CRM2 is officially old news—specifically for MFDA advisors, since the SRO last week published a discussion paper on disclosing total fund costs to clients.
The paper isn’t a surprise, as the MFDA has been considering expanded cost disclosure the last few years, in tandem with CRM2 changes. (An initial consultation paper was published in December 2015.) The SRO aims to ensure clients have a “complete and accurate understanding” of the total costs of investing so they can make informed choices, says the paper.
Adding to CRM2 disclosure, additional costs to potentially disclose include portfolio management fees, fund operation expenses and transaction fees. (These fees are paid to either investment managers or other third parties—not to dealers.)
Edwin Pavey, regional director at Investors Group in Barrie, Ont., supports total cost reporting as a positive development for clients—provided advisors take the time to walk clients through those costs. He dismisses the idea that expanded reporting would overburden advisors, though its success could depend on them. Capable advisors know how to effectively conduct review meetings and walk clients through statements, he says. Further, advisors are adept—or should be adept—at explaining costs relative to value provided, he says.
His firm has already been considering full reporting in anticipation of increased regulatory requirements and a potential ban on embedded commissions. “We still may get there before the MFDA comes out with its position,” he says. For example, the firm is moving toward offering all funds in unbundled series, with management expense ratios (MERs) represented separately from advisory fees, so clients can better evaluate product costs and advisory costs, he says.
Taking such a proactive approach is challenging, however. “It’s kind of a moving target, trying to anticipate what are the minimum expectations,” says Pavey, referring to potential regulatory requirements for the disclosure’s form and substance.
Still, he believes proactive firms gain a competitive advantage. “There’s a real opportunity for firms and advisors if they take the lead,” says Pavey. “Clients deserve to have a clear understanding of what they’re paying. […] It’s about providing better service and value to our clients.”
The additional disclosure would build on CRM2 transparency, and would allow investors to make cost comparisons across firms, says Pavey. Such universality serves investors and weeds out bad actors, he says.
Devil’s in the details
Uniform reporting would please Marian Passmore, director of policy and COO at FAIR Canada. But she’s not convinced that’s what the MFDA paper describes.
For example, the MFDA recommends that cost reporting be “sufficiently flexible” to reflect how compensation is paid or earned by registered firms and investment managers. And the paper offers two examples of potential cost reporting, based on members’ business models and practices. For the integrated firm example, trailing commissions aren’t listed separately from ongoing costs, since these firms earn compensation through internal transfer payments.
Passmore calls out the omission.
“We do not support that form of disclosure because it is not telling investors how much that dealer is getting paid to keep them invested in those funds,” she says. Further, investors wouldn’t be able to effectively compare trailing commissions between integrated firms and firms using third-party funds, she says.
Standardized reporting would be ideal, she says, since presentation affects client understanding. Information quality is more important than quantity, she adds.
The paper says more integrated firms are moving toward total cost reporting, as is the case with Pavey’s firm.
Bernard Pinsky, a partner at Clark Wilson in Vancouver, is also concerned about reporting quality—especially since the added disclosure will come at a cost. It’s worth considering whether clients want to see costs, like those for transactions, enumerated, he says. So long as clients know total costs, he says, “is there a real appetite among investors to have a [cost] breakdown?”
Further, increased costs for dealers can push clients toward low-cost brokers, he says, resulting in clients missing out on advice.
Similarly, Rebecca Cowdery, a partner at BLG in Toronto, is concerned about reporting complexity. She says reporting should be “relatively simple” and “useful for investors.” She questions whether the disclosure examples in the MFDA paper fit the bill, calling them “too complicated,” and not easily digested by investors. If disclosure is ultimately left unread, then it comes at a cost but with little benefit, she says.
Cowdery says the end game is an industry reporting standard that’s not cost prohibitive for dealers. With expanded reporting focused on fees paid to third parties, specifically investment managers, the paper “may reopen discussions about sharing of expenses and the costs of producing these reports,” she says.
Pavey notes the risk of increased client confusion, since account statements can already be multiple pages, and present a challenge to many clients. And CRM2 reporting may have further confused clients, he adds.
Since the implementation of CRM2, there has been an improvement in awareness of trailing commissions, the BCSC’s CRM2 study found: 41% said they agreed at least partly with a statement saying they knew about the fees, up from 34% in 2016 (net agreement increased to 9% from 0%).
Any changes to disclosure should be fully tested with investors before implementation to ensure its effectiveness, urges Passmore.
Further, a potential best interest standard, still live in Ontario and N.B., and a ban on embedded commissions proposed by the Canadian Securities Administrators (CSA) would affect disclosure, so the timing of the paper isn’t ideal, says Passmore. “The reporting of advice costs would be much simplified if you removed trailing commissions from the equation,” she says. (The paper acknowledges that a ban on embedded commissions would impact reporting requirements, but not the determination of including ongoing costs of fund ownership in reporting.)
Language used to describe costs should also be standardized to improve investor understanding, says Passmore. When assessing CRM2 disclosure, the MFDA found that some firms used different terms for trailing commissions, which impedes clients’ ability to make comparisons between firms.
And, not to ignore controversy over embedded commissions, Passmore calls out regulators for having no specific requirement to provide advice in turn for trailing commissions. (However, IIROC issued recent guidance for brokers to offer only funds without trailing commissions whenever possible and to otherwise rebate to the client those commissions.)
A closer look at the discussion paper
Any proposal to expand cost reporting would require CSA to make amendments to NI 31-103, notes the MFDA in the paper. However, the SRO provides evidence for why it’s leading the charge on charges: “As 96% of MFDA members’ assets under administration are held in investment funds and 56% of households in Canada are serviced by MFDA members, cost transparency for retail mutual fund investors is of particular importance to us.”
Expanded cost disclosure would apply to mutual funds, as well as ETFs, labour sponsored funds and commodity pools.
Costs to be potentially disclosed include:
- ongoing costs—such as management fees and fund operating expenses; currently, only trailing commissions must be disclosed on the report on charges and other compensation (RCC), as stipulated by CRM2
- transaction costs—such as redemption fees and trading fees, which are paid to the fund; and account administration fees, such as custodial fees, which are paid to third parties and taken directly from clients’ accounts
To help clients understand ongoing fund costs and total investing costs, the proposal says account statements and RCCs could be expanded. For example, MERs for each fund held by a client could be disclosed on account statements to remind clients of ongoing costs.
“Currently, clients are provided with MER information through the delivery of the Fund Facts document,” says the paper. “However, clients receive this information for each fund separately and there is no mechanism for clients to receive regular MER reporting of all their investment fund holdings.”
Transaction costs reflected on account statements should be reported and aggregated on RCCs, says the paper. RCCs would also potentially include management fees and fund operating expenses.
The proposal acknowledges the challenges to collecting and reporting these additional costs. For example, integrated firms with proprietary funds can access cost data more easily. Firms who use non-proprietary funds would require reporting from investment fund managers via Fundserv, for example. “Further development of registered firms’ back office systems would also be required to receive, aggregate and report such costs,” says the report.
The MFDA says it welcomes feedback on whether additional disclosure should be considered for other investment products.
Comments can be submitted until July 20.
Correction: A previous version of this article misstated a figure from the BCSC’s CRM2 study about trailing commissions.