Suitability, conflicts of interest and a greater focus on the cost of investing are the priorities for securities regulators regarding the client/advisor relationship.

These priorities were made clear in the proposed client-focused reforms the Canadian Securities Administrators (CSA) published in late June. Even though the CSA did not propose the introduction of a broad, statutory best interest standard, advisors and their dealer firms will need to start providing advice that puts clients’ interests first.

These proposals will be subject to extensive comment and then likely some amendments in the ensuing months. However, it’s clear that these changes will have a considerable impact as advisors look to balance their compliance requirements with the impact on the client experience.

For advisors who are proactive, want to be ahead of the game and deliver better outcomes for their clients, there’s plenty they can start doing now as it relates to the following proposals:

  1. Suitability (including “know your client” [KYC] and “know your product” [KYP])

The CSA is proposing extensive changes around suitability. The group of provincial and territorial regulators is concerned about the current suitability process and the level of unsuitable recommendations taking place.

Under the proposed rule, advisors will be expected to “put the client’s interest first.” In addition, the proposed regime moves toward suitability based on a client’s overall situation and away from trade-based suitability.

KYC is one important element of suitability. The proposed rule will require advisors to collect more specific information about a client’s personal and financial circumstances, investment needs, time horizon and risk profile. Clients will have to confirm that their KYC information is accurate and there will be new timelines for how often dealer firms and advisors will need to update it.

KYP is the other key element of suitability. The proposed rule includes an express KYP obligation for both dealer firms and advisors. This will impact the “product shelf” that each firm offers and the products that specific advisors can sell. Advisors will also have to consider factors such as the impact of costs when making a product recommendation.

Proactive response for advisors:

  • Consider suitability at a portfolio level to help clients think about their investments more holistically.
  • Start including more questions about a client’s financial circumstances in your KYC conversations. This will help you make more insightful recommendations and avoid an undesirable outcome in a regulatory audit.
  • The investment industry treats KYC as a technical process in which advisors fill out questionnaires while talking to their clients. Instead, advisors should use this as an opportunity to really understand their clients and to help these clients articulate their goals better.
  1. Conflicts of interest

The CSA’s proposed rule will require dealer firms and advisors to identify and address all conflicts — not just those that are material, as is the case today. If a conflict can’t be addressed in the client’s best interest, the conflict must be avoided. Disclosure, even though it’s required, will not be enough.

Although the CSA has chosen not to ban trailing commissions, the group specifically states that it considers embedded commissions to have inherent conflicts of interest. The CSA will expect dealer firms to demonstrate that products on their shelves 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.

Proactive response for advisors:

  • Start thinking about conflicts from the client’s perspective. What would be helpful for them to know? Prevent clients from feeling that you’re hiding something from them.
  • When talking to a client about a conflict, be sure to use plain language and resist using industry terminology and acronyms.
  1. Continuing focus on costs

The CSA makes several references in the proposed rule to the impact of costs on clients or on products — and it’s clear advisors will be expected to consider these impacts when making a suitability determination.

Regulators also have indicated that they’re “very supportive” of the Mutual Fund Dealers Association of Canada’s efforts to consider improvements to the current reporting as mandated by the second phase of the client relationship model, including setting out the total costs of investing.

Proactive response for advisors:

  • Have transparent conversations with your clients about fees. Give them a better awareness of what they pay, how you’re compensated, and how these costs affect their returns.
  • Explain how the fees they’re paying connect to the advice and value they receive. Clients trust you more when you talk openly to them about the fees they pay.

The CSA introduced these proposals to ensure that clients’ interests are paramount in the client/advisor relationship. The regulators are hoping to see significant behavioural changes and they’ll likely be keeping a close eye out to see if they occur.

If the desired outcomes aren’t achieved, the regulators have indicated that they will revisit an overarching best interest standard. Given that, taking steps now to improve investor outcomes is in everyone’s best interest.

As published, July 26, 2018 by Investment Executive, Susan Silma’s Compliance CX article for Inside Track.

Practice Leader, Client and Industry Strategy