The Canadian Securities Administrators (CSA) have now implemented amendments to National Instrument 31-103 Registration Requirements Exemptions and Ongoing Registrant Obligations (NI 31-103) and to its Companion Policy 31-103 CP as amended (the Policy Statement). This is the second phase of its long standing project on enhancing a registrant’s relationship with its clients, called the Client Relationship Model (CRM) Project. This second phase (Phase II) mainly expands cost and registrant compensation disclosure and introduces performance reporting requirements. These changes, while strongly debated with members of the industry as to the time and expense they entail, have not been altered substantially by the CSA since their latest proposal last year, except as to the transition period over which they will be implemented. Certain of these changes will come into application on July 15, 2013, while others will be introduced on July 15, 2014, 2015 and 2016. See the table under “Transition” below.

These new disclosure and reporting requirements apply to all registered firms, including investment fund managers as regards providing prescribed information required by registered firms to perform their own reporting obligations, and are focussing essentially retail clients, regardless of their sophistication. Some of these requirements will therefore not have to be supplied to permitted clients that are not individuals. Also, dealers merely executing trades for clients under the direction of the clients’ advisor will be subject to lighter obligations.

The Phase II amendments will also impact dealers that are members of the Mutual Fund Dealers Association (MFDA) and the Investment Industry Regulatory Organization (IIROC). While these self-regulatory associations (SRO) have carried out independently changes to their own rules over the last years to meet objectives of the CRM, these amended rules were suspended by the CSA in order that they be harmonized with the Phase II amendments. Further changes to the MFDA and IIROC rules are expected to follow.

A link to the CSA Notice is found here:

http://www.lautorite.qc.ca/files//pdf/reglementation/valeurs-mobilieres/31-103/2013-03-28/2013mars28-31-103-avis-publ-en.pdf (PDF)

Phase II amendments will amend current disclosure and reporting obligations as follows:

Definitions

Certain new terms have been added to assist in interpreting the new obligations, such as book cost, operating charge, original cost, total percentage return, trailing commissions and transaction charges.

Some commenters have raised the difficulty of answering accurately when determining book cost as applied to different securities over time, due to legislative changes, product features and the quality of data relied on. The CSA acknowledged these difficulties and granted a two-year transition period to July 15, 2015 to allow greater standardization in the calculation book cost.

Investment Fund Managers

Investment fund managers will have the duty to provide dealers and advisors whose clients own securities of investment funds they manage with information on a timely basis, concerning deferred sales charges, any other charges deducted from the fund securities’ net asset value, as well as concerning trailing commissions paid to dealers or advisors, as required for these registrants to meet their reporting obligations. This obligation for investment fund managers will phase in on July 15, 2016, together with the related reporting obligations of dealers and advisors (see below Pre-trade Disclosure of Changes).

Relationship Disclosure Information (RDI)

Clarifications have been made in the formulation of current RDI requirements in Part 14 of NI 31-103. Section 14.2(2)(m) will require registered firms to explain to their clients how investment performance benchmarks may be used to assess the performance of the client’s account, and to inform them of any options for benchmark information that are available with the firm. Further discussion of appropriate benchmarks may be found in the Policy Statement.

A dealer merely executing trades of securities directed by the client’s registered advisor will be relieved of its RDI obligations as regards those trades respecting the risks associated to the products, as well as leverage, the products’ suitability, and know your client (KYC) obligations. In addition to its remaining RDI obligations, the dealer will now have to give its client a 60-day written notice of any new operating charges and of any increase in existing operating charges.

The Policy Statement emphasizes in the Relationship Disclosure Information section the need for registered firms to take the time to communicate with their clients in simple words in-person, by telephone or otherwise to adequately explain the reports provided to them. The CSA expects registered firms to have policies and procedures requiring registered individuals to be able to demonstrate they have done so.

Pre-Trade Disclosure of Charges

Before accepting to trade a security in a non-managed account for a client, a registered firm will have to disclose to the client beforehand the charges or a reasonable estimate applicable to the trade, in dollars or percentage, including deferred sales charges, where they apply, and if the firm will receive a trailing commission respecting the security. This disclosure may be oral or in writing. This new provision does not apply if the client is a permitted client other than an individual or if the trade is performed on the direction of the client’s advisor.

Determining Market Value

When determining the market value of a security for client reporting purposes, a registered firm will need to follow a set of valuation methods, selected by the registrant exercising professional judgment, taking into account whether the security is listed on an exchange or not, whether it is an investment fund or not and the extent to which the valuation information is available. If the firm is able to estimate the market value of a security despite the fact there is no active market for it, it will have to notify clients by a written statement to that effect. If a registered firm reasonably believes the market value cannot be determined for a security position, it must be excluded from the calculation of the position cost information in prescribed statements, by assigning it a value of zero, as mentioned in news. 14.11.1(3) and s. 14.19(7) of NI 31-103.

This hierarchy of valuation methods may allow for potential difficulties in calculation and potential confusion for clients, particularly with respect to the preferred method of bid/ask price calculation where deviations in the reported prices would not necessarily reflect a security’s market value. Other comments have been made that the bid/ask calculation method is not appropriate for some types of securities, such as long and short securities. While the suggested currently used last trade calculation was not retained, other alternative forms of calculation were included, some of which comprise “observable” and “unobservable” inputs, which are concepts under International Financial Reporting Standards (IFRS). Please consult in this respect the Policy Statement at s. 14.11.1 for further discussion on the matter.

Trade Confirmations - Debt Securities

Registered firms will be required to report compensation from debt securities transactions, whether as a total dollar amount of compensation applied to the transaction, or as a commission. If compensation was in any other form, such as a mark-up, a mark-down or a service charge, a prescribed notification in writing must be given to that effect. The Policy Statement mentions that each trade should be reported in the currency in which it was executed and, if in a foreign currency, the exchange rate should be reported to the client. As the calculation of the dollar value of each foreign exchange spread may be complicated technically and remuneration from the spread may not be significant, perhaps future amendments to the rule may alleviate the requirement.

Account Statements and Other Statements

Account statements which registered firms are required to deliver to their clients will now appear in two sections reporting specified information on all transactions made during the reporting period, and separately, from July 15, 2015 onwards, on securities held by the registered firm. Statements must still be delivered quarterly, except if a client request that it be monthly. This latter requirement was clarified in the wording of NI 31-103.

Quarterly additional statements, which will provide information generally similar to the one the registrant provides on client securities held by the registrant, may be combined with the account statements and must be delivered by a registered firm starting July 15, 2015:

  1. to clients owning securities held by a party other than the registered firm, when the firm has trading authority over the security or the client’s account where it is located;
  2. to clients owning a security for which the registered firm receives continuing payments from the security issuer or other party; and
  3. to clients owning a security for which the registered firm acts as dealer or adviser of record for the client, where the issuer is a scholarship plan, a mutual fund or a labour sponsored fund or venture capital corporation under legislation of a Canadian jurisdiction.

Position cost information will be disclosed for every security’s position in an account statement or additional statement, or separately. Position cost information will provide the market value of the security together with, at the option of the registered firm, either the security’s original cost or book cost, as defined. When a security is transferred from another registered firm, and position cost is unavailable, the Policy Statement tells us that market value will suffice.

Effective July 15, 2015, when the new provisions come into force, investment fund managers (where there is no dealer or advisor of record) and scholarship fund dealers that are not also registered as dealers or advisors will have to provide the account statements and additional statements with the additional disclosure discussed above.

There have been a number of comments challenging the appropriateness of requiring registered firms to track client-name securities held outside the firm as they do not have IT systems in place to do the tracking and to seize the information on a timely basis. Setting up such systems would be costly and take time. The CSA consequently granted a two year transition period to July 15, 2015 to allow firms to meet the requirement. Also, dealers are exempted from them in respect of accounts where they execute trades only on direction of the client’s advisor and for accounts of permitted clients. Mutual fund securities not held in a registered firm’s books should not cause hardship as the CSA also provides for the investment fund manager to supply the firm with the reporting information concerning the fund’s securities.

Report on Charges and Other Compensation

Registered firms will now have to provide each client with an annual summary of all charges incurred in the client’s account and all other compensation, including compensation received from third parties, showing their nature and amount, that have been generated by the client’s account.

There have been comments that reporting the calculation of charges for this annual report as they relate to debt securities and disclosure of mark-ups and mark-downs as compensation of the registered firm may result in a challenging exercise when comparing these charges for the same securities between dealers, as the cost of their position in each dealer’s inventory may differ.

The disclosure of trailing commissions received by registrants for mutual fund securities by issuer and by account with the registrant also brought resistance from the industry. Provisions were added in NI 31-103 to require this disclosure to be provided to registrants by the mutual funds’ investment fund managers.

The Policy Statement suggests that payments meeting the definition of “trailing commission” in NI 31-103 must provide, with adjustments, a prescribed notification for trailing commissions.

Investment Performance Reports

The Phase II amendments introduce account performance reporting requirements to clients by registered firms. Investment performance reports are account based, so that securities reported separately in additional statements (see Account Statements and Other Statements above) respecting the same account must be included in the investment performance report. Consolidation of investment performance reports for more than one account is allowed if the client consents and the consolidated report specifies the accounts and securities that are consolidated.

These account performance reporting requirements do not apply to accounts existing for less than 12 months, accounts in respect of which the dealer only executes trades directed by the client’s advisor and accounts of permitted clients that are not individuals.

These account performance reports are required to disclose the opening market value of the account, the market value of deposits in and withdrawals out of the account for the latest 12-month period and since inception.

The calculation methodology chosen by the CSA to determine the annualized total percentage return for a client’s account is the money-weighted rate of return (i.e. the dollar-weighted method), following a long debate with the industry on the merits of that method over those of the time-weighted method, which the industry argues is currently used by most firms, despite the suggestive wording of s. 14.19.1(i) of amended NI 31-103. It will be interesting to see how the money-weighted rate of return methodology in investment performance reports will achieve over time the CSA’s objectives of transparency and comparability of securities’ performance results for investors.

Scholarship Plan Dealers

Scholarship plan dealers will now have to include in their RDI an explanation of any terms of a scholarship plan that, if breached by the client or designated beneficiary, may cause the latter to suffer a loss of contributions, earnings or government contributions in the plan.

Scholarship plan dealers will also have to provide clients with specific investment performance reporting requirements.

Transition

Transition periods for Phase II amendments cover, as discussed, one, two or three years from adoption of the amendments.

The table below sets out the transition periods for the key amendments discussed above.

Click here to view table.