Will new ETF rules let MFDA advisors compete with IIROC reps?

Even though MFDA advisors can sell ETFs that qualify as 81-102 mutual fund trust units, they don’t. Why? They lack market access.

And in order to get access, they have to become IIROC-licensed.

“The stand-pat answer to MFDA advisors who have wanted to sell ETFs has been, ‘Move to the IIROC side and get licensed,’ ” says Howard Atkinson, former chair of the Canadian ETF Association and president of Horizons ETFs Management.

Further, many MFDA advisors aren’t well versed on the exchange-traded aspects of ETFs, he adds. That’s because the courses they take to get MFDA-licensed don’t offer much information on ETFs. So, these advisors likely don’t know enough to ensure the funds are suitable for clients.

But that’s about to change.

So far, one mutual fund dealer has taken steps to offer such funds to clients—Ontario-based Mandeville Wealth Services. In April 2014, the dealer launched a proprietary back-office solution to gain market access, so that it could sell eligible ETFs.

And, in June 2015, BCSC proposed an amendment to MFDA Rule 1.2. It wants MFDA advisors to get additional training before they sell anything other than traditional mutual fund investment products.

As a result, in July 2015, the MFDA released a consultation document that outlines a proposed ETF proficiency standard that would satisfy the BCSC’s proposed MFDA Rule 1.2.3.

If the rule is accepted and the MFDA’s proficiency standards are put in place, the MFDA would provide training to address the characteristics and features of ETFs, which ETFs are approved for sale by their dealerships and how ETFs will be offered through their particular dealerships. Also, the MFDA wants mutual fund dealers and advisors to understand ETF trading details, such as:

81,000 The number of registered MFDA dealers in Canada.

US$17 billion How much Canadian retail investors own in U.S.-listed ETFs.

34% of advisors who do not use ETFs blame lack of licensing.

• how market quotes are obtained for ETFs;
• the types of ETF trades that will be accepted by the MFDA;
• how trade orders are processed, and the information required for each trade accepted; and
• how evidence of trade instructions and disclosures should be maintained.

“MFDA advisors have a good grasp on how to use funds to invest, and on assembling portfolios and assessing risk,” notes Atkinson. But their firms need to teach them about the creation and redemption of ETFs versus mutual funds, and how indexed investing strategies have evolved.

Impact on MFDA firms

If ETF proficiency rules are implemented, the MFDA says that firms will be expected to “develop their own policies and procedures prior to making ETFs available to approved persons.” The MFDA has also issued internal guidance (which it wouldn’t share with Advisor’s Edge Report) to members to help them develop such policies. As well, the SRO plans to release a summary of the comments it has received on its proposed ETF proficiency consultation. In a comment letter to the MFDA, the Canadian ETF Association called for more guidance, stating firms should apply ETF proficiency rules to ensure MFDA reps are uniformly educated and regulated (see “More suggestions from CETFA”).

To educate MFDA advisors on how ETFs work, the MFDA says firms will also be expected to determine which courses advisors will need to take to meet proposed proficiency standards.

More suggestions from CETFA

In September 2015, the Canadian ETF Association responded to the MFDA’s consultation document on proficiency standards for Approved Persons selling ETFs.

The CETFA’s comment letter urges the MFDA to push mutual fund dealers to take the following steps:

• Explain how and why ETF distribution by MFDA advisors is restricted to Canadian-listed ETFs, and list what ETFs can and cannot be used by these advisors.
• Teach advisors about complex topics, such as derivatives and exposure to commodities.
• Offer more information on the creation and redemption process for ETFs than is currently proposed: for example, talk about the operational costs of ETF transactions, and how the Canadian Investment Funds Standards Committee categorizes funds and assigns their risk levels.
• Make sure reps meet know-your-client and suitability requirements, and inform them of how volatility can impact ETF investors.

Atkinson adds, “Some firms may try to build their own courses, while others may work with ETF providers.” He notes most industry organizations offer ETF courses, including an ETF certified specialist program, which would likely surpass training requirements proposed by the MFDA.

Firms must also keep track of whether the industry finds a market access solution. Over the last two years, the Canadian ETF Association has been working toward offering such a solution to allow all mutual fund dealers to handle ETF trading and reporting, says Atkinson.

“At CEFTA,” he adds, “we’ve worked with back-office suppliers, such as Univeris and FundSERV, and right now we’re targeting Level 4 mutual fund dealers to test the back-office portion of our solution—that includes about 35 firms that have about $435 billion in assets.” A Level 4 MFDA dealer must maintain a minimum capital amount of $200,000.

Before setting up ETF proficiency standards and rules, says Atkinson, “most dealers are likely waiting for guidelines to finalize,” and for technological developments to be completed. As such, he predicts MFDA firms likely won’t move to educate advisors and revamp back-office systems until the end of 2015 at the earliest.

“I think what will happen with most MFDA reps is they’ll be advising their clients on which ETFs to use, but their firms will do most of the execution of the trades,” he adds.

Impact on the industry

Looking ahead, one question remains: do MFDA advisors even want to sell ETFs as a way to bridge the gap between themselves and IIROC reps?

Edwin Pavey, regional director and CFP at Investors Group in Barrie, Ont., doesn’t think so. He points out that only a small number of MFDA advisors are becoming IIROC-licensed so they can sell ETFs. So, if MFDA advisors could offer the funds, he predicts most wouldn’t right away.

“There’s nothing wrong with ETFs being a part of your portfolio, but they’re not for everyone,” says Pavey. “I’ve never been a big fan of ETFs because, even though I get the idea of passive investing, the funds are always going to underperform the market. Not all managed products beat the market, but they have the potential.”

Another issue is whether clients of MFDA advisors even want to invest in ETFs.

Snigdha Malik, an independent, MFDA-licensed advisor, says, “I’ve only had three or four clients ask about ETFs, and they usually focus on their low cost. Right now, I have to say I don’t have the capability to sell them, but my firm is working on offering them by summer 2016. When that happens, I will find out what I can offer and keep doing research. If there are opportunities for clients to get better returns, I will use some ETFs.”

Over the long term, Atkinson expects that increased competition from peers will push most MFDA firms to sell ETFs. “The use of ETFs will probably gain momentum as firms that haven’t started offering them see competitors doing so, and as they’re put at a disadvantage in the marketplace.”

But he says the gap between MFDA and IIROC advisors will only narrow. “Mutual fund dealers will be able to offer similar products as IIROC advisors, but that will still stop short of 81-104 products, such as leveraged ETFs, and individual securities.”

IIROC ends CSI Monopoly, sort of

The Canadian Securities Institute’s monopoly on IIROC proficiency assurance has come to an end, though not without caveats. IIROC is sticking with the single-provider model, but a competitive process will determine who that provider will be. “[A] single provider will be selected for a basket of regulatory courses for terms of five years and the contract will be awarded through a transparent and competitive procurement process,” IIROC says in a release.

The caveat: you’ll have to wait for the first process, since IIROC is giving CSI the first five-year term, saying, “This contract includes high performance standards, robust oversight, improved pricing caps and facilitates a smooth transition through the competitive procurement process.”

Another development: under the new model, IIROC will be responsible for setting and publishing competency standards. “These standards will indicate the knowledge and competencies required to successfully complete IIROC licensing courses,” says the IIROC release.

Says John Fabello, a partner at Torys in Toronto: “Within reason, IIROC setting the standards and controlling them [is] good for both investors and advisors, because it adds to the credibility of the profession […] and investor confidence.”

He likes that IIROC will do this openly. “Not only are they going to create these standards themselves, but they are going to publish them.” This moves in line with global regulatory standards. “Allowing investors to access what the standards are […] is consistent with regulation generally. The standards and course material prepared by CSI aren’t under lock and key; if you’re enterprising, you can access them, but it’s not easy.”

And accessible standards help define legal standards in court and regulatory proceedings. “In a court case, you can see an investor counsel pointing to these standards,” Fabello says. “This is part of the code and proficiency, the baseline standards and, in this case, the argument would go that the advisor fell below those standards. That’s pretty significant.”

–Allan Tong