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6 | INVESTMENT EXECUTIVE NEWS Mid-October 2020 Corporate tax policy is likely to be the main market-mover
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from Trump can likely create con- tinued market volatility beyond the [Nov. 3] election date.”
Hardy was speaking before the president tested positive for Covid- 19, which has added another layer of uncertainty to the race.
With regard to policy, cor- porate tax levels are a signifi- cant topic of contention between Democratic candidate Joe Biden and Republican candidate Donald Trump, as are their stances on the environment and health care.
A report from Toronto- Dominion Bank’s economics department predicts that if Trump wins in November, “markets may expect to see policy lean toward greater tax cuts and more of the same policies from the past,” add- ing that such a result would offer “some comfort in the status quo for business and personal taxes.”
Corporate tax policy is likely to be the main market-mover fol- lowing the election. In 2017, the Trump administration enacted the Tax Cuts and Jobs Act, cut- ting the corporate tax rate to 21% from 35%. If elected, Biden prom- ises to raise the corporate tax rate to 28%. (See story on p. 12.)
Hardy points out that such tax increases tend to have a greater impact on small companies and
technology firms.
To increase corporate taxes
and implement other propos- als, Biden would have to bring Congress on board, which could prove difficult if Republicans retain control of the Senate.
“The biggest factor that will influence whether [Biden] is able to implement any part of his plat- form with regard to taxes or spend- ing is the makeup of Congress,” says Leslie Preston, senior econo- mist with TD, since “the power of the purse lies with Congress.”
Another sector that could be impacted by a Biden win is health care. Biden is in favour of expand- ing the Affordable Care Act and lowering the eligibility age for Medicare to 60 from 65. Those changes would benefit health- care companies, Hardy says.
A Biden win also could mean renewed focus on the environ- ment, which could help compan- ies focused on clean technologies while creating headwinds for the energy sector. Limits on car- bon emissions are a negative for energy companies, Hardy notes, while green-energy subsidies and green-behaviour tax credits would be a positive for compan- ies creating clean technologies, such as electric cars.
The candidates’ immigra- tion policies also could influence
markets, particularly over the long term. Immigration levels have dropped during Trump’s presidency. This, Preston says, could constrain how quickly the U.S. economy can grow, given the country’s aging population. Biden’s platform is pro-immi- gration, which could offset the impact of proposed tax increases.
Should the election result in four more years of a Trump administration, markets will have some understanding of the status quo in terms of policies — but with Trump, nothing is certain.
“Trump’s policies can change overnight with a tweet,” Hardy says. “And so, with a Trump vic- tory, there is continued poten- tial for unexpected behaviours and volatility, which result in unexpected outcomes and mar- ket volatility.”
Another area of unpredictabil- ity is Trump’s trade relations with other countries. The president tends to act unilaterally on trade, instigating trade wars by slapping tariffs on other countries, includ- ing close allies such as Canada.
Biden has protectionist ten- dencies regarding trade too. His administration is expected to take a tough stance against China on issues such as intellec- tual property. A key difference between the candidates is that
Biden promises to take a multi- lateral approach and work with other countries — a style that is likely to be more even-keeled and predictable for markets.
Another unknown in this elec- tion is whether the results will be accepted or lead to recounts and court battles. During the Sept. 29 presidential debate, Trump com- plained about mail-in ballots, claiming the election was “rigged.”
In 2000, Democratic presi- dential candidate Al Gore did not concede the election until Dec. 13 due to an ongoing recount in Florida. (The S&P 500 composite index dropped during that period. However, Preston notes, the weak- ening economy at the time could have accounted for that decline.)
Should the U.S. once again find itself in a situation in which the election results are contested, markets are likely to respond negatively. “[Recounts] tradition- ally [are] a recipe for financial market volatility,” Preston says.
However, such volatility would be short-term in nature, she says,
while other concerns, such as the pandemic’s effects on the health of the population and the economy, are likely to have a more long-term influence on markets.
The Federal Reserve Board’s monetary policy also is likely to impact markets, Hardy says.
But what will U.S. monetary policy look like after the election? The TD report notes that Biden supports an independent Fed and, as president, would not criti- cize the Fed publicly or nominate unconventional candidates for board positions. This is in stark contrast to Trump, who has repeat- edly lambasted Fed chair Jerome Powell via Twitter and nomin- ated questionable candidates — such as Judy Shelton, who openly questioned the need for the Fed’s
independence — for board roles. “At this point, [given] where we are in the economic and market cycle, monetary policy is probably a much more important component of asset evaluation than the U.S. election results,” Hardy says. IE
“With a Trump victory, there is continued potential for unexpected behaviours
and volatility”
A DSC recommendation to a client will be tough to justify
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Administrators (CSA) unveiled the final part of their policy tar- geting embedded fees in mid- September. The first part, announced in February, effect- ively bans DSC funds — except in Ontario, where the government is opposed to an outright ban. The entire CSA is participating in the second part, which outlaws the practice of discount brokers receiving trailer commissions. Both measures take effect on June 1, 2022.
Ahead of the reforms’ imple- mentation, the CSA is warning the industry against actions that would harm investors and stressing that firms “treat inves- tors fairly and recommend suit- able products” as the industry adapts to the new requirements.
In particular, the CSA indi- cates the provincial regulators and the self-regulatory organiza- tions — the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) — “will be highly attuned to inappropriate sales of DSC products ahead of the ban.”
Some observers worry the countdown to curbs on DSC funds will lead companies to push those funds more heavily before they go extinct.
“I believe regulators are con- cerned with seeing a sudden
increase in DSC purchases as the effective date approaches,” says Karen McGuinness, senior vice president, member regulation, compliance, at the MFDA.
The MFDA has seen a “material decrease” in DSC assets among fund dealers over the past few years, she says, “so a change in the opposite direction would raise red flags.”
These concerns have only intensified with the effects of the Covid-19 pandemic on the economy and financial mar- kets — effects that underscore the fragility and importance of investor liquidity.
“Covid-19 has highlighted how some products, including mutual funds sold under the DSC option, would not be appropri- ate for investors who might need emergency access to funds,” the CSA stated in an email.
Indeed, the prospect of pay- ing redemption fees in order to seek safety only exacerbates the pain of plunging markets.
“With these elements in mind, the CSA will be cognizant of any changing trends in DSC sales in advance of the ban coming into effect,” the regulator warned.
Between now and mid-2022, the industry is on notice — and the window for appropriate DSC sales is rapidly closing.
With the imminent demise of DSC funds and heightened sensi- tivity to the fair treatment of
investors during the pandemic, determining an appropriate DSC recommendation is increasingly fraught with complexity.
Dan Hallett, vice president, research, and principal with HighView Asset Management Ltd. in Oakville, Ont., suggests the CSA’s forthcoming client- focused reforms (CFRs) — coupled with the Ontario Securities Commission’s (OSC) proposed restrictions on DSCs — may pro- vide a framework for assessing whether DSC recommendations will be considered offside.
The CFRs are slated to take effect ahead of the DSC/trailer ban in two stages: enhanced conflict of interest provisions will be adopted by June 30, 2021, and the remain- ing requirements will come into force by the end of next year.
The CSA has granted dealers relief from the CFRs’ enhanced conflict of interest requirements leading up to the DSC ban. Yet, the CSA also singled out the new conflict provisions as being central to resolving its long- standing investor-protection and market-efficiency concerns with embedded fee structures.
Those concerns led to the CSA’s conclusion, outlined in its 2017 consultation paper, that these structures fundamentally misalign industry and investor incentives, encourage biased rec- ommendations, harm investors and inhibit industry competition.
Banning DSC funds while sig- nificantly toughening the rules on conflicts is expected to negate the destructive effects of embed- ded fees.
The CFR measures will require that “material conflicts” are either
resolved in the client’s best inter- est or avoided entirely. Under the new rules, this won’t be as simple as disclosing a conflict or getting clients to sign off on it.
“Determining what is in the ‘best interest’ of the client is a facts- and circumstances– specific determination, not a check-box exercise,” the CSA’s newly issued guidance on imple- menting the CFRs explains.
That guidance indicates that the CSA, IIROC and the MFDA will take a principles-based approach to assessing whether a conflict has been addressed in a client’s best interest, and also specifies that disclosure alone isn’t enough to deal with signifi- cant conflicts.
The CSA stated it expects firms to use other tools along- side disclosure, such as pre- trade controls and post-trade reviews, to ensure that conflicts are addressed adequately.
The regulator warned that simply securing a client’s con- sent to proceed with a trans- action that involves a material conflict won’t be satisfactory.
“Consent without other action on the part of the registrant will not be enough to address a material conflict of interest in the best interest of a client,” the guidance on CFRs states.
Alongside these tougher expectations for resolving con- flicts, Hallett suggests that the parameters outlined in the OSC’s proposed curbs on DSC sales may provide a guide for appro- priate transactions.
The OSC seeks to prevent the most egregious uses of DSC funds by prohibiting sales to investors
aged 60 and older, banning the use of leverage and capping account sizes at $50,000, among other pro- posed constraints.
“[The OSC’s proposals] paint a pretty specific and restrictive picture of what may be deemed appropriate DSC sales,” Hallett says. “Everything else would be viewed as inappropriate.”
The OSC, despite taking a softer line on DSCs generally, indicated it shares the CSA’s con- cerns about the fair treatment of investors ahead of the DSC ban in the midst of a pandemic.
“In Ontario, we are still consid- ering the comments received on our DSC proposals, but we also have an interest in monitoring to ensure that investors, who may have heightened needs for liquid- ity due to the pandemic, are being treated fairly and sold suitable products,” says Kristen Rose, man- ager, public affairs, with the OSC.
To that end, the regulators will be reviewing the suitabil- ity of DSC sales as part of their ongoing compliance work, notes McGuinness. For now, whether those sales are in Ontario or else- where won’t matter. “Pre-ban, the suitability standard is the same across Canada,” she says.
That approach is echoed by IIROC, which stated its “focus is to ensure that there are no inappropriate sales of invest- ment products (including mutual funds) in all jurisdic- tions, regardless of whether or not a particular jurisdiction has decided to ban DSC products.”
By mid-2022, DSC funds should be on life support. Until then, regulators will be on the lookout. IE
“Regulators are concerned with seeing a sudden increase in DSC purchases as the effective date approaches”