Canada Proposes Soft-Dollar Regs
July 26, 2006
Following the U.S. and U.K. lead, Canada is taking on soft-dollar compensation. The Canadian Securities Administrators (CSA), which represents the securities regulators of Canada's 13 provinces and territories, has issued a request for comment on a national policy covering soft-dollar practices, whereby money managers' brokerage commissions cover other costs.
"The goal here is to ensure that advisers manage the appearance of conflicts of interest that may develop when investors do not have complete information about how the adviser spends their money," says Jean St-Gelais, chair of the CSA and president of Quebec's Autorité des Marchés Financiers. "Investors may not be aware of soft-dollar practices. Enhancing disclosure requirements in this area will improve investors' confidence."
The request for comment on the proposed "national instrument"--use of client brokerage commissions as payment for order execution services or research--went out July 21, and the deadline is Oct. 19. The document follows responses to a concept paper issued in February 2005. "The overall response was that while we should continue to permit client brokerage commissions to be used as payment for trading-related goods and services in addition to order execution, the existing provisions were too broad and required too much interpretation," said the CSA.
Quebec and Ontario adopted soft-dollar commission policies in 1986, but they do not apply outside those two provinces. The U.K.'s Financial Services Authority adopted its final rules on soft-dollar commissions in July 2005, and the U.S. Securities and Exchange Commission voted on July 12 to place limits on soft-dollar practices.
According to Susan Greenglass, assistant manager of market regulation at the Ontario Securities Commission, soft dollars are "common practice" in Canada. Over 60 percent of Canadian investment managers acquire third-party research via soft-dollar arrangements.
In its request for comment, the CSA asked whether the new regulation should be applied only to exchange-traded securities or also in over-the-counter markets where commissions are charged. The SEC has decided that client commissions on agency transactions and fees on certain risk-free principal transactions fall under the soft-dollar rules, but not fixed-income trades executed on a principal basis, most principal trades and other instruments traded with no commissions. The FSA has restricted the application of its rules to equities, options and warrants.
Unlike in the U.S., the CSA addressed commission-sharing arrangements with third-party service providers. Under the proposed instrument, dealers are not restricted from forwarding commissions to a third party on the instructions of an adviser to pay for order execution services or research.
The new proposal follows to a large extent current Canadian regulations that specify that the only services that may be paid for with client brokerage commissions are "investment decisionmaking" and order execution services, provided that the benefit does not accrue to the manager. However, the new proposal provides additional clarity: To ensure that the order execution services or research paid for with the brokerage commissions benefit the client, the adviser should have adequate policies and procedures in place to make sure that a "reasonable and fair allocation of the goods and services received is made to its client(s)."
The proposal also explains which types of goods and services may be paid for with brokerage commissions. Examples of goods and services that are generally considered to be order execution include trading advice, algorithmic trading, trading software and raw market data to the extent it assists in the execution of orders. The CSA is not following the SEC's lead in deeming market data part of research. The FSA has said that raw market data should not be research but should be included in order execution services. Clearing and settlement as well as custody services, according to the CSA, could be considered part of order execution.
