Beware the unintended consequences of banning embedded fees

Contributed to the Globe and Mail July 6, 2017

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For regulators everywhere, there is one discipline that transcends all sectors and circumstances: resisting the urge to impose solutions to problems that do not exist.


This is the dilemma that currently confronts the Canadian Securities Administrators (CSA). It has embarked on a public consultation process that revives the notion of banning mutual-fund trailing fees and other embedded commissions, although there does not appear to be any convincing evidence that Canadian investors are either ill served or concerned about the status quo.

Protection of consumers is a matter of public interest and essential to the mandate of all regulators. The clarity and rigour of rules and standards are all the more essential at a time of uncertainty and volatility in capital markets. Investor confidence, after all, provides ballast in choppy markets.

Such principles extend as well to the potential disruption and cost that unneeded regulation may cause. "Investor protection" reforms should not be advanced when there is no evidence that embedded commissions are harmful to investors and where investors have not signalled a desire for change. The unintended consequences of such action may undermine investor interests by limiting choice, as well creating an "advice gap" or "wealth gap" for investors.

Recent research conducted by the Gandalf Group reflects a growing concern that the cost of replacing trailing fees with a direct-fee arrangement will diminish access to professional financial advice for those Canadian investors with smaller portfolios. In fact, faced with the prospect of phasing out trailing commissions in favour of a direct fee, 24 per cent of all investors surveyed (including one in four small investors) indicated it would be a disincentive to seeking advice.

This is a concern when household debt is at historically high levels and more Canadians are required to take direct responsibility for their long-term financial and retirement planning.

The CSA proposes that where higher adviser costs push smaller investors out of the adviser circle, robo-advisers and other virtual options fill the gap. While this may be a solution for some, not all investors want to move in that direction. In fact, many robo-advisers now acknowledge the need to combine the efficiencies of automation with a human touch.

This is evident in research that finds 70 per cent of advised investors are "highly satisfied" with their adviser relationship and the advice they receive. Not only that, but 74 per cent of all Canadian investors – and 82 per cent of advised investors – agreed that advisers are concerned about how their clients' portfolios perform.

About 64 per cent of advised investors are very satisfied with the financial statements they receive – only 5 per cent are very dissatisfied – and most report that they read them closely. Fifty-three per cent of investors read fee-disclosure elements in every financial statements they receive. Four in ten investors believe that disclosure has improved over the past three years as disclosure about fees and other charges became more clearly presented in investor statements and reports. Over all, 81 per cent of advised investors surveyed stated they are "very satisfied" or "somewhat satisfied" with the current level of transparency around the adviser fees.

Most investors (and the majority of advised investors) indicated that trailing commissions are no different than any others an adviser would directly charge. Those who consider themselves knowledgeable about investing were even more likely than others to approve of trailing commissions.

The fact that other countries have phased out trailing fees has frequently been cited as rationale for doing the same in Canada. However, only 13 per cent of total worldwide mutual-fund assets of $39.4-trillion are covered, or slated to be covered, by a ban on embedded commissions.

Debate and consultation are a critical part of healthy capital markets, but we also need to bring stability to our industry. That means ensuring access to financial advice and choice, so that when it comes to investing, no one gets left behind.