While CSA hasn’t yet decided to ban embedded commissions, it has mapped out how it’d do so in great detail.

The focus of CSA’s long-anticipated consultation paper is not surprising: it says embedded commissions create inefficient markets and give rise to conflicts of interest that misalign the interests of investment fund managers, dealers and representatives with those of the investors they serve.”

The paper released Tuesday also says that such commissions “generally do not align with the services provided to investors,” and that DIY and underserved investors “indirectly subsidize certain dealer compensation costs that are not attributable to their investment in the fund, which means they indirectly pay excess fees.”

While it had considered capping embedded compensation, enhancing disclosure and using fund manager-focused initiatives, CSA ultimately offers three regulatory options to address its concerns about commissions:

  1. using existing tools, namely enhanced transparency of fund fees under POS and CRM2, and review of sales incentives under NI 81-105 Mutual Fund Sales Practices (NI 81-105);
  2. exploring the CSA 33-404 proposals to strengthen the obligations of dealers and reps toward clients; and
  3. discontinuing embedded commissions and transitioning to direct pay arrangements.

Direct pay arrangements could include “upfront commissions, flat fees, hourly fees, fees based on a percentage of assets under administration or other arrangements.”

Trailing commissions are the most popular form of compensation for mutual funds. CSA finds that at the end of 2015, back-end, low load, front end, and retail no load funds made up 67% of assets and increased by 58% over the five years ending 2015.

On the other hand, fee-based options were only 6% of industry assets at the end of 2015, but “fee-based assets had the highest rate of increase over the five years ending 2015, increasing by 248%.”

6 benefits of axing commissions

CSA outlines six benefits to eliminating embedded commissions.

  1. Reducing the number of fund series and simplifying fees.

Citing Morningstar, CSA says eliminating commissions would cause the number of fund series to fall from 13,899 to 4,901 – a 65% decline. At the same time, average assets per fund series would rise from $86.6 million to $245.5 million, creating potential economies of scale.

  1. New lower-cost product providers may enter the market

Eliminating commissions would reduce barriers to entry, says CSA. The paper estimates MERs for index funds offered by new entrants could be up to 40 bps lower than average index fund costs today. It also suggests MERs for active funds offered by new entrants could be up to 75 bps lower than average actively managed fund costs today.

  1. Increased price competition

CSA says that more competition could cause MERs to drop 25 bps to 50 bps for actively managed equity funds and 10 bps to 25 bps for actively managed fixed income funds shortly after the discontinuation of embedded commissions. “This estimate is based on incumbent investment fund managers reducing their existing fees by one third to two thirds of the difference between their fees and those charged by new low-cost market entrants,” says CSA.

  1. Advisors would start recommending lower-cost and passive products

Based on what happened after the commissions ban in the U.K., CSA expects index fund market share to increase from 1.5% of the market to between 5% and 10% five years after the transition away from embedded commissions.

  1. Shift in assets across existing investment fund managers

CSA points out that funds with negative alpha and poor performance records would be under further risk if commissions are banned. In fact, the paper says, “87% of investment fund managers offering actively managed funds today have some funds with negative alphas, which could be at risk of redemption if embedded commissions were discontinued and these managers were not able to adjust their fees or improve performance.”

  1. Product distribution and advice would improve

Specifically, CSA posits that more advisors would become discretionary managers, and more clients would demand such services. To show their value, advisors will need to “show the client that the use of discretionary advice creates a savings discipline, simplifies their life and frees up their time,” suggests the paper.

Addressing concerns

The comment paper recognizes several issues that would arise with a commission ban. Among them:

Regulatory arbitrage: CSA recognizes that advisors who sell non-securities products, like segregated funds, could potentially put clients in funds that are still allowed to pay commissions. As such, CSA says it “will accordingly continue to liaise with insurance regulators to address the potential risk of regulatory arbitrage between investment funds and individual segregated funds.”

Advice gap: CSA acknowledges that lower-asset investors could be discouraged “from seeking financial advice, particularly where they are indirectly paying for, but are not receiving, [quality] advice […] as they may be unwilling to pay a fee for such advice.” But, it suggests that robo advisors could fill the gap.

Pressures on independent firms: A ban on embedded commission would create expenses, new processes and revenue loss. This will particularly affect independent firms, CSA says. But it points out this is already an issue. “This may already become a trend to a certain degree with the introduction of the annual report on charges and other compensation (CRM2), whether or not embedded commissions are discontinued.”

What could happen

CSA offers two options for implementing a commission ban.

Option 1: Discontinue all embedded commission payments within a 36-month transition period after the ban takes effect. Advisors could no longer sell DSC funds after the transition period is over.

Option 2: An alternate option could be to transition to direct pay arrangements in phases, by phasing in a dealers’ account base over multiple periods, CSA says. This approach would require dealers to transition a certain percentage of accounts by a certain date, a further percentage by a later date, and so on until all accounts have fully transitioned. It also suggests a 36-month transition period.

CSA is open to hearing about longer or shorter transition periods.

Want to comment?

Submit your comments in writing on or before June 9, 2017 to:

The Secretary
Ontario Securities Commission
20 Queen Street West
19th Floor, Box 55
Toronto, Ontario M5H 3S8
Fax: 416-593-2318

Me Anne-Marie Beaudoin
Corporate Secretary
Autorité des marchés financiers
800, square Victoria, 22e étage
C.P. 246, tour de la Bourse
Montréal (Québec) H4Z 1G3
Fax : 514-864-6381

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If I’m “forced” to convert to fee based, my income will probably double. Who’s better off in that case? Thanks CSA!

Tuesday, Jan 31, 2017 at 4:03 pm Reply

Maurice Matte BBA

I agree with John Brown.

The CSA and it’s regulatory affiliates are, unfortunately, deficient in understanding the effects of ending all trailing fees for all Canadians. This “Ivory Tower” mindset completely loses track of the notion that the overwhelming majority of Canadians desire to be served by human beings, not “Robo advisors”. The average Canadian requires much hand-holding (carefully managed on-going supervision and guidance) by a qualified professional “human” advisor in order to adequately meet their long-term needs. A 100% fee-based model will eliminate vast segments of the Canadian population from receiving the professional advice they require. Unfortunately, the end result will be a continued shift in wealth from the lower and middle classes to the wealthy. Very unfortunate consequence of the CSA’s professed actions.

Robo advisors have no interest in the long-term success and happiness of their “clients”. Robo advisors will exist for one purpose: “To maximize the profits of the companies they represent”. Robo advisors by definition (and basic limitation) have no empathy for people and no ability to connect on a very fundamental human level. It’s unfortunate to see the CSA seems to be completely comfortable assigning massive segment of Canadians to being served in this manner. How sad! What short-sighted behaviour.

A further major problem arises from the CSA notion that self-managed portfolios and ETF-type funds will somehow enhance the value of investments and general financial advice for Canadians. In such a complex world as global investments, this notion is akin to the Surgeon General recommending that Canadians perform their own surgeries. Insanity. The self-managed/ETF model of investments completely precludes the notion that there are other (non investment) discussions which take place between Canadian clients and their advisors which dramatically benefit Canadians financially. Discussions about debt, cash flow management, career decisions, TFSA vs RRSP, early retirement, education, etc etc etc will not likely be happening with many people in the lower and middle classes of society (as we all realize would happen in a world where every minute of time is being billed). The majority of those portions of society cannot afford direct billing in that manner. The lower and middle classes are the very segments of society which require the most financial guidance. Those segments of society make up the majority of all Canadians by a large margin (by maybe 10 to 1). Why would the CSA directly/indirectly target such a group and relegate them to little or no “real” advice?

The notion of eliminating the DSC portion of embedded commissions does have some merit, but throwing out the entire trailer fee model in the process is throwing out the good with the bad. Front End “0” fee offers the lower and middle classes the opportunity to stay in the game. The elimination of such options will be akin to making those lower classes of society pay for even more of the transfer of their money to the wealthy. They require help making good financial decisions but without real people to guide them those Canadians will fall through the cracks in the system. Is this the goal of the CSA?

If the CSA and it’s affiliated governing agencies desire to lower costs and increase transparency, then why don’t they simply do just that? DSC fees are a major contributor to higher MERs, consequently, their elimination will directly reduce MERs but this doesn’t mean the trailing portion of fees has to be eliminated too.

In addition, if the CSA does desire to reduce the use of negative alpha funds then it should look to formulate some sort of implication for fund companies which offer the sale of negative alpha funds which exhibit poor performance for extended periods of time. Those fund companies with perennial under-performers should be made to make fund consolidations, management changes, or fund closures if it can be proven they provide no consumer value (a much more detailed discussion than can be had here). So, CSA, the notion here is to advise you to address your appropriate concerns regarding fund performance directly with the fund provider…not in such a convoluted manner through the advisor channel. This is akin to charging Ma & Pa retail gasoline stations for crimes committed by refineries. CSA should look to address problems where they actually reside: at the manufacturer level.

In order to achieve the best results for Canadians with the least potential for extreme negative effects on society, my recommendation to the CSA is simple:

1.) Stage out DSC fees over a period of time
2.) Retain embedded trailing fees
3.) Develop a strategy to address failed/failing fund mandates.
4.) Improve fee communication (like CRM2 as is being done)
5.) Observe this system over the coming decade, record results, and refine.

Hopefully some of these ideas resonate with you.

Respectfully submitted.

Monday, Jan 16, 2017 at 2:45 pm Reply


Are you kidding?
They have quoted previous cases of ending embedded fees and had open discussions over the past three years. I doubt there is anything that will change their decision in this 150 days. It is too bad that actual advisors or those that really work in the field of advice are not on this committee that is going to make a decision to effect so many careers and lives. I understand a number of those advisors that have switched to fee based advice are also actually making more income now so it is not the cost nor going to change any unethical practices, just make it harder for the little guy to get help. It is always about the money not what you do for others.

Friday, Jan 13, 2017 at 10:45 am Reply