Reader alert: This is part one of a three part series.
How is Distribution evolving, and what are the forces at play in this evolution? Will managing general agents (MGAs) get their own self-regulatory organization? Does the Mutual Fund Dealers Association (MFDA), and the distribution model it oversees, have a future? Is there a place for smaller players in the emerging landscape, or does the writing on the wall say only big guns need apply? What does the evolution of the distribution space mean for advisors, and the clients whom they serve?
These are the questions we posed to a group of industry leaders for a Big Questions series, which ran through the May issue of Advisor’s Edge Report and in conjuction with our annual Distributors’ Summit.
We spoke to:
- Terri DiFlorio, President, Hub Financial Inc.
- Chris S. Reynolds,President and CEO, Investment Planning Counsel Inc.
- David Velanoff, President and CEO, MGI Financial Inc.
1. What direction is distribution taking?
Terri DiFlorio: On the mutual fund side, in some instances it’s evolved to a place where there are rules for the sake of having rules, and bureaucracy for the sake of bureaucracy. On the insurance side we’re struggling with a completely opposite perspective. As a recent Canadian Council of Insurance Regulators (CCIR) paper makes clear, there hasn’t been a lot of regulation on MGAs. From a HUB perspective, we’ve been very diligent in the business we’ve done on both sides, and we’ve got our own compliance regime in place, and are very comfortable in our position for the future. But the CCIR paper is accurate when they state that there really haven’t been
regulation or compliance requirements on MGAs.
From what I’ve seen, [the regulatory overreach on the mutual fund side has] peaked, and there’s some backlash now. Certainly at the meetings I attend, participants seem a lot more willing to push back at the MFDA. And giving credit where it’s due, the MFDA seems a lot more willing to listen to those comments now. In the first few MFDA meetings I attended they sat at the front and said, ‘This is the way it is,’ and dealers shook their heads and left the room. It appears to be a lot more of a conversation now.
Chris Reynolds: The trend of merger-acquisition or consolidation is definitely going to continue. If it was unprofitable five years ago, it’s even more unprofitable today. You need to be a survivor in this business, and over the next five-to-ten years, you’ll need two things. One is size, and leverage off that size. Number two, you need to participate in the margins generated through manufacturing. So you have to have both sides of the equation. In my opinion you can’t be just a single-line distributor in the Canadian marketplace.
David Velanoff: I believe it’ll go back to proprietary product and service platforms but it won’t happen overnight. The only place for advisors to go will essentially be the large, well-capitalized organizations with manufacturing and distribution. They will have the power to limit the product shelf solely to their own product, or to their own product plus those of competitors who sell significant amounts of their product.
The next stage will involve fully integrated firms cutting each other out. They’ll say, ‘We have enough product,’ and you go right back to the old days, though I’ll suggest some key differences later.
Another evolution will see financial planning and investment advice becoming two separate disciplines. You’ll be licensed to do both, but you’ll be forced to choose one, as both are too complex and sophisticated. Investment advice is very sophisticated now with the required computer systems and the amount of resources needed to compete. I don’t think financial advisors are going to be able to cope with that in the future. The financial advisor will either choose to be a financial planning advisor or he or she will work in an Investment Counsel-type of operation and provide professional investment advice that ties into the financial plan.
Another change has to do with back office. Current back-office platforms are vulnerable because discount brokerage platforms have become easier for clients to use. As technology and forward-thinking management evolve, you will see the current dealer back-office systems and infrastructure crumbling — they just won’t be needed. Clients can get a separate financial plan, receive investment advice and execute stock, bond and mutual fund trades online at a discounted rate, or they can deal directly with an investment counsel service.
2. What is the biggest threat to the current distribution model?
Terri DiFlorio: For some smaller dealerships with limited resources, it’s probably going to be extremely difficult to shoulder the regulatory or compliance burden, and [to obtain] the resources necessary to do a good job there.
That will also come to bear on the insurance side as more comes out of the CCIR paper. There are some smaller entities in the MGA world that perhaps don’t have a niche focus, or don’t have the boutique-type shop, and have one or two insurance MGA contracts. I think they will find it very, very difficult to operate with the technology and the compliance resources that will be necessary going forward.
Chris Reynolds: The biggest threat is the dysfunctionality of the whole distribution model. From an advisor’s point of view, the objective is to get the distributor to pay the highest possible amounts of commission and provide them with the greatest amount of services. The distributor’s objective is to pay advisors the lowest amount of commission with the least amount of services.
That dysfunctionality causes a constant squeezing of everybody’s margins. In other words, advisors have to do way more than they ever had to do five or 10 years ago. The dealer has to do and take responsibility for way more, and yet the economic model hasn’t changed in 25 years.
David Velanoff: Here are three: margins, capital and risk. If you’re tied to a manufacturing arm you have margin and can afford risk, assuming the manufacturing arm is mature enough. Manufacturers’ margins are decreasing, because there’s pressure on them to reduce their MERs and other factors; therefore we will see the need for bundling distribution and manufacturing as a key solution.
3. What happens to MFDA dealers if their regulator is shut down or merged into IIROC?
Terri DiFlorio: It makes sense for there not to be multiple regulators that are duplicating their efforts. But there’s something to be said for having your regulator really understand the industry. There’s certainly something to be said for the expertise at the MFDA. It’s a tough question.
It’s not necessarily a win or a loss, and I think it’s a decision that has to be made very carefully. The devil you know is usually better than the devil you don’t know. I’m pretty comfortable with the relationships we’ve formed as a dealership with the MFDA, and that’s not something I would give up lightly.
Chris Reynolds: The MFDA is just another regulator. At the end of the day, they have a job to do, and whether it’s the MFDA, IIROC, or whatever other organization, their job is to put rules in place that protect the investing public. It’s our job to adhere to those rules and make sure that everyone else does.
Would it make much of a difference if the MFDA folded? Not really. It would just be one regulator over another regulator. Would the rules and the oversight be different? Probably.
At the end of the day, we’ve had to adapt as an industry to a constant barrage of new rules, but they are seemingly in the best interest of the investing consumer. So it is incumbent upon us as a company and as an industry to institute those rules, and make sure the investing public is safe.
I’m not one to sit and complain. If there’s something we’re not comfortable with, we have the opportunity to make our thoughts known.
David Velanoff: Dealers will either upgrade, be sold in advance and/or shut down. MFDA dealers will definitely have warning — it won’t happen overnight. They’ll have to decide if they want to move towards a securities dealer platform; or they’ll decide that they just don’t want to go through the process of getting the licences, enhanced capital requirements, proficiency and compliance, so they will sell. Others will wait too long and they’ll just be shut down.
I don’t see this happening until most MFDA dealers are sold to firms with an IIROC platform. I think it’s going to happen by evolution, not revolution. It’ll just be a natural thing when the regulators see there is hardly a need for the MFDA because there’s nobody left to regulate.
This is more than five years away. Some think it’s going to be tomorrow, but I just can’t see it. The insurance companies are too strong and they are really supporting the MFDA side. But it will also depend on how quickly the current dealers on the MFDA side sell their businesses.
4. What are the biggest barriers to effective distribution?
Terri DiFlorio: On the insurance side the biggest barrier will be the evolution over the next little while. The insurance industry is now going through what the mutual fund world went through a long time ago. I always tell people HUB Financial was very lucky to enter the mutual fund world after it changed drastically — after the MFDA already existed and a lot of the requirements were put in place.
As a result, we were able to build our dealership understanding what the requirements were and what we had to do to be in the business for the long term. If anything, it was easier for us because the expectations and rules were laid out, and we were able to set up our dealership with that in mind. We’ve got a pretty efficient system in place and it works well for us.
Chris Reynolds: The biggest barrier is, bluntly, the lack of any economic alignment. As I said, it’s a business model that’s marginally profitable at best. If it’s a marginally profitable business, how do you possibly raise enough cash to reinvest into your business to make it better?
David Velanoff: The ones I mentioned: margins, capital and risk. There’s so little margin in our business no matter how efficiently you run it. If something goes wrong, you automatically have to put up capital to offset the risk, and unless you have a strategic reason for existing, like the manufacturing arm, you start to scratch your head and ask yourself what you’re doing this for.
5. What changes would help you serve both advisors and the investing public better?
Terri DiFlorio: If I could wave my magic wand I’d love to have the ability to overlay more common sense and logic in the rules-based environment.
It’s sometimes very difficult to operate in both [the insurance and mutual fund] environments because they are so very different — from a regulator perspective, but also from a processing perspective. In terms of technology, the mutual fund world is absolutely light-years ahead of the
It makes it so much easier for us to recognize economies of scale and to make sure we’re using technology to the best of our abilities. That obviously translates into better service for the advisors, which means better service for the investing public. So the changes I would make are probably already underway in the two areas of financial service, and coming together to a happier medium for both.
Chris Reynolds: The most important person in this value equation is the advisor. The advisor is the face to the public, the one who holds their hands. They’re the ones who provide the entire realm of what I describe as the value of advice. The conduit, or how they get paid, is through the selling of various products, whether it’s mutual funds, insurance, or whatever. But in this particular case we’re talking about mutual funds. The company that’s put between the manufacturer and the advisor is the dealer. And over time, more and more responsibility has been downloaded onto the dealer for the behaviour of the advisors, when the value creation is at the manufacturing level. There has to be much better co-operation between the manufacturing and the distribution levels.
David Velanoff: Education will be a catalyst for change. We need to move to a university model, similar to lawyers, accountants and doctors. Providing financial planning and investment advice is a profession and it has to be sanctioned by a higher educational platform.
This would mean most people would be hired on salary, at good wages with bonuses and share-purchase plans. The big, well-capitalized players in the industry will hire them.
This is pretty radical, but I think the banks can certainly make it happen, and the other big players will eventually fall into line because it makes a lot of sense from a margin and valuation perspective, and also from the point of view of doing the right thing for the client. The client is going to get better financial and investment advice because there will be no conflict of interest in terms of an advisor needing to be compensated by commission.