On April 28, 2022, the Canadian Securities Administrators (CSA) published for comment proposed amendments to National Instrument 31-103 that will add further cost disclosure by dealers and advisers to clients holding investment funds. Nicknamed "Total Cost Reporting" (TCR) by the CSA , the amendments will add disclosure to periodic account statements and annual cost reports as described in greater detail below. The disclosure applies to all investment funds owned by clients, regardless of whether the fund is public or non-public, and regardless of whether the fund is managed in Canada or abroad. Read Fasken's comments to the CSA on TCR [PDF].

TCR also includes an initiative by the Canadian insurance regulators to increase disclosure regarding segregated funds. Those insurance-related initiatives are not discussed in this bulletin.

Total Cost Reporting Details

Under TCR, each account statement will include the fund expense ratio of each fund held in the account. The "fund expense ratio" simply is the sum of the management expense ratio (MER) and trading expense ratio (TER) of the relevant series of the fund. Account statements also will include a prescribed description of the impact of fund expenses, as well as an explanation of any approximations or assumptions used.

TCR will have a greater impact on annual cost reporting, which will include the following for the year covered by the report:

  • The sum of all amounts charged directly to the investor in respect of their fund holdings (defined as direct investment fund charges in TCR). [14.17(1)(i)(a)]
  • The direct investment fund charges excluding the transaction charges disclosed elsewhere in the report (direct investment fund charges excluding commissions). [14.17(1)(j)]
  • The sum of all fund expenses indirectly borne by the investor, calculated using a daily fund expense factor for each fund held (indirect fund expenses). [14.17(1)(i)(b)]
  • The sum of direct investment fund charges and indirect fund expenses (direct and indirect fund expenses). [14.17(1)(k)]
  • The sum of the amounts charged by the dealer or adviser directly to the client and the direct and indirect fund expenses (total fund expenses). [14.17(1)(l)]
  • A prescribed description of the impact of fund expenses and any redemption fees paid during the year, together with a short explanation of any other charges paid by the client, and of any approximations or assumptions used.

TCR also includes rules for the provision of information by fund managers to dealers and advisers, and protocols for circumstances where the information is stale, misleading or unavailable.

Specific drafting issues with the amendments are provided later in this bulletin.

Possible Implementation Issues

Cost and Timeline

The CSA are proposing that TCR will come into effect in September 2024. Account statements for periods after that date would include fund expense ratio information, and the first enhanced annual cost reports would be for the 2025 calendar year.

We expect that implementation of TCR will require that managers, dealers and their service providers establish new procedures and electronic interfaces for exchanging information in order that production of the additional disclosure can be automated. No estimate of those anticipated costs is included in the proposals, and we expect that those costs will be significant. While the timeline is aggressive, the CSA have not identified an imminent harm to investors resulting from the current absence of TCR.

Non-Public and Non-Canadian Funds

Larger non-public investment funds (pooled funds) in Canada likely will have the same implementation challenges as public investment funds, but can build on existing infrastructure to generate and communicate the new information required by TCR. Smaller pooled funds may not have such infrastructure currently in place and may instead rely to a greater degree on manual processes. Those smaller pooled funds may face significant challenges complying with TCR.

It is unclear how TCR will be applied to non-Canadian funds, whether they are public or private. Those funds and their managers are not required to comply with Canadian disclosure obligations and may not calculate and publish MERs and TERs in the same manner as Canadian investment funds. Over time, the Canadian dealers and advisers that recommend those non-Canadian funds to their clients may need to assess whether the risks of complying with the TER protocols for these circumstances outweigh the benefits of making these non-Canadian funds available to their clients.

Will Total Cost Reporting Make a Difference?

A threshold question is whether investors need or want TCR. While focus groups may suggest that investors always will take additional information when offered, we have not seen research on the extent to which that information is used. Do investors want to analyze this information, or do they prefer to rely on advice from their adviser? The low request rate by investors for optional documents such as management reports of fund performance suggests that investors are more comfortable relying on the professional training of their advisers than second-guessing that advice.

The CSA's rationale for TCR is that investors generally are unaware of the ongoing costs of holding units of an investment fund, and this should be rectified. However, consumers understand that any product or service they purchase includes embedded costs to manufacture that product or to deliver that service. Consumers simply do not research those costs and instead focus on the outcome – in the case of investment funds and other securities, their rate of return. We do not consider this an inherent flaw. It simply reflects the relative priority of investment considerations that ranks performance paramount to costs.

Possible Unintended Consequences

Providing unhelpful information also risks diluting an investor's focus through information overload, potentially reducing the overall effectiveness of annual cost reporting. If a goal of TCR is to empower investors to seek out investment funds with lower cost structures, it may instead lead investors to switch to an order execution only (OEO) dealer, or from an investment product to a savings product. Both of those outcomes could be harmful to investors as it may result in investors choosing unsuitable investments through the OEO channel, or foregoing entirely the benefits of investing.

A Need to Review Existing Disclosure Requirements

TCR is the most recent in a lengthy history of regulatory initiatives to provide investors with more information about their investment funds. This history includes:

  • the introduction of the "simplified prospectus" in 1987
  • the creation of the improved simplified prospectus 2000
  • the introduction of management reports of fund performance in 2005
  • the client relationship model (CRM) included in NI 31-103 in 2009
  • the introduction of fund facts in 2011
  • enhanced reporting under CRM2 enacted between 2013 and 2016

Market participants may be skeptical whether TCR will be more successful at engaging investors to read regulatory disclosure than the initiatives that preceded it. A quantitative analysis of the anticipated benefits and costs of TCR (a prerequisite to rule-making in Ontario) was not included with the proposals.

These disclosure initiatives were in addition to other regulatory changes intended to provide investors with greater protection including:

  • the general conflicts of interest regime of NI 81-107 and mandating of independent review committees in 2007
  • the registration of investment fund managers commencing in 2009
  • the Client Focused Reforms implemented in 2021
  • the recent banning of deferred sales charge purchase options, and trailer fees paid to order execution only dealers.

In each case, the rationale for these changes included statements by the CSA that disclosure to investors is an insufficient tool to address the concerns identified. Given the lack of understanding among the general public of basic investing concepts and the CSA's discomfort with relying on disclosure, it seems inconsistent to be promoting the benefits of more disclosure through TCR.

As an alternative to introducing further disclosure obligations, we would encourage the CSA to set as its next regulatory priority a review of the effectiveness of their previous initiatives to identify which have produced the anticipated benefits (and therefore should be retained) and those which have not (and therefore should be eliminated). Such a review should include metrics such as:

  • narrowing the gap between average account performance compared to market performance generally, and
  • greater investor satisfaction through fewer complaints.

In our view, reassessing the usefulness of existing disclosure requirements should be at least as high a regulatory priority as introducing new disclosure requirements.

Drafting Issues

As currently drafted, the amendments contain some ambiguities that we expect will be clarified in the final version. These include the following:

  1. "Direct investment fund charges" is defined in the amendments as amounts charged to the investor by the investment fund or its manager. However, other provisions (such as sections 14.17(1)(i)(a) and 14.17(1)(j)) refer to amounts charged by the investment fund, its manager, "or any other party". It is unclear whether third party charges (such as those of registered plan administrators and custodians) are intended to be included. Even charges by dealers and advisers could be included within these extra words. If the broader scope is intended, it is unclear whether third party charges can be proportioned between investment fund holdings and non-investment fund holdings. Further, the definition carves-out amounts included in the "investment fund's fund expenses" but does not indicate whether this is the same as its "fund expense ratio".
  2. The methodology for calculating the indirect fund expenses of each fund holding is set out in section 14.17(6). It entails multiplying a daily fund expense factor [fund expense ratio X net asset value per unit] by the number of units owned by the investor. The methodology states that it is to be used for calculating both direct investment fund charges and indirect fund expenses. However, the methodology works only for indirect fund expenses. TCR needs to devise a separate calculation for direct investment fund charges.
  3. The prescribed disclosure regarding redemption fees paid during the year directs the client to the fund's prospectus or fund facts for additional information regarding the redemption fee schedule. However, following the implementation of the ban on deferred sales charge purchases, a fund's prospectus and fund facts no longer will include redemption fee schedule. In addition, the redemption fee schedule applicable to the investor would be described in the prospectus or fund facts at the time the units were purchased, rather than the current prospectus or fund facts of the fund.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.