Charred And Charted – Did CRM2 Work?

On April 25, 2024, the Canadian Securities Administrators (CSA) published two research reports that examined how the implementation of the Client Relationship Model Phase 2 (CRM2) amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) have impacted the investment fund industry and investor behaviour. The report looked at a 7-year study period, from January 2013 to December 2020. The study period chosen was designed to isolate the impacts of the CRM2 amendments while controlling for the impacts of other regulatory changes. The CSA conducted their analysis in three time periods: 2013 to 2020 (the total study period), 2013 to 2016 (preimplementation period) and 2017 to 2020 (post-implementation period).

The purpose of the research was to test the CSA's hypothesis that increased disclosure of fees and performance information because of the CRM2 amendments would enable retail investors to make more informed investment decisions, resulting in market-wide impacts of lower investment fund fees and better performance.

As a recap, the central aim of CRM2 was to improve transparency and disclosure of information to investors, particularly in respect of fees and performance of investment accounts. CRM2 introduced the reporting requirement of two annual reports: the report on charges and other compensation and the investment performance report.

To test the hypothesis, the researchers examined changes in mutual funds and exchange-traded funds (ETFs) by asking the following four questions:

1. Have investment fund managers (IFMs) lowered fees, specifically management expense ratios (MER) and management fees, and what is the extent of these changes?
2. Have product manufacturers and product distributors been shifting to products that are not captured by the new account costs and performance disclosures?
3. What have been the changes in product creation and distribution trends?
4. Has greater transparency about investment returns led to IFMs improving the risk-adjusted performance of their mutual funds and ETFs?

The findings were generally as follows:

1. MERs and management fees decreased for both mutual funds and ETFs over the total study period.
2. There was no evidence that product manufacturers and distributors shifted to products that were not subject to CRM2 requirements.
3. There was an increase in popularity of fund-of-fund products for both mutual funds and ETFs over the total study period.
4. There was a substantial increase in growth of the ETF market compared to mutual funds.
5. Within the mutual fund market, there was a notable shift towards fee-based series away from commission-based series over the total study period.
6. Demand for products with an ESG mandate increased.
7. There was a rise in online advisers.
8. Risk-adjusted performance improved relative to chosen model benchmarks in the post-implementation period.

The CSA emphasized that changes in industry behaviour can not be attributed directly to CRM2, as other factors that can not be accounted for in the analysis may have contributed to these changes.

In Brief

Grilling of Disclosure – Is it Clear and Conspicuous Enough?

The type and use of promotions for securities has long been scrutinized and regulated. For example, in 2021, the British Columbia Securities Commission (BCSC) released for comment Proposed BCI 51-519 Promotional Activity Disclosure Requirements, which set out a framework for required disclosure in relation to promotional activities (see our bulletin article here for more information). However, according to regulators, some issuers and registrants continue to engage in problematic promotional activities.

On April 25, 2024, the BCSC released BC Notice 51-703 "Clear and Conspicuous" Disclosure of Investor Relations Activities under Section 52(2) of the Securities Act, RSBC 1996, c. 418, detailing expectations for "clear and conspicuous" disclosure regarding the relationship between an issuer and those that engage in investor relations activities for the issuer. For context, "Investor Relations Activities" are defined to include "any activities or oral or written communications, by or on behalf of an issuer..., that promote or reasonably could be expected to promote the purchase or sale of securities of the issuer."

Except for a few narrow exceptions, all disclosure relating to Investor Relations Activities must be:

1. In plain language;
2. In a prominent spot and in prominent font; and
3. Designed to catch the attention of the reader.

Although the notice does not prescribe specific language, it states that including disclosure at the end of a document is not enough. To be "clear and conspicuous", the disclosure must be displayed at or very close to the beginning or substantive portion of the material and cannot be buried in disclaimers. In addition, hyperlinking the disclosure is insufficient to meet this expectation, especially if the hyperlink is entitled "disclaimer" or "legal notice". The concern noted was that these hyperlinks do not inform the reader that it would direct them to information about the relationship between the disseminating party and the issuer.

The notice indicates that the "clear and conspicuous" expectation is in line with the objective of section 52(2) of the Securities Act (British Columbia), which is to "assist investors in assessing the objectivity of the information received from a person engaging in investor relations activities."

Through fines recently imposed, we can see the continued concern for the integrity of the capital markets that can result from unbalanced promotional activities. Coupled with the client focused reforms in recent years, those involved in investor relations activities should continue to mind the position and appearance of required disclosures in all such promotional activities.

Annual BBQs, Annual OSFI Risk Outlook

Earlier this month, the Office of the Superintendent of Financial Institutions (OSFI) released its annual risk outlook for 2024 to 2025. Each year, OFSI releases this report, which provides an overview of the current risk environment facing the Canadian financial system. This year, the following items were identified as priority risks:

Real Estate Secured Lending and Mortgage Risks

This risk relates to the high percentage of mortgages that are coming up for renewal prior to the end of 2026 in a much higher interest rate environment. OSFI expects payment increases to lead to higher residential mortgage arrears or defaults, with variable rate mortgages with fixed payments being of specific concern. It is also noted that loan-to-income and loan-to-value ratios of new mortgage originations are at almost record low levels.

Wholesale Credit Risks

These risks, including from commercial real estate lending and corporate and commercial debt, are still a significant exposure for financial institutions. Current interest rates have made refinancing challenging for some borrowers, and OSFI expects there could be a negative impact on the wholesale credit market this year. The move toward hybrid work environments is also noted as a challenge for the office sub-segment of the commercial real estate market.

Funding and Liquidity Risks

There is a persistent concern with liquidity shocks that may occur if there is a dramatic shift in depositor behaviour. The digitalization of banking may result in faster deposit outflows than is expected by some market participants. OSFI expects financial institutions to continue to improve reporting and operational capabilities to be responsive to market disruptions.

Integrity, Security, and Foreign Interference

Finally, OSFI is concerned about threats to the integrity and security of financial institutions, including fraud, cyber security, and foreign interference. It is noted that geopolitical instability can increase the likelihood of these risks materializing, and that public confidence in the Canadian financial system depends on institutions acting with integrity and securing against these kinds of threats.

Firing up Consumer Protections: FSRA Panel Releases Report

The Consumer Advisory Panel (Panel) to the Financial Services Regulatory Authority of Ontario (FSRA) provides advice from a consumer perspective on policy and regulatory matters and initiatives, among other duties. Earlier this month, the Panel released its report for the fiscal year 2023-2024. As well as its other activities, the Panel established topic-specific working groups related to:

• Strengthening protection of vulnerable consumers;
• Building outreach and partnerships with the public interest community;
• Governing unclaimed deposits held by credit unions and caisses populaires;
• Evaluating FSRA's Financial Professionals Title Protection Framework, and its Check Credentials Tool;
• Guidance for mortgage brokers on mortgage product suitability; and
• Eliminating deferred sales charges for insurance products.

Interestingly, the Panel also organized a meeting with different regulators and other consumer-focused advocacy organizations to discuss challenges and opportunities in consumer protection and future collaborations. Some challenges discussed included fragmented regulations and conflicting business considerations. The group discussed potential solutions to some of the challenges identified, including reporting dashboards, enhanced ombuds services and additional consumer guidance. Much concern was expressed about the dangers of placing the onus for financial literacy solely onto consumers.

Flame Broiled: CIRO's Proposed Integrated Fee Model

On April 25, 2024, the Canadian Investment Regulatory Organization (CIRO) proposed a new integrated fee model for investment dealers and mutual fund dealers, to be effective April 1, 2025. The model is comprised of three components: the Annual Dealer Member Fee, Fees for Membership Applications and Dealer Member Business Changes, and the Qualified Market Maker Discount.

The proposed changes will have a large impact on dealer members and should be reviewed carefully by industry.

CIRO is proposing that the Annual Dealer Member Fee for all dealer members be based on a combination of total dealer revenue and the number of Approved Persons, subject to a minimum fee.

The revenue component is an amount equal to the product of the total revenue of the dealer member for the previous calendar year and the annual rate for the revenue "tier" applied to the dealer. Mutual fund dealers with assets under administration over $1 billion will be subject to a minimum threshold amount. The minimum amount will be calculated in relation to the median amount of revenue from all mutual fund dealers. Those dealers with revenue below the threshold will have their revenue for fee purposes adjusted upward to align with the minimum threshold amount.

Dealer members will need to pay an Approved Person fee of $250 per Approved Person based on their average number of Approved Persons over the previous calendar year.

CIRO is proposing to raise fees for membership applications. It will also introduce new fees for reorganizations and material changes to a dealer's business, and new fees to reimburse the cost of applications that require "excessive" time and resources.

CIRO is also proposing to amend its Equity Market Regulation Fee Model to eliminate the per trade fee discount currently provided to Qualified Market Makers.

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