At some point after July of 2016, when investors open their account statements, they will see the result of new rules requiring investment and mutual fund dealers to report annually in writing to clients about the cost and performance of their investments.
The changes are part of the Canadian Securities Administrators' Client Relationship Model, Phase 2, or CRM2. Of the two reports, the one outlining fees and commissions is expected to get the biggest response.
"There's going to be some sticker shock," says Tom Bradley, co-founder of low-fee mutual fund firm Steadyhand Investment Funds Inc. and former chief executive officer of Phillips, Hager & North.
"We might have a million free agents, investors [who] have seen what they're paying compared to what they're getting and are looking somewhere else," Mr. Bradley says. "It's potentially quite a big deal."
The performance numbers – to be spelled out both in dollar and percentage terms – will strip out all costs to the client. For mutual funds, this includes the management expense ratio (MER) as well as transaction and administrative fees. The net number will then be compared to the relevant benchmark. The common practice now is simply to subtract the MER.
Dealers must also provide statements showing all commissions and fees paid to or charged by the dealer. This number will not include fees paid to mutual fund managers, but will show embedded commissions, or trailer fees, which typically comprise about half a fund's posted MER, according to Dan Hallett, a vice-president and principal of HighView Financial Group, a Toronto-based investment counselling firm.
Trailer fees are what most mutual fund companies pay to dealers to cover the cost of client service for as long as the client holds a fund.
But Neil Gross, a securities lawyer and executive director of FAIR Canada (Canadian Foundation for Advancement of Investor Rights), says more astute investors stand to benefit most from the new rules. Less astute ones "will benefit if the format is one that makes the information accessible," Mr. Gross says. "If it's impenetrable, they won't be able to dig the information out."
For people with little understanding about investments, the new rules won't make a big difference, Mr. Gross says. "To the extent they may be taken advantage of, the only thing that would benefit them is imposing a best-interests standard."
Perhaps the strongest argument many in the industry mount against CRM2 is that the changes could hurt small investors, who they say benefit from the advice given by their sales reps. While investors with larger portfolios could opt for a fee-only arrangement, either within their dealer or with an investment counsel, small investors who balk at the fees they are paying would have fewer choices.
That assumes the industry will not find lower-cost ways to serve clients, Mr. Gross says. But banks have been innovative in the past and they have both the reach and the technology. Already, a number of mutual fund companies have pared their fees and some have introduced Series D funds for do-it-yourself investors. These funds strip out embedded commissions.
"The real question is whether firms have already developed contingency plans that they will implement or not, depending on the shift," Mr. Gross says
Ken Kivenko, a retired engineer and investor advocate, agrees. "The banks will find a way to make money somehow," he says. "The big gainers will be the bank-owned funds and brokers, the losers will be the independents."
Changes are already afoot. For example, the Mutual Fund Dealers Association of Canada is looking for ways to make it easier for sales reps to sell lower-fee exchange-traded funds (ETFs) by raising proficiency standards. This would include salaried reps at bank branches. If this comes to pass, small investors would have a low-cost alternative to mutual funds at their local bank branch.
The shifting landscape, with its increased fee transparency, as well as changing business model, could see investors moving to ETFs, as well as low-fee mutual funds offered by firms such as Steadyhand, Mawer Investment Management and Leith Wheeler, in search of better value. So far, ETFs have been slow to catch on in Canada. Mutual fund and ETF assets together total slightly more than $1-trillion, with ETFs consisting of a mere 6 per cent, industry statistics show. ETFs and low-fee funds could be helped further if clients flee high-cost dealers in favour of so-called robo-advisers, online firms that offer computerized portfolio management using various funds.
The industry will be watching closely. "My guess is it won't require a stampede for some of the players to reassess what they're doing," Mr. Gross says. Responses could vary, with dealers cutting some fees and services while expanding others. "Even as little as a 5-per-cent shift would cause them to seriously re-examine their position. … It won't take much to positively affect the outcome for consumers."
Unfortunately, the new rules do not apply to the insurance industry and its segregated funds or to bank products such as index-linked notes and guaranteed investment certificates. Both products have been criticized for their hidden costs.
Looking past CRM2
Will regulators stop at CRM2, or will they press ahead with even more reforms? Other changes are being seriously considered, Mr. Hallett says. Dealers are strenuously opposed.
One is doing away with trailer commissions entirely, as Britain and Australia have done. Embedded commissions pose two problems. First, they put commissioned sales reps in a conflict of interest with their clients. The reps may be reluctant to recommend low-fee mutual funds, which pay no embedded commission, or exchange-traded funds, very few of which pay a commission.
Another problem with trailer commissions is that clients may not get the advice and service they are paying for, especially if they are buying through a discount or online broker.
The second big change regulators are mulling is even more controversial: Imposing a best interests standard on sales reps, which means they would be required by law to put their clients' interests first. This "fiduciary standard," as it is called, is under serious consideration in the United States, but only for people giving advice on retirement accounts. On Monday, U.S. President Barak Obama put forward a plan to reduce conflicts of interest and hidden fees that the Labor Department says cost Americans billions of dollars in lost retirement savings.
While it's not clear how the best interests standard would work in Canada, it's worth noting that Britain and the European Union already impose a qualified best interests standard on advisers. In Britain, for example, securities firms are required to "act honestly, fairly and professionally in accordance with the bests interests of (their) clients," according to a 2012 discussion paper by the Canadian Securities Administrators.
While Mr. Hallett gives regulators credit for pushing forward with the rules, "What I think would have been more helpful is providing a rough estimate of total cost [including manager fees] because that is a more all-encompassing figure," he says.
Investors, take note:
Ken Kivenko, a retired engineer and investor advocate, cautions investors about these issues, leading up to the Canadian Securities Administrators' Client Relationship Model, Phase 2, or CRM2, which comes fully into effect July of 2016:
1. An attempt by dealer representatives to sell banking or insurance products, such as segregated funds, and so bypass the stricter rules governing the sale of securities.
2. A sales pitch that promotes a fee-based account, thereby converting commissions into fees and possibly costing more.
3. Once investors get fuller disclosure, they will have less of an argument if a dispute arises. Investors should take the time to read and understand the information provided.
4. Remember that CRM deals mainly with disclosure. It does not require sales reps to act in investors' best interests. It's still caveat emptor, but investors will be better informed.