By Tom Bradley

There was great news today. The Investment Industry Regulatory Organization of Canada (IIROC) released a proposal to enhance disclosure requirements for over-the-counter (OTC) trades, including bonds.

IIROC is one of two regulatory bodies for investment dealers (why have one when you can have two?). The other is the Mutual Fund Dealers Association (MFDA), which regulates Steadyhand.

While our industry generally scores poorly on transparency, OTC trading is particularly bad. There are no public quotes that the client can look at to assess how well the dealer has done on his/her behalf. In the case of bonds, investors don’t know what commission they are paying, and most don’t know that they’re paying a commission at all.

In essence, the dealer is taking a commission out of the spread or difference between what the trader acquires the bond for (i.e. a 5-year bond priced at $100 and yielding 5%) and what it goes into the client account as (i.e. $100.75 yielding 4.85%). Every dealer’s process is a little different and the size of the spread depends on the type of account and how big the trade is. Some advisors facilitate trades at a very small spread.

But no matter how it works, none of this is revealed to the client.

I don’t know if the new disclosure rules will eventually happen, how it will work, or whether it will be effective, but I’m encouraged with the direction IIROC is taking. If clients are going to make an informed decision about how they want to invest in bonds, they need to understand what they’re paying.

Buying individual bonds makes sense if the account is big enough, the client or advisor knows what they’re doing and the pricing on the trades is reasonable. For other investors, a low-fee bond fund is a much better option (note: most bond funds are high-fee and don’t make sense). With a fund, the investor gets professional oversight and a diversified portfolio of bonds, which is particularly important when investing in corporates.

I am an equity guy by training, but I’ve worked with family members who held bonds in their brokerage accounts. From that experience, I can say unequivocally that better disclosure, any disclosure, is desperately needed and long overdue.