Stay tuned over the next few days, as Advisor.ca summarizes the comments on CSA’s proposal to ban embedded commissions. Today, we look at industry associations IFIC and Advocis.
IFIC opposes to the ban, saying it won’t eliminate other compensation conflicts and is a disproportionate response to the potential harms identified by CSA.
For instance, IFIC notes in its comment letter that the proposal offers no evidence that fee-based arrangements result in fewer conflicts.
“Research by Cumming et al. provides evidence of the effect of embedded commissions on the mutual fund market but cannot answer the question as to whether fee-based or commission-based remuneration is better for individual investors,” says IFIC.
Further, “CSA, IIROC and MFDA sales practice compliance reviews, while finding some instances of non-compliance, provide no support for widespread non-compliance with registrants’ duties.”
Advocis comments that no compensation scheme is behaviourally neutral.
“We have recently seen an outcry in popular media against the questionable sales techniques of employees at large, vertically integrated firms [incentivized] by proprietary product sales targets and the constant threat of dismissal for failure to hit revenue targets,” says the association for financial advisors. “Yet the elimination of commissions would suffocate the independent channel that competes with — and counter-balances the influence of — vertical firms, and it would give even more leverage to the latter.”
In response to potential harm from embedded commissions, IFIC cites Morningstar research that disputes the claim that Canada has some of the highest mutual fund fees worldwide. That research shows that an appropriate comparison of U.S. and Canadian fees, for instance, must include the cost of advice and federal and provincial tax.
Further, IFIC claims CRM2 and Fund Facts have made embedded commissions transparent, with the reforms raising investor awareness of direct mutual fund fees to 76% (from 67%) and of indirect fees to 59% (from 48%).
But, regardless, IFIC argues that not all investors need to understand their fees to curb potential misbehaviour from conflicted compensation. The institute cites PwC research showing that, where a market is characterized by asymmetrical information, only a subset of all consumers need to be informed to create an effective deterrence that discourages registrant abuse of less well-informed investors.
“We believe the costs disclosure can be improved by including the fund company’s management expenses in the annual cost report,” adds IFIC. “We will work with the CSA to implement this change.”
IFIC provides research to support its view that an advice gap could result from the proposal, potentially affecting millions of mass-market households. The gap would be particularly stark in Canada, it says, because Canadians hold more investment funds as a percentage of total financial assets than any other country in the OECD.
“Countries that have chosen to ban embedded commissions — the Netherlands, the U.K. and Australia — rank 27th, 28th and 32nd respectively,” says IFIC. Further adding to the gap, the proposal applies only to investment funds, not across the whole financial sector, as is the case for the three countries with bans.
“Those who could potentially be deprived of access to financial advice following the ban on embedded commissions would accumulate, on average, $240,000 less in savings prior to retirement than those with access to advice,” says IFIC, citing research.
Advocis agrees, saying “the elimination of commissions by regulatory fiat would cripple the ability of low- and middle-income consumers to access financial advice.”
IFIC provides its own solution to conflicted compensation, including capping or standardizing embedded fees, and disclosing the full MER. The institute also provides research on how to improve disclosure and how to measure investor outcomes beyond the terms of the proposal, which focuses only on product cost and compensation for outperformance. “While these are important,” says IFIC, “investors also need to measure progress relative to specific financial goals.”
Advocis agrees, saying the CSA must look beyond alpha (i.e., returns) and beta (i.e., portfolio construction and asset allocation).
“The value of advice is about gamma, the ability of an advisor to transform clients’ ingrained savings apathy toward a forward-looking mindset of long-term investments. […] Changing clients’ predilections is an extraordinarily difficult task that the vast majority of investors cannot achieve alone,” says the association.
Advocis suggests subjecting advisors to a duty to act in clients’ best interests. (Update, June 15: In an email, Advocis clarified that this duty would be part of “self-regulated standards” in an effort to “elevate financial advice to a profession.”)
“By raising proficiency standards across the board and re-aligning the regulation of advice so that it accords with the modern consumer’s perspective, we could solve more consumer protection issues, more dynamically and effectively, than prescriptive regulation ever could.”