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Guaranteed Investment Certificates – dull – but interesting!

For many investors, Canada’s most boring investment has to be a GIC (Guaranteed Investment Certificate). If you were thinking Canada Savings Bonds – they were eliminated in the 2017 federal budget. However, is GICs dull reputation truly deserved?

Lately, there has been renewed interest about this safe, dull-as-grass investment...

Question: What is a GIC?

Answer: A GIC is generally described to be a term deposit with a Canadian bank, trust company, credit union or caisse populaire. The term can be anywhere from a 30 day term to a term of 5 years. The “G” in GIC stands for “guaranteed” but guaranteed by whom? With one significant exception, in the case of an insolvency of a financial institution, almost all GICs in Canada have a government depositor protection program. For example, the Canadian Deposit Insurance Corporation (CDIC) is the federal government agency responsible for chartered banks and trust companies in Canada. In the case of insolvency/bankruptcy, the government agency ensures that eligible GIC investors are paid their full principle (up to certain maximum limits) along with any accrued interest owing. The one exception? In the Province of Manitoba, GICs issued by Manitoba-based credit unions have a depositor protection plan however it is not backed by government as there is no affiliation with any provincial government agency. However, here in the province of Ontario, GICs issued by credit unions are covered. As per DICO’s website: DICO’s (Deposit Insurance Corporation of Ontario) role is to protect depositors of Ontario credit unions and caisses populaires from loss of their deposits. Deposit insurance is part of a comprehensive depositor protection program for all Ontario credit unions which is backed by provincial legislation.”

In my view, if there is no comprehensive deposit protection program backed by federal or provincial legislation - then it is not a true GIC.

Question: How are deposit brokers and advisors paid? Are GIC finder’s fees a referral fee or a commission?

Answer:  Both! In speaking at great length with one of the founding fathers of the GIC deposit brokerage industry many years ago (sadly, now long gone) he described “agency agreements“as formal referral arrangements he personally made at each bank or trust company. I believe the first referral arrangement he made was with Morgan Trust in Toronto - late ‘70’s. The founder described mutual fund remuneration as commissions and GIC remuneration (to the dealer) were considered to be finder’s fees or referral fees. I believe that things haven’t changed since the 1970’s and banks and other financial institutions still pay finder’s fees or referral fees derived from GIC business to either the adviser’s head office or for smaller firms – directly to the deposit broker. Therefore an advisor can claim that he is earning GIC fees directly or is being paid a GIC commission from his head office. In the regulatory world it is said that there are very important differences between the definition of a commission versus the definition of a fee. GICs can have both fees or commissions. Sorry about that - apologies to securities lawyers everywhere!

Question: What is the history of the deposit brokerage business in Canada?

Answer: A thorough search on the internet did not reveal much information about the very early beginnings of the Canadian deposit brokerage industry. I believe that if it was written down, it may have been lost in the sands of time.

Therefore I have cobbled together some of the history that I’ve collected over the years by speaking to one of the early founders and I recall some of the stories from the “old-timer” deposit brokers now long retired.

In the 1970’s, 80’s and most of the 90’s there was no such term as a GIC dealer or mutual fund dealer in those early days - nor did the MFDA (Mutual Fund Dealers Association) even exist. By the late 1970’s there were at least three major deposit brokers. These deposit brokers offered both GICs and mutual funds to their clients and some offered deposit products from insurance companies as well. In the mid- 1990’s, both client held GICs and mutual funds co-existed on the same investment statement.

I became a GIC broker in 1992 but started my career in 1987 as a stockbroker. Although stockbrokers had mainframe computers back then, I got to see the installation of the very first personal computers - sporting huge 20 meg hard drives and monochrome (choice of green or amber!) screens in 1987 and 1988.

GIC brokers were far smaller operations and there were no mainframe computers or personal computers until the very early 1990’s. We still have our old GIC/mutual fund database going back to circa 1980 or so and they are on recipe cards! Yes, you heard right – recipe cards. If a client bought a GIC or a mutual fund, their advisor wrote it down on a recipe card. One card per client. More cards if you were a HNW (High Net Worth) client. The interesting thing about this multi-platform database is that it never required constant upgrading or updates, never crashed and never required any computer power whatsoever. Most importantly, it works just as well today as it did decades ago. The cards do tell me that client name GICs and mutual fund purchases did at one time appear on the same statement and on the same recipe card. If an investor requested a statement, we photocopied the recipe card and gave a copy to the client. [Note: now we know why many computed mutual fund book values do not accurately reflect investor’s true costs – they were never entered on the dealer’s computers!]

Fast forward to the late ‘90’s and my firm at the time, eagerly joined the newly created SRO (Self Regulatory Organization) for mutual fund dealers around 1998. There was a condition though – a big one. The brand new MFDA (Mutual Fund Dealers Association) made a request to the dealer to divest all client-held GICs (half of the dealer’s total assets). It was determined that GICs are not mutual funds and they would have to go. All GICs from all dealers had to be to be purged from the dealer’s mutual fund statements and computer systems. From now on, the dealer’s mutual fund operation had to be kept separate and distinct from the client name GIC business.

When the dust settled, the dealer separated out GICs from the mutual fund statements and put them on a separate client query and order entry platform and with the parting of ways from the newly formed MFDA created a separate GIC deposit operation based strictly on GIC trading. Deposit brokers were born (or reborn!) As it turned out, the dealer’s operation were eventually split into two or three separate operations: client name GICs (deposit broker), mutual funds (client name and nominee) and insurance.

Interestingly, client name GICs could not be mixed with client name mutual funds although mixing nominee GICs with nominee mutual funds was and still is even today, perfectly OK.

Note: the modern term is “nominee” type of account. In the 1980’s and 1990’s there was no such term – we used the term “self-directed” account to indicate that the securities are held with the broker in a trustee arrangement.

Although there was a predecessor association called the Federation of Canadian Independent Deposit Brokers going as far back at 1987, it is now known as the RDBA (Registered Deposit Brokers Association) which is the national professional standards association for deposit brokers.

Question: Do I have to pay a commission to buy a GIC?

Answer: The short and definitive answer is – absolutely not! Investors do not pay commissions to buy GICs because the advisor’s dealer1 is compensated by the bank issuing the GIC. Part of this compensation is paid to the advisor in the form of a commission. Deposit brokers are also compensated in a similar manner.

Note: For investors that buy their GICs through a securities dealer, starting in 2017, investors will receive new fee reports which will indicate the amount of GIC remuneration that the advisor’s dealer has received from the banks. Some GIC investors are misinterpreting this dollar number as commissions they have paid to buy GICs. That is not correct as there are no commissions to buy GICs.

 Question: Is it preferable to buy a GIC at a securities dealer?

Answer: Yes and no. Nominee GIC accounts can only be found at securities dealers or third party trustees but may not have the best interest rate.

Although deposit brokers had at one time, set up nominee (self-directed) GIC structures in-house in the mid 1990’s (pre-MFDA), today you would have to be affiliated with a securities dealer to set up a nominee GIC account. So today, all GIC deposit broker GICs are client-held meaning the GICs are held (by the investor) directly at the issuing financial institution. If you want a nominee type of account, you have to buy your GICs through a securities dealer, but not through deposit brokers. Yes, it is somewhat complicated behind the scenes. Since many deposit brokers are also financial advisors, it is easy to buy a GIC in either format, but you have to take off your deposit broker hat and put on your financial advisor hat to do a nominee GIC purchase with a securities dealer. Conversely, if you want to buy a client name GIC, you have to take off your financial adviser hat and put on your deposit broker hat to do the trade.

There are however, issues with credit union GICs in nominee accounts at securities dealers. Due to an interpretation of credit union regulations, most credit union GICs are generally not allowed to be held at a securities dealer which is most unfortunate because credit unions often have much higher interest rates than banks. Credit union GICs can however be easily obtained at a deposit broker.

 A nominee account is a lot less paperwork intensive than client name GICs. And nominee account structures have other advantages too – especially for estate planning reasons. But on the other hand, there is more choice of financial institutions for client-name GICs. More choice – a much greater chance of consistently obtaining higher interest rates for GIC investors. The choice often comes down to choosing between the conveniences of a nominee account versus the possibility of obtaining better interest rates with deposit brokers.

Question: Why do deposit brokers and financial advisers offer higher GIC interest rates than my bank?

Answer: This is the best keep secret in the entire investment industry. Interestingly, deposit broker GIC rates and financial advisor GIC interest rates are almost always higher than retail bank GIC interest rates. In other words, advisor compensation drives GIC yields higher for the same identical “no-cost” GIC in a bank branch. For example, a broker GIC rate is almost always quoted higher than the bank in-branch posted retail rates for the exact same GIC. See example of Bank ABC rates below. Even if the broker rate was the same as the retail rate, shopping the entire marketplace for the highest yield from all the available issuers would ensure a higher rate is obtained.

EXAMPLE

                                                                                          1yr         2yr       3yr       4yr    5yr

Bank ABC (retail in-branch GIC rate)                             0.55       0.65   0.85     1.05   1.25

Bank ABC (securities broker GIC rate)                           1.25       1.45   1.45     1.65   1.85

DEPOSIT BROKER (survey of top GIC rates)               2.30       2.45   2.50    2.60    2.75

Interest rates as of Aug 23, 2017, min $5,000

A GIC is an unusual type of investment where the existence of a commission or fee can result in a higher rate of return to the investor. Needless to say – never buy your GICs at your own bank without comparing and shopping for better interest rates. As you can see in the above example, the differences in rates can be mind-boggling! Contact your deposit broker or financial advisor who will show you how to obtain the best GIC interest rates.

Question: The rates you quoted are in some cases, more than triple my bank’s rate and have the same guarantee! How do securities dealers and deposit brokers offer such dramatically higher rates?

Answer: There are a couple of reasons. Banks, trust companies and credit unions are in the deposit taking and lending business. If the bank requires a large inflow of deposits to offset new mortgage obligations they will approach a deposit broker with a higher interest rate in order to attract new deposits. Deposit brokers can move a lot of money to a bank very quickly and efficiently. From the bank’s perspective, deposit brokers and stock brokers are inexpensive sources of capital. The bank doesn’t have to pay costs for brick and mortar operations to sell GICs at a deposit broker or at a securities dealer. It is a highly competitive business. Secondly, a deposit broker (or securities dealer) deals with dozens of banks – not just one. They can shop for the highest interest rate and obtain a much higher interest rate than the investor can usually obtain on their own.

Question: How can GICs be used in conjunction with mutual funds or other investments?

Answer: GICs should not be considered as a stand-alone investment. They can be used to reduce overall risk in any investment portfolio as GICs do not fluctuate in value and their rate of return is known ahead of time. You can reduce the risk of owning a stock based mutual fund (equity mutual fund) by investing the GIC interest income into equity mutual funds. In other words, you can reinvest your annual interest income into mutual funds; keeping your GIC principle intact.

For a bit more of a sophisticated way of mitigating equity mutual fund risk, you could buy a 5 yr term compound interest GIC and invest the expected compound interest immediately into mutual funds right now. If the mutual fund outperforms the GIC’s compounded interest rate 5 years from now, you are ahead. Worst case scenario - if the mutual fund drops to zero in 5 years (highly unlikely) at least you get your principle back.

Often overlooked too, is that GIC rates have recently handily beat Government of Canada bond yields (1 - 5 years) for the past several years. Bond purchases incur commission costs, driving down their yields even further. GICs have no commissions and yields have been much higher than bonds so GICs can be a superior investment and alternative to short term government bonds.

Question: Do GIC s have embedded commissions?

Answer: I think it depends where the GIC is sold. For the banks, some sort of commission element is likely wrapped into the pricing of GICs, especially those GICs that are sold at a bank branch to their customers. However for deposit brokers and financial advisors, I have come to the conclusion that GICs in fact, might not have embedded commissions at all.

The argument goes like this; Of course there must be commissions because like most investment products, the broker or adviser needs to be paid by charging a commission or fee or building in a commission into the product ( like a bond or mutual fund).

At first glance, this seems like a reasonable argument. However, GICs are unlike most investments and due to their unique nature they are sold in a different way than most investments. GICs investors are not charged a fee or commission to buy a GIC. It’s the advisor’s dealer (head office) that earns a referral fee from the bank and then the dealer pays part of the fee to the advisor as a GIC commission. The interest rate on the GIC is set by the bank not by the investment firm. Since neither the dealer nor the advisor sets the interest rate then the remuneration - can’t be embedded.

Question: Are GICs securities?

Answer: I first explored this question in the late 1990’s. At the time, some industry participants said yes, some said no. A GIC is merely a bank deposit – not that far off from the concept of a daily interest account – except with a fixed term.

In writing this article in 2017, if we ask the same question whether or not GICs are considered to be securities, we might get the same answer as we did in the 1990’s – some say yes, some say no.

Why is this question even important? If GIC were to be considered as securities, then securities regulations naturally, would apply but if the regulatory jurisdiction view is that a GIC is not a security, then certain securities regulations do not apply.

Here in Ontario, the provincial securities regulator is the Ontario Securities Commission (OSC). The OSC says that GICs are not securities. The national self-regulatory organization for Canadian mutual funds (MFDA) also says GICs are not securities. For the national self-regulatory organization for stockbrokers (IIROC) the definition has been less clear. However, on October 29, 2014, IIROC approved Dealer Member Rule 2800C – Transaction Reporting for Debt Securities (“Rule 2800C”) which clarified GICs status as non-securities. However, other provincial securities regulators outside of B.C., Alberta and Ontario, may treat GICs as securities. This question leads into another question; who nationally, regulates GICs?

Question: In Canada, who regulates GICs?

Answer: From a national viewpoint, we are not sure. The sale of GICs is governed by a number of organizations including the federal government under the DTIR (Deposit Type Instruments Regulations). Deposit brokers are recognized by the federal government as deposit-taking agents or mandataries. Deposit broker’s professional standards association is the RDBA (Registered Deposit Brokers Association) www.rdba.ca. There has been some debate about who precisely regulates the sale of GICs in Canada. I doubt there is any single entity that does. In my experience, the sale and regulation of GICs is governed depending where they are sold. If sold at a bank, then bank regulatory rules apply. If sold at a securities dealer, then securities rules apply. Deposit brokers have their own rules and guidelines to follow as set by the Registered Deposit Brokers Association. The late Finance Minister, Jim Flaherty best described Canada’s securities landscape as a “patchwork quilt” of different regulators. I think very few would argue the point.

Question: Are there any other interesting GIC tidbits?

Answer: Here is just a few more to consider...

-        GICs with a term exceeding 5 years (they do exist) are not insured by the CDIC (Canadian Deposit Insurance Corporation).

-        Non-redeemable GICs are generally not cashable before their maturity date (there are exceptions; depending on the issuer), and although there are some cashable or redeemable GICs, all GICs are generally cashable or transferable at death.

-        Credit union deposit protection programs vary from province-to-province. For instance, in British Columbia, it is unlimited for all plans. In Ontario it is a $100,0001 limit for regular GICs but unlimited for RRSPs, RRIFs, TFSA and other registered plans. In Nova Scotia, deposit protection programs are up to a $250,000 limit.

-        In some provinces, a credit union deposit protection program might also include foreign currency deposits – like U.S. dollars, something that the CDIC doesn’t cover.

1 Note: Ontario credit union deposit insurance will be increased to $250,000 on January 1, 2018

Question: With interest rates so low, and taking inflation and taxes in consideration, why bother at all with GICs?

Answer: Great question! It depends what you mean by low. In Japan and Germany, a 10 year government bond interest rate in recent years have gone negative - interest rates had actually gone below 0%. And that’s before commissions have to be paid which would have reduced the rate even more. Canada’s top GIC rates are staggeringly high by comparison.

The demand for GICs is generally inelastic meaning that demand does not change much regardless of the current level of interest rates. A typical GIC buyer is not interested in growth or risk – they are interested in safety, preservation of capital and certainty. Arguments about low after-tax rates of return and inflation will surely fall on deaf ears. There is no other widely held investment option that has such an iron-clad guarantee. Often times, an investor who has cashed in considerable amounts of stock-based investments will crystallize their gains by placing them in GICs. The same applies to business owners that have sold their family businesses – they’ve dealt with risk all their working lives so the security of GICs can be very appealing to them. Seniors too may be thinking about rebalancing their investments to more conservative GICs. And lastly, we can’t ever assume that interest rates will stay low forever. GICs by nature, are floating rate investments which will keep pace with higher interest rates should interest rates rise.

Are GICs as dull as grass? Yes certainly. And we are thankful they are!

Notes:

Referral or finder’s fees from the sale of GICs can be paid either to the advisor’s dealer or in the case of smaller deposit broker firms that hold contracts directly with the banks, can be paid directly to an advisor.

DICO (Deposit Corporation of Ontario): www.dico.com

Government of Canada Bond yields: http://www.bankofcanada.ca/rates/interest-rates/canadian-bonds/

Acknowledgement: Thanks to Brian Evans – Chair of the Board of Directors for the Registered Deposit Brokers Association (RDBA) for his discussion regarding GIC commissions and GIC fees.