81-402 - Striking a New Balance: A Framework for Regulating Mutual Funds and Their Managers [Concept Proposal]

An overview

A truism:  the importance of the mutual fund industry to Canadian consumers
We know we state the obvious when we remark that the mutual fund industry in Canada has experienced tremendous growth in the last two decades.    Its equally obvious that Canadian investors continue to place unprecedented amounts of money into mutual funds and other similar investment vehicles.  The assets under management by mutual fund managers have grown more than threefold since Glorianne Stromberg published her seminal report recommending changes to our mutual fund regulation in 1995.^[1]   As of January 31, 2002, Canadians had invested $427 billion in over 2,500 mutual funds managed by some 75 mutual fund managers.   Based on demographics we know this trend will continue and will likely accelerate.^[2]Certainly a sizeable amount of public money and, by extension, public trust is invested—and will continue to be invested —in this key segment of the financial services marketplace.

Our mandate
We are charged with regulating this maturing industry and it is incumbent upon us to ensure that our regulation keeps pace not only with the complexity and creativity of the industry, but also with global standards.  We must strike the correct balance between protecting investors and fostering fair and efficient capital markets where healthy competition and innovation can operate to multiply investment choices and services.  All the while, we must be cognizant of the fact that the Canadian mutual fund industry operates in an increasingly global marketplace where adherence to world standards will be central to its continued success.

Our thesis
In recent years, a number of voices have called for improved mutual fund governance and other changes to the way we regulate mutual funds in Canada.   This concept proposal underscores our agreement with earlier commentators that a well-defined fund governance system—one that relies on increased scrutiny of fund managers by independent groups charged with looking after investors’ best interests—is a desirable thing.  

But while we accept the need for improved fund governance, we are not interested in simply layering new regulation on top of old.  We think it is important to understand the goals of fund governance and where they fit within the broader context of mutual fund regulation.  The result is a proposal than goes beyond simply recommending fund boards.  This concept proposal describes a renewed framework for regulating mutual funds and their managers that is congruous and comprehensive yet flexible and tailored to suit the Canadian mutual fund industry.

Our desire for an informed dialogue
We launched the current foray into regulatory reform by asking Stephen Erlichman, a senior partner of Fasken Martineau DuMoulin LLP in Toronto, to provide us with a summary of the fund governance discussion in Canada and abroad and to make specific recommendations to improve fund governance.  We released his report entitled Making it Mutual: Aligning the Interests of Investors and Managers: Recommendations for a Mutual Fund Governance Regime for Canada during the summer of 2000 to generally further the discussion on this subject and to elicit further comment.^[3]    

Since we released Mr. Erlichman’s report, we have consulted widely on the topic of fund governance with industry participants, their legal and accounting advisers, legal scholars, and international mutual fund regulators.   At the same time, we took this opportunity to learn more about the industry and its practices.  

The background reports: our empirical and legal research
We began our empirical research by reviewing what mutual funds say about their governance practices in their annual information forms (a required disclosure item since February 1, 2000).  We then held face-to-face interviews with more than a third of the mutual fund managers across Canada, travelling from Québec to British Columbia.  Finally, we sent an electronic survey to each fund manager with fund governance experience and worked to obtain a 100 percent response rate.  We are satisfied that our research has given us additional insight on the business realities of the Canadian mutual fund industry.  Staff of the Ontario Securities Commission (the OSC) have summarized this research in a background paper to this concept proposal entitled The Canadian Mutual Fund Industry: Its Experience With and Attitudes Toward Mutual Fund Regulation: A Background Research Report to Concept Proposal 81-402 of the Canadian Securities Administrators.  We refer to this background paper as the staff research paper.

Our understanding of the mutual fund business is complemented by our research into the legal environment mutual fund managers operate in.  We know that most mutual funds in Canada are structured as trusts, therefore we retained David Stevens, a trust law expert with Goodman and Carr LLP in Toronto.  Mr. Stevens has prepared a second background paper to this concept proposal entitled Trust Law Implications of Proposed Regulatory Reform of Mutual Fund Governance Structures.  In this paper, Mr. Stevens analyses the private law context in which mutual funds currently operate and suggests ways in which a fund governance regime can be created using that body of law. We refer to this background paper as the Stevens legal research paper.  

Thank you
We appreciate the many industry participants—including the members of the Fund Governance Committee of the Investment Funds Institute of Canada—who have generously shared their time and thoughts with us.