Overview

On January 29, 2015, the Canadian Securities Administrators (CSA) published CSA Staff Notice 81-325 Status Report on Consultation under CSA Notice 81-324 and Request for Comment on Proposed CSA Mutual Fund Risk Classification Methodology for Use in Fund Facts (Staff Notice).

As its names  reveals, the Staff Notice was a follow-up to previously issued CSA Staff Notice 81-324 (Previous Staff Notice).  The Previous Staff Notice proposed a new framework and methodology (Proposed Methodology) for the purpose of calculating and disclosing a fund’s volatility risk in its Fund Facts document (or other similar documents for other types of investment funds, such as ETFs) and requested feedback on the Proposed Methodology.  Currently, the manager of a mutual fund has the discretion to choose what it believes to be an appropriate risk methodology.  The CSA were therefore seeking industry feedback on the merits of introducing a standardized methodology  to determine a fund’s risk rating.

The Staff Notice set out the key themes arising from the feedback received, as well as potential next steps to be taken by the CSA.

Key Themes

Certain of the key themes discussed in the Staff Notice were as follows:

  • Use of Standard Deviation (SD) as the risk indicator – the majority of commenters agreed with the use of SD as a fund’s risk indicator.
  • 10 year history to calculate SD – many supported a 10 year history, as such a relatively lengthy measurement period would be less sensitive to sudden market changes. Such period would also provide a reasonable balance between indicator stability and availability of data.  However, concerns were raised by some that a shorter period is more appropriate given that the lifespan of the majority of mutual funds is only 5 or 6 years.
  • Fund series/class used - most commenters agreed that, in most instances, all series and classes of a Fund bear the same risk and therefore applying the Proposed Methodology to the oldest series/class of a fund (rather than all series/classes) is appropriate.
  • Use of reference index data – for funds without a 10 year history, the Proposed Methodology contemplates using the returns of an appropriate index to provide the missing performance data required to calculate SD. There were a wide range of comments, concerns and discussion points that arose from this suggestion.
  • Six Category Risk Scale - the Proposed Methodology contemplates changing the Fund Facts volatility scale from five bands to six. Most were opposed as such a change would likely lead to a large number of funds being re-labeled with an apparent higher risk classification, without any change in the fund’s volatility.
  • Monitoring and changing of risk categorizations – the Proposed Methodology sets out a monthly process that must be followed by fund managers when monitoring changes in the risk categories. Many commenters felt that monthly monitoring is excessive and burdensome and that an annual monitoring process would be more appropriate.

Next Steps

The CSA confirmed that SD continues to be the preferred risk indicator for the Proposed Methodology.  The CSA will continue also to assess the impact of moving to a six category risk scale.  Proposed rule amendments, based on the feedback received on the Proposed Methodology, are expected to be issued for comment by the CSA at some point in 2015 addressing risk classification.