. He adds that in 2016 this requirement will apply to fully-licensed securities advisors who trade stocks.
In his opinion, banks will also be affected by the requirements that come into force in July 2016, when he says that clients of financial planners who work for banks and who offer their mutual funds will also be given information on the fees they paid. For example, bank branch customers who purchase BMO Global Asset Management products will receive information. However, Garneau Jackson does have reservations about these pending disclosures. “What is disclosed on bank statements will not be uniform from one institution to another. There will be some differences. We do not yet know exactly what we will include,” he says.
Garneau-Jackson believes that this transparency will be a good thing for independent advisors. “Many advisers will manage this situation well and benefit from it. Starting today, they have an opportunity to initiate a discussion with clients and articulate their value proposition.” However, he warns that advisors should not assume that clients are aware of that value. “Those who do nothing now will have a difficult discussion with their customers later on.” He suggests that all compensation models are good, no matter whether they are based on fees or commissions, provided they are well explained by the advisor and well understood by the client.
Manulife Financial is busy encouraging its advisors to take action, and is providing them with support to demonstrate this value proposition. “[After the 2016 deadline], the question that most consumers will ask is: ‘Am I getting high quality planning advice for the fee I pay?’ says Paul Lorentz, executive vice president and general manager of retail markets at Manulife.
“We work with our advisors as they start meeting their clients and make sure they are being very clear with them about which services they are getting for their dollars. Many advisors already do quite well in that disclosure,” he explains.
He adds that the new regulations could put pressure on fund fees. “It’s an opportunity for the industry to come up with solutions. There may be some fee reductions but it won’t be that much,” he says.
Lorentz also believes that the change could cause some advisors to switch to a fee-based model. Others might decide to sell their books of business. He believes, however, that there is still a significant demand for advisors who earn commission.
“It comes down to whether the consumers are willing to pay for the value of the advice. Those who are not comfortable with the level of fees might look for another distribution channel. But research shows that a majority of Canadians prefer embedded fees and that they are better savers when they use an advisor,” concludes Lorentz.