Since the news broke a couple of weeks ago about a proposed series of regulatory reforms by the Canadian Securities Administrators (CSA), there’s been a lot of industry commentary (both positive and negative).
In the article “Split reactions to CSA proposals“, I shared my reactions to the long-awaited proposals. I said that much of the wealth management industry initially felt they’d dodged a bullet with no ban on trailing commissions and no introduction of a broad statutory best interest standard. But I believe there are a number of proposed changes in the reforms that ultimately could have considerable impact on firms and their advisors.
Here are the proposed client focused reforms that could be the most significant:
Extensive changes in suitability requirements
The regulators are concerned that some advisors are recommending investments that aren’t suitable for clients. They’re proposing extensive changes in this area, including to KYC and KYP rules. They propose that investment recommendations must “put the client’s interest first”. So although the rules will continue to include a suitability requirement instead of incorporating a broad statutory best interest standard, it’s not clear at first glance how “putting the client’s interest first” differs from a best interest standard.
More (and more detailed) KYC information
The regulators indicate that part of the problem with the suitability process is that advisors are collecting insufficient KYC information, and that leads to an improper risk assessment. Advisors will need to collect more specific information about a client’s personal and financial circumstances, investment needs, time horizon, and risk profile – and they want advisors to have a “meaningful interaction” about this information with clients. Clients will have to confirm (in writing or through file notes) that their KYC information is accurate, and there will be new timelines for how often KYCs need to be updated.
A formal KYP obligation
While people have talked about KYP for years, it was never a specific regulatory obligation under CSA rules. The regulators have now included in the proposed rules an obligation for both dealer firms and advisors to know the products they sell. This will impact the “product shelf” that each firm offers and the products that specific advisors can sell. Again, there’s a specific focus on the costs of investing – the proposed rules require advisors to understand the impact of all costs associated with acquiring and holding an investment.
A focus on conflicts
The regulators have identified conflicts as a “key concern”, and have adopted a best interest standard in the proposed rules. They have determined that all conflicts, not just those that are material, must be addressed. They have identified specific conflicts of interest, including those arising from sales and incentive practices and embedded commissions, and also from the use of proprietary products. They make it clear that conflicts must be managed or avoided, and that disclosure – while required – will not be enough.
A continued focus on the cost of investing
The regulators are very focused on the impact of costs on investing. Advisors will be expected to consider that impact in making a suitability determination. They also indicated they’re “very supportive” of the MFDA’s efforts to consider improvements to current CRM2 reporting, including setting out the total costs of investing.
More compliance training for advisors
The regulations will include a section mandating specific compliance training for advisors, including around KYC, KYP, and suitability, as well as around the impact of costs on a client’s investments.
No ban on all embedded commissions
While they’re not banning trailing commissions, regulators specifically state that they view embedded commissions as having inherent conflicts of interest. They will expect dealer firms to demonstrate that products on their shelf and client recommendations are based on the quality of the investment without influence from any embedded commissions. Dealer firms and advisors will have to mitigate these conflicts. The regulators have indicated they anticipate publishing another set of proposals on embedded commissions in September.
Regulators’ balancing act
I believe the regulators were trying to balance competing concerns, and decided to strive for a pragmatic approach that didn’t result in a splintered solution across the country.
As I mentioned in the Investment Executive article, “the proposals include an assertion on behalf of some of the regulators that, if the desired outcomes and behavioural changes are not achieved, they will revisit an overarching best interest standard. I think that they may be testing us as an industry to prove our assertions that we don’t need their interventions and we will do what’s right on our own.”