Daniel Dorenbush of Scotiabank discusses how the CSA’s proposed
rules to modernise investment funds will affect the Canadian market
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Can you tell us about the CSA proposals to modify current regulatory framework for mutual funds and what the aim of the framework is?
The Canadian Íø±¬³Ô¹Ï Administrator (CSA) is preparing to adopt new rules that will modernise the regulation of investment funds in Canada.
In September 2016, the CSA published proposed amendments to NI 81-102, which includes an alternative mutual funds category. When adopted in final form, the rules will permit alternative mutual funds to be sold to investors in Canada in much the same manner as conventional mutual funds.
These funds will be able to employ certain investment strategies such as shorting and leverage—within strictly regulated limits—that have traditionally been utilised by hedge funds.
This change will expand opportunities for investors in Canada, particularly in the retail market segment and likely create new opportunities for hedge fund and mutual fund manufacturers.
What challenges and opportunities will the proposed regulation have for the Canadian mutual fund space?
Some mutual fund manufactures have been challenged by competition from exchange-traded funds (ETFs) and a shortage of differentiated products. The result has been a compression of fees and a strong desire to create new, differentiated products. The proposed rule changes will allow mutual fund manufacturers to consider new products, which can draw on a broader set of investment tools to serve their investors. Some traditional asset managers may find that they have a learning curve in running these new strategies, both from an investment and an operational standpoint. This may inspire the outsourcing to third party managers (such as established hedge funds) or a ramp-up in internal expertise. Other traditional manufactures may already be well positioned in terms of their skill set.
How will the changes affect the hedge fund market in Canada?
These are positive changes for the Canadian hedge fund space. To date many hedge funds in Canada have been challenged in distributing to retail investors. There are several worthwhile speed bumps that have been put in place throughout the retail distribution channels, such accredited investor rules and risk ratings, which are designed to protect retail investors. While it is a good structure overall it can sometimes make it difficult for average retail investors to access some high-quality hedge fund managers in Canada. The proposed new rules should make it easier for these investors to access a broader set of managers while ensuring certain limits are in place to continue to protect the end investor. For hedge fund managers it could mean that some of their products will be more accessible to investors and offer them an opportunity for growth.
How will the changes affect Canadian prime brokers?
Given that most traditional asset managers do not have an account with a prime broker—as their strategies do not necessitate this—they will need to establish this relationship. The CSA has very smartly designed the proposed rules so that they ultimately protect end investors. One example of this is the proposed directive to utilise, to a large extent, domestic banks and dealers for custody and borrowing services, where the CSA has greater oversight. It is important for Canadian service providers who want to support the alternative mutual fund market to be able to support investment strategies across global markets while offering a variety of solutions to accommodate the custody and prime brokerage requirements of new funds. In this light, Scotiabank is well positioned for these changes. The firm is fully committed and has made significant investments in the prime brokerage business. With offices in Toronto, New York, London and Singapore, Scotiabank can facilitate prime brokerage services in 35 geographic markets, both in cash and synthetically.
When are the changes set to take effect?
That’s the million dollar question. The CSA requested industry commentary following the most recent publication of the draft rules in late 2016. There were many industry comment letters offering valuable feedback on the proposed rules. These need to be adequately reviewed and contemplated by regulators with the final version approved by 13 provinces and territories in Canada. There are unconfirmed suggestions that we may see the final version of the rules in fall this year.
How do you expect the Canadian mutual fund space to grow over the next 12 months?
Hopefully, we will see the finalisation of the rules later this year. We will likely see some new products offered by both Canadian mutual fund and hedge fund managers and we may see some mutual funds team up with hedge funds to manage these products. Over time there will likely be some shifting of assets from traditional, long only strategies to the new alternative. While it’s difficult to put a number on how big this market could be, and while there are some reservations about the possibility of managers with less experience in alternative strategies moving into the space, there is broad support for the proposed rule changes across the industry and meaningful optimism about the road ahead.
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