Regulation is one of the key drivers of increasingly low mutual fund fees around the world, as identified in the Fees and Expenses chapter of Morningstar’s latest Global Investor Experience Study, or GIE. While other drivers of lower fees include investor awareness, competition, and the growth of passive products, regulation is the most powerful top-down driver that can lead to rapid and material investor benefits.
Regulators employ two main tactics to ensure that fees are competitive and proportionate to the value that investors derive. The most prevalent, which we explore below, are disclosure requirements and specifications around what and how mutual fund costs can be charged.
Disclosure Requirements Around the World
The majority of the 26 markets in our GIE Study have increased disclosure requirements in recent years. Here are a few examples of how those look across regions:
- Europe. MiFID II requires comprehensive fee disclosure both at the point of sale and annually thereafter. The depth of disclosure required is significant. This regulation puts a new lens on transaction costs, which previously were rarely disclosed, and fills a vacuum that has existed since the 2010 UCITS IV Directive removed the requirement for portfolio-turnover ratios to be disclosed.
- Asia. Multiple Asian markets have strengthened their local disclosure requirements. Since November 2018, the Securities and Futures Commission of Hong Kong has enhanced point-of-sale disclosure by requiring intermediaries to disclose the maximum percentage of trailer fees received for a particular fund per the distribution agreement and to make a one-time disclosure on whether the intermediary is “independent.” Similarly, in 2019, the Securities Investment Trust and Consulting Association of Taiwan began requiring asset managers to clearly disclose the composition of the total expense ratio associated with investing in each share class of an offshore fund. And in China, changes to the regulations on distributor-commission disclosure are underway, with a proposal issued by the regulator to require fund sales agents to disclose commissions and trailer fees to investors.
- North America. The full implementation of the Client Relationship Model (this phase is known as CRM2), which improves the reporting of investment costs and performance, took effect on July 31, 2017. CRM2 has enabled Canadian investors to begin receiving detailed reports on the cost of their investment holdings. Investors now receive an annual fee/compensation report, detailing in dollars the amount paid for products and services.
Though these regulations are a step in the right direction, disclosure requirements on their own are not a panacea.
While improved transparency has benefited investors, in some markets, particularly in Asia, regulators generally need to intervene more forcefully in mutual fund industries to drive material, rapid reductions in mutual fund fees.
Regulating How Mutual Fund Costs Can Be Charged
- Separating embedded distribution costs. One of the most impactful regulatory measures to reduce mutual fund costs has been the separation of embedded distribution costs, which are used by funds to compensate the financial advisors and platforms that act between them and their investors. This separation—now mandated in Australia, the Netherlands, and the United Kingdom—coupled with a trend toward fee-based advice in other markets, has spurred the creation of many new “clean” share classes and a reduction in mutual fund costs, though not necessarily in the total costs incurred by investors.
- Fee caps. In September 2018, market regulator Securities and Exchange Board of India reduced the expense-ratio caps for funds across categories, which passed larger funds’ economies of scale to investors. The expense ratio “slabs” were introduced in 1996 and had not been altered, which meant that the expenses had not reduced commensurate with the growth of the Indian fund industry. With these expense-cap reductions, India has seen a meaningful decrease in asset-weighted median fund-expense ratios. And in Singapore, the government has announced a plan to reduce expenses for the Central Provident Fund Investment Scheme. The implementation of this plan is ongoing and should ultimately lower sales charges to 0% from 3.0% and lower the cap on wrap fees to 0.4% from 1.0%.
The Next Chapter: Regulation and Taxation
The Regulation and Taxation chapter of our GIE Study will be published in late March 2020. The regulatory initiatives highlighted above, while important, are just one aspect of this chapter of the study.
As in previous Regulation and Taxation studies, we will evaluate markets based on four key dimensions:
- Policies that incentivize individuals to invest for their futures
- Operations and distribution
- Governance
- Regulatory structure
In line with the first five editions of our GIE Study, we aim to encourage a dialogue about global best practices for mutual funds from the investor’s perspective.