Trail commissions are anti-investor: that’s the conclusion that the Canadian regulator (CSA) has reached in its recent discussion paper where it calls for eliminating embedded commissions in mutual funds, to be substituted by a fee based model. CSA has made 3 points on why it believes trail is anti-investor – which bear careful reflection. And, if there is an element of truth in its observations, it is only right that the industry takes proactive steps with sensible remedial measures rather than have a sledgehammer solution come our way, by way of adoption of international best practices.
Lots for us to learn from the Canadian consultative process
Having gone through the very exhaustive discussion paper, I must say I have come away impressed with the manner in which the regulator constructs their case and puts it forward to the industry for views. One may agree or disagree with the conclusions, but one must say that their regulator is very transparent in disclosing their mind – which is in stark contrast to SEBI’s stated position that it is reluctant to disclose “the mind of the regulator” as it stated in response to an RTI request by a South based IFA last year.
CSA’s discussion paper’s approach highlights:
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What it thinks is the key issue
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What is the evidence that suggests that the issue is real (and not perceived)
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What are the options considered by the regulator, which options were dropped, which were shortlisted and why
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Clear recognition of the industry’s position on the matter and the stated rationale for the industry’s objection/reluctance towards a change
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Clear direction to the industry to come up with arguments, backed by research and numbers, that demonstrate that the benefits of status quo are more than the benefits of making the suggested change.
A time frame of almost 6 months has been given to the industry to present its views – which gives enough time to conduct research to independently assess both options – status quo and change. It would indeed be great if our regulator adopts this methodology for its discussions on proposed regulatory changes.
Three points on why trail is anti-investor
Now, let’s come to the key finding of CSA that trail commissions are actually anti-investor. There are three key points which CSA is making:
1. Most investors don’t know they pay trail and can’t influence it anyway
Canada, like India, has moved substantially in recent years from a front end load model to a trail fee model. In Canada, front end loads were negotiated between investor and distributor (while in India, it was fixed and the pass back form of negotiation was officially banned though widely prevalent).
CSA says that in the days of entry load, distribution costs were very clearly known to the investor, who had an ability to negotiate and agree the amount he was willing to pay – though the payment was made by the fund house deducting it from the investment amount and paying to the distributor. Now that commissions are embedded into product costs and paid out as trail, many investors don’t even know that there is an embedded commission and the few who know are anyway not in any position to influence it. Investors’ sensitivity towards distribution costs has reduced over time. Not knowing that they are paying is anti investor. Not being able to influence it, if they know they are paying is also anti investor.
Canada is implementing this month, commission disclosure in account statements, which is similar to what SEBI introduced effective last October in India. But CSA says mere disclosure is not enough as it only will reduce ignorance of commissions paid – it still does not give back to the investor the right he used to have to determine what he wanted to pay to his distributor.
2. Investors cannot ensure they get service commensurate with trail paid
The second issue CSA has with trail commissions is that there is no mechanism for the investor to ensure that he gets ongoing service that is commensurate with the trail commission paid annually. CSA points out to discount brokers who sell funds with full trail commissions, even though they do not offer any ongoing advice or hand-holding. CSA points out to advice embedded products (packaged solutions that dynamically alter asset allocation either in keeping with life stages or market parameters) – which by definition do not require ongoing advice, but which are still sold with full trail commission. And then of course will be individual instances of intermediaries who earn trail but do not actually deliver the kind of ongoing advice for which this trail is paid to them. In all these cases, there is a trail commission paid for ongoing advice – which is either not required, or not delivered even if required. That is anti-investor.
source: wealthforum.com