Regulatory Arbitrage

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Regulatory Arbitrage

• William Donegan, Chief Compliance Officer
• Scotia Securities Inc.
• Ken Rousselle, President CEO
• Professional Investment Services (Canada) Inc.

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Definition (Merriam-Webster)

• arbitrage
• Etymology French, from Middle French,
  arbitration, from Old French, from arbitrer to
  render judgment, from Latin arbitrari, from
  arbitr-, arbiter
• Date 1875
• 1 the nearly simultaneous purchase and sale of
  securities or foreign exchange in different
  markets in order to profit from price
  discrepancies
• 2 the purchase of the stock of a takeover
  target especially with a view to selling it
  profitably to the raider

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Regulatory Arbitrage

• The conduct of business in a specific regulated
  entity as opposed to another regulated entity in
  order to gain the benefit of less onerous
  regulatory requirements or cost.

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Economic Law of Regulatory Arbitrage

• All things being equal.
• Given a choice of distribution channels with
  different regulatory requirements and burdens.
• A rational market participant will conduct
  business in the distribution channel with less
  onerous regulatory requirements and/or cost.

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Financial Products Distribution

• Three (soon to be Four) Regulated Distribution
  Channels
• MFDA
• Insurance
• IIROC
• EMD (Exempt Market Dealer)

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Distribution Channel Overview
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Application of the Law of Regulatory Arbitrage 1

• All things being equal.
• A rational market participant will conduct
  business in the Insurance and EMD channels rather
  than the MFDA channel.
• Reason No SRO oversight for Insurance or the
  EMD.

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Application of the Law of Regulatory Arbitrage 2

• All things being equal.
• A rational market participant will conduct
  business in the IIROC channel instead of the MFDA
  channel.
• Reason Both have SRO, but IIROC has the benefit
  of an expanded product shelf.

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Impact on Distribution Channels

• Ageing demographics look for guarantees are
  prime candidates for these products
• Large volumes of existing mutual fund investment
  and future deposits are being directed to
  segregated funds, and in particular GMWB

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Impact on Distribution Channels

• MGA
• Lower transactional costs
• Minimal to non-existent Compliance structure and
  staff
• Limited legal liability?
• Benefits to Advisor
• Easier to do business with
• Higher Compensation
• No Big Brother watching over them

• Dealership
• Higher transactional costs
• Robust compliance and systems
• Comprehensive Insurance Coverage
• Deterrent to Advisors
• Trade Suitability leading to potentially rejected
  trades
• Lower Compensation

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Impact on Distribution Channels

• Maturity and Death Benefit Guarantees reduce risk
  but dont eliminate risk
• Guarantees are being diluted
• Minimum required guarantee - 75/75
  Maturity/Death Benefit Guarantee (no maturity
  date specified)
• Financial Planners use product for very specific
  needs (RIF) and follow Suitability requirements
• Product salespersons are more indiscriminate

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Questions ?

• Is regulatory arbitrage a long term threat to
  the MFDA channel?
• Are Mutual Fund assets migrating to Segregated
  Funds?
• Are advisors going to IIROC Dealers?
• Will HNW assets migrate to EMDs or IC/PMs?
• Who is considering setting up an EMD?

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Heading

• Content
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Distributors Summit 2009