Promoting competition

16. Enact a prohibition on registrants benefiting from tying or bundling of capital market and commercial lending services, and a requirement for an attestation by a senior officer of the appropriate registrant under the applicable disclosure requirements.

Smaller and independent investment dealers have repeatedly raised the issue of intermediaries engaging in practices which may impede competition, such as arrangements where a commercial lender purportedly requires clients to retain the services of an affiliate investment dealer for their capital raising and advisory needs, as a condition for preferential rates on commercial lending transactions. As a consequence, issuers do not maintain their existing relationships with their independent investment dealer or exempt market dealer.

Although tied selling is restricted under the federal Bank Act, as well as National Instrument 31-103, multiple presentations from dealers and issuers have advised that commercial lenders, through their affiliated broker dealers, continue to engage in these practices. We heard from multiple stakeholders that these practices are having significant negative impacts on the viability of independent dealers and on the ability of issuers to receive independent advice. However, we have also heard that some intermediaries indicate that their bundling of capital markets and other services result in lower financing costs for issuers. In addition, it may not be in the best interest of issuers to procure their underwriting and advisory services from their lender — they may benefit from independent advice.

Discussion:

The Taskforce proposes making legislative amendments to the Securities Act to extend the provisions of National Instrument 31-103 to prohibit registrants, as a consequence of an exclusivity arrangement, from providing capital markets services under certain circumstances.

An exclusivity arrangement would be defined to arise when an issuer is required, as an inducement for any service received from or in connection with any direct or indirect benefits received from a financial institution or any other affiliate, to terminate or curtail the services of any specified firm registrant and replace it with services provided by a specified firm registrant affiliated with the financial institution.

A senior officer of a specified firm registrant, such as the Ultimate Designated Person, would attest that no such prohibited conduct has occurred each time the registrant provides such capital markets services to a reporting issuer with whom it had a commercial banking relationship. Stakeholders believe that such an attestation would be the most effective measure to drive behaviour beneficial to issuers, independent dealers and the capital markets generally.

The Taskforce also proposes that a lender be considered a “connected issuer” for a specified firm registrant. This would mean that, under National Instrument 33-105, an independent underwriter would be required.

These steps are carefully being proposed to ensure that this policy would be in line with provincial jurisdiction over registrants.

Would commenters consider this an important step towards re-invigorating Ontario’s intermediary market, particularly for smaller or independent intermediaries? Are the provisions in National Instrument 31-103 sufficient or should the amendments go further to prohibit exclusivity arrangements?

What provisions should the proposed prohibition include? Do commenters agree that it is in the best interest of issuers to receive advice independent of their lender? Do commenters agree that mandating independence from lenders in underwriting and advisory will enhance investor protection? What would be the implications, including costs, to issuers of doing this?

To increase the participation of independent dealers, should the Taskforce consider recommending mandating a specific percentage of all underwriting arrangements to be comprised of non-bank owned investment dealers?

Another option considered was a blanket prohibition for any registrant to provide capital market advisory or underwriting services to an issuer to which an affiliated financial institution is also providing commercial lending services. Do commenters feel that a full prohibition on lenders providing capital markets services to issuers would better achieve the desired outcomes?

17. Increase access to the shelf system for independent products

Currently, an estimated 80 per cent of distribution of investment products to investors is through bank-owned shelf distribution channels. There have been concerns raised that such shelves incentivize the sale of proprietary products and restrict access to products from independent product manufacturers. In the case of smaller independent manufacturers, their products are suggested to be of higher risk and, as such, excluded from the shelf.

In October 2019, the OSC released Client Focused Reforms (CFRs) which will require bank-owned dealers that offer independent products in addition to related products to ensure that their shelf development and know-your-product processes, as well as their advisors’ product recommendations, are not biased towards proprietary products.

Discussion:

The Taskforce supports the OSC’s CFR initiative and reiterates the need for CSA/SRO oversight of product shelf issues, including targeted reviews and publication of guidance regarding conflicts of interest as a result of shelf composition.

In addition, the Taskforce proposes that closed product shelves/proprietary-only shelves should not be allowed in the bank-owned distribution channel and recommends a new requirement that all bank-owned dealers include independent products on their shelves if requested by an independent product manufacturer, unless the bank-owned dealer has determined, on a reasonable basis, that a particular product is not suitable for their clients. The OSC should consider a regulatory reporting requirement where such bank-owned dealers would report on the percentage of proprietary versus independent products on the shelf or sold on a quarterly basis.

To ensure that independent products are not unfairly excluded, bank-owned dealers will be required to document a detailed rationale when independent products are not added to their open shelves, and to provide a copy of that documentation to the independent product manufacturers that have requested a product be included on the shelf, within a certain period of time. Independent product manufacturers should be able to raise these restrictions with the regulator/SRO and their compliance staff should review such documentation to ensure compliance with regulatory requirements, including conflicts of interest requirements.

What concerns would commenters have with this approach? Would these requirements increase the access of independent and alternative products to retail investors? Should any entity that sells only proprietary products be labelled a sales person? Should there be a prohibition on charging a fee to gain access to a shelf, including no-advice channels? Should there be a review of redemptions from high performing third party funds into proprietary funds and report on those as well?

18. Introduce a retail investment fund structure to pursue investment objectives and strategies that involve investments in early stage businesses

We have heard there is a funding gap for small issuers that want to raise capital for their business or that it is very costly for an issuer to become listed. In addition, there are retail investors that want to invest in these types of investments. However, individual investors may not have the know-how and confidence to make decisions on their own. The investment expertise of asset managers, retail investors’ relationship with their dealing representative and established distribution channels in the public funds industry can help to provide the access and the confidence for retail investors to explore private equity investing. Asset managers can also lend their expertise to guide and help small businesses to overcome challenges. Retail funds’ participations will further increase the depth in the private equity funding with more buyers and sellers.

Discussion:

The Taskforce proposes that the OSC establish a retail private equity investment fund proposal for public input to incorporate private equity investing good practices, and the strengths of the retail investment fund industry. The Taskforce proposes that the OSC examine an established example in other jurisdictions, such as the Interval Fund concept in the U.S.

In mutual funds, investors have the right to redeem on a frequent basis confining mutual funds to invest in liquid investments. In an interval fund, the fund has the control to provide liquidity to investors. Retail investors do not have the right to redeem. An interval fund is a type of closed-end fund that is not listed on an exchange, but periodically (every three, six or twelve months) offers to buy back a stated portion of its shares (typically 5 per cent to 25 per cent) from shareholders. Shareholders are not required to accept these offers.

Interval funds are priced daily at net asset value (NAV), but since they are not listed on an exchange, they do not trade above or below NAV.

Given the periodic repurchase schedule of an interval fund (as opposed to the daily redemption associated with a conventional mutual fund), portfolio managers can take a longer-term investment view and take advantage of investing in less liquid, potentially higher-return asset classes that may not be suitable for a conventional mutual fund offering daily liquidity. This may enable a portfolio manager to invest in more “private equity” type investments.

Do you think this type of fund would provide a meaningful new source of financing for small businesses in Ontario? Should the scope of the investments, or a portion of the investments, for this type of fund be specifically limited to small businesses or expanded to other kinds of businesses? Since these funds would be available to retail investors, are there any specific conditions that should be prescribed to protect investors?

19. Improve corporate board diversity

Since 2014, TSX-listed companies have been required to provide disclosure regarding their approach to gender diversity, including data regarding the representation of women on boards of directors and in executive officer positions. The disclosure follows a “comply or explain” model and does not require TSX-listed companies to adopt any gender diversity policies and practices, including targets. Progress on the representation of women in these leadership roles at TSX-listed companies has been slow, with the OSC reporting that the total board seats occupied by women in their review samples increased only from 11 per cent in 2015 to 17 per cent in 2019. Based on the OSC’s 2019 review, only 22 per cent of companies in their review sample had adopted targets regarding the representation of women on boards.

Investors require data on diversity on the board and in executive officer positions to make informed investment and voting decisions. footnote 1

As of this year, companies incorporated under the Canada Business Corporations Act (CBCA) are required to report representation of the following designated groups on boards of directors and in senior management: women, Aboriginal peoples, persons with disabilities and members of visible minorities.

Discussion:

The Taskforce proposes amending securities legislation to require TSX-listed companies to set targets, and annually provide data in relation to the representation of women, black people, indigenous people, and people of colour (BIPOC), on boards and in executive officer positions. What should be the appropriate target for women and BIPOC’s on TSX-listed company boards? One suggestion we have heard is 40 per cent women and 20 per cent BIPOC. TSX-listed companies are already required to report on their progress towards achieving any targets, but they should also be required to review and assess the appropriateness of the targets on an annual basis.

What timeline should be prescribed for these targets to be achieved, for example, within three to five years? What would commenters think would be ways to increase compliance for companies who do not meet these targets?

The Taskforce also proposes to amend securities legislation to require TSX-listed companies to adopt a written policy respecting the director nomination process that expressly addresses the identification of candidates who are women and BIPOC during the nomination process.

The Taskforce further proposes to amend securities legislation to set a 10-year maximum tenure limit for directors, with an allowance that 10 per cent of the board can exceed the 10-year maximum for up to two years. This is aimed to encourage an appropriate level of board renewal. The issue of board entrenchment and board renewal is a concern from a governance perspective as continued refreshment of the board helps to ensure that fresh and diverse perspectives and skills are brought into the boardroom.

Lastly, the Taskforce recommends that diversity — including racial diversity — be similarly represented at the board and executive level of the OSC who will be responsible for discharging this important mandate.

Please provide feedback on the proposal above and identify any challenges or concerns that may arise. Should this requirement be extended to all reporting issuers?

Footnotes