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Ban trailer fees and mutual fund costs will drop, CSA report says

A Bay Street sign is pictured in Toronto’s financial district.


New mutual fund companies with lower-cost products are expected to come to Canada if regulators move ahead with proposals to ban trailer fees in Canada, according to a new report from provincial securities regulators.

The Canadian Securities Administrators, an umbrella group for provincial securities commissions, released a long-promised report Tuesday on mutual fund fee reform, outlining a host of potentially positive impacts that could emerge if regulators proceed with proposals to ban the use of all embedded commissions, including trailer fees paid by fund companies to financial advisers who recommend their products.

The report predicts new mutual fund players will emerge in Canada offering lower-cost mutual funds, including both actively managed funds and passive funds tracking indexes. Based on experiences in other countries, the CSA estimates management expense ratios (MERs) for index funds offered by new market entrants could be up to 40 basis points lower than average index fund costs today, while MERs for new actively managed funds could be up to 75 basis points lower. (One percentage point is 100 basis points.)

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The report also predicts existing mutual funds would lower their costs because of increased price competition that would emerge in an environment in which financial advisers will be focused on picking the best-performing funds for clients rather than those paying the highest commissions to advisers.

It estimates that shortly after a ban, the average MER for an actively managed equity fund could decline by 25 to 50 basis points, while fees for an actively managed fixed-income fund could fall by 10 to 25 basis points.

The rosy picture painted by regulators in the new report stands in contrast to gloomy predictions offered by industry representatives, who have opposed banning commissions. They argue a ban will raise costs for investors who will have to pay directly for advice, and will force disruption on the industry with no evidence clients will be better off.

Regulators have not yet committed to a ban, but are clearly moving closer to taking the step, asking for public and industry input on their latest report by June 9. The report strongly advocates for the merits of an outright ban and details a host of concerns with the use of trailer fees and similar commissions, arguing they create a conflict of interest for financial advisers.

Although regulators launched their review of embedded commissions in 2012 and have already consulted broadly on the issue, Ontario Securities Commission chair Maureen Jensen said Tuesday's report is a final consultation asking more specifically for comment on the practical issues in moving forward with a ban. If regulators proceed, the next step would be a proposed new rule, which Ms. Jensen hopes would be out for comment within a year.

She said she agrees with the report's conclusions that a ban on embedded commissions should drive MERs lower in Canada.

"Our fees are the highest in the world," she said. "There are a lot of funds like Vanguard and others that have passive investment funds with MERs that are quite low, but they just don't get traction because they don't pay trailers or embedded fees. So there's no incentive to sell them, even if they would be appropriate and suitable for the client's portfolio."

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The report predicts investors would pull out of many existing mutual funds that are below-average performers if a commission ban led advisers to recommend funds based solely on their performance.

It predicts 44 per cent of actively managed mutual fund assets in Canada "may experience redemption and reallocation pressure" over time if they were not able to adjust their fees or improve their performance.

The Portfolio Management Association of Canada, which represents companies that manage large portfolios funds on behalf of clients such as pension plans or foundations, was quick to support the report's findings Tuesday, saying investors are best served when there is up-front transparency about the fees they are paying.

The Investment Funds Institute of Canada, which is the voice of Canada's mutual fund industry, had no immediate comment on the report. IFIC issued a statement last week saying there is no justification for banning embedded fees and arguing harmful conflicts of interest are already prohibited under existing rules.

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