Behind the scenes of the upcoming OSC roundtable

Investor protection vs. efficiency: The precedents, pace and fine print should have investors paying attention

Andrew Willis 19 March, 2019 | 2:00PM

There’s something brewing in the background of the Ontario investor landscape. On January 14, the Ontario Security Commission (OSC) asked for suggestions aimed at scrapping old rules and reporting requirements in the name of industry competitiveness. And on March 27, the OSC will hold a roundtable with industry stakeholders to discuss comments.

The Investment Industry of Canada (IIAC) blamed regulations for the doubling of operating expenses in 2018 with IIAC president and CEO Ian Russell saying as much in his January 2019 letter to the industry.

However, that doubling of operating expenses also included technology and systems improvements for efficiency and convenience reasons – at a time of increasingly higher profits.

Operating profits for the first three quarters of 2018 rose by 28%, according to the IIAC. And the IIAC projects that although there was a 20% fall in fourth-quarter profits, the industry is still up 10% over 2017 and 2016. “Further, over the past three years, operating profit has averaged well above 2014-15 levels,” Russell said in his letter, “roughly 50% higher.”

Reduction of costs is no bad thing – if cost savings are indeed passed on to investors, it could be a good thing.

What do the comments say?

In response to the January request, a variety of wish lists came in from investment firms and industry associations, covering a plethora of seemingly benign suggestions, from administrative time-saving measures to unnecessary duplications of legal disclosures.

Several of the comments focus on reducing duplication, making administrative tasks more effective, joining the Passport System (a coalition of all provincial securities commissions except for Ontario) and reducing burdens of reporting outside business activities.

For example, the Investment Funds Institute of Canada (IFIC), among other things, has asked for exemptive blanket relief, pointing out that it is unduly burdensome and costly to both the OSC and individual firms to address individual applications for exemptive relief that is required by multiple industry participants.

“All other members of the Canadian Securities Administrators (CSA) have the ability to provide blanket exemptive relief, which increases efficiency for both the regulator and the industry”, the comment states.

Many of the suggested improvements would be welcome moves.

The submissions from investor advocates came with red flags and questions about the end-target of the taskforce, who point out that the focus of investors should be on the precedents, the pace and the fine print surrounding the balance between efficiency and safety.

The precedents

Investors cannot have forgotten the harsh precedent in the deferred-sales-charge (DSC) decision last September, where Ontario’s majority Conservative government led by Doug Ford opposed not only the OSC, but rejected the unanimous agreement of the Canadian Securities Administrators, which represents regulators across Canada, to ban DSC.

“We share the CSA’s concerns about the harmful effects of DSCs,” said the Chair of the OSC’s Investor Advisory Panel (IAP), Neil Gross in a letter to the CSA. A lack of investor knowledge around how their advisors as compensated, and the availability of front-end load funds with a 0% up-front fee are among reasons that suggest the DSC option is not driven by investor choice, he adds.

“We note Finance Minister Fedeli’s recent statement that the government of Ontario does not support this proposal as currently drafted,” said Gross. “We look forward to seeing the Minister’s revisions and hope the CSA will afford all stakeholders an opportunity to comment on them in due course.”

We question whether any decisions made as a result of this roundtable might be undermined by the government going ahead? On the flip side, are these consultations an attempt by the OSC to align themselves with the Ford government and the finance minister?

“The government is committed to lowering business costs and sending a clear message that Ontario is open for business. We support the OSC’s efforts to reduce burden on market participants while also working to enhance investor experience and protection,” said a spokesperson for the Ministry of Finance.

The pace

The swiftness with which this proposed reform was drafted and tabled has caught some by surprise, but in all fairness, the OSC is making the right moves to engage stakeholders. They’ve reached out to the public and personally invited investor advocates to join the roundtable. They’re even going so far as to set up online access to the event.

There still however remain practical questions if they intend to make decisions: How are they going to sift through so many suggestions so quickly? How are they going to decide what burdens to discuss? And how are they going to calculate the cost-benefit analysis of efficiency vs. safety?

“This consultation was unlike most others in that the OSC did not make proposals to reduce the regulatory burden, but simply asked (mostly) registrants for feedback and suggestions,” says Dan Hallett, Vice President and Principal at Highview Financial Group adding that it may well be that many of the changes resulting from this will be discussed behind the scenes.

The OSC’s Investor Advisory Panel, however, sees a need for a swift policy process, saying that a slow-moving process is in itself burdensome for both investor advocates and investment firms in their submission to the consultation.

The IAP also echoes the need for a win-win arrangement of “smart” burden reduction in their submission, while warning that “there will be no true public interest benefit if this review must be conducted as a zero-sum exercise in which burdens are reduced at the expense of investors protection or market integrity.”

The fine print

The IAP cleverly suggested that a phased approach ought to be taken first, where changes are purely administrative in nature at first and do not impact investor protection measures.

The IAP’s phased-approach suggestion seems even more clever when you read about two-thirds of the way down the OSC notice.

“We are currently reviewing comments submitted on several significant CSA initiatives, such as the proposed Client Focused Reforms, amendments regarding embedded commissions for investment funds and new derivatives rules. We intend to consider these submissions as part of our review of regulatory burden. As such, there is no need to repeat comments provided in response to these projects”

Not so fast. The IAP categorizes this topic of discussion in the realm beyond simply red-tape refinements, and specifically calls this out, in their submission.

“Some matters, in our view, should be entirely excluded from this exercise. In particular, the CSA’s proposed Client Focused Reforms and amendments regarding embedded commissions for investment funds already have been exposed to a protracted and thorough review process that, in no small part, sought to achieve a fair balance between industry cost and investor benefit.”

The Ontario government, touting its Open for Business philosophy, supports the notion that fund dealers and fund companies should be able to continue a long-established compensation practice, and that investors should be free to choose how they pay for advice.

On the face of it, reducing regulatory burden is not, in and of itself, a bad thing. Reducing paperwork and unnecessary duplication, and implementing time-saving measures are all good steps. But it is imperative to explore what lies underneath this seemingly benign talk of increasing administrative efficiency. The biggest question we are asking ourselves is what the risks are of reducing the regulatory burden. For example, investment dealers have repeatedly demonstrated that they will exceed regulatory limits when it comes to incentivizing sales. The IAP’s suggestion to first tackle low-hanging fruit that do not impact investor protections is a sensible one.

The Ford government is positioning this as a question of freedom of choice, but just because laws govern how we should drive doesn’t mean we’re not free to choose what cars we buy. Similarly, just as advisors need to be licensed, regulatory burdens exist in the first place to protect investors and their life savings. The uncharacteristic speed of this development and the decision by the OSC to not make proposals but solicit feedback and suggestions gives us pause. With all this said and done, we at Morningstar will be watching the March 27 roundtable closely.

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Andrew Willis

Andrew Willis  Andrew Willis is a content editor for Morningstar.ca.