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Globe Investor ‘Transformative impact’: Proposed regulations could sink smaller firms, investment group says

Regulatory proposals that outline changes to the way financial advisers provide investment advice and to the products being sold to retail clients may force smaller wealth-management firms out of business, according to the head of an investment industry association.

On June 21, the Canadian Securities Administrators (CSA), an umbrella group for all provincial securities commissions, announced it would not go ahead with a widespread ban of trailing commissions, embedded fees mutual-fund firms pay to compensate financial advisers and firms that sell their funds.

At the same time, regulators have proposed amending the rules on what advice and which products are in a client’s “best interest.”

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The proposed rules will include additional requirements in certain areas of the retail advisory business such as know-your-client procedures, suitability of products for clients and conflicts of interest.

The proposed rules and guidelines are out for public comment until Oct. 19, but Ian Russell, president and chief executive of the Investment Industry Association of Canada, says one thing is for certain: The rules will revolutionize the way advisers – and their firms – currently do business.

“These rules and guidelines will result in changes to existing business practice to meet the targeted outcomes of best interest and client-first conduct,” Mr. Russell said in an industry note last week. “Over time, these reforms could have a transformative impact on the retail business in the investment industry, particularly driving further structural change and forcing greater reliance on financial technology.”

Developing clear and well-defined guidelines for advisers will be critical to provide a “bright-line test” for investment firms on required conduct, and for regulators responsible for monitoring compliance with the rules, he adds.

Mr. Russell says once the consultation process has ended, firms will need to implement new compliance systems, including adjustments in business practice, new policies and procedures for operations, new supervisory and oversight systems and new technology systems. One-time fixed costs will be significant and continuing variable costs will increase, which will be a heavy burden for small retail firms.

“The increased costs and reduced operating margins that will result from implementing the new rule framework will lead to further consolidation of the domestic wealth industry as small firms amalgamate, merge and terminate operations,” Mr. Russell said.

“The reforms are far-reaching, covering all aspects of the retail business, and will be costly to implement. Over time, they will have significant impact on the conduct of the advisory business, on offered products and services, and on the application of financial technology.“

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Wealth management firms will have to improve adviser productivity by introducing more desktop technology, which the larger and mid-tier firms will be more likely to afford, Mr. Russell said. As well, firms will experience increased pressure on adviser compensation (i.e. payouts) to cover the increase in operating costs, he added.

The new proposals will also force mutual-fund distributors who are more reliant on embedded fee mutual funds into alternative products that pay lower fees, and could accelerate the shift to advisers partnering with robo-investing platforms – online services that provide investment management at a fraction of the cost. These partnerships reduce compliance costs and risks for wealth managers and Mr. Russell said they may be the most economic option for clients with assets below the $250,000 threshold.

Many of Canada’s online portfolio managers − such as Wealthsimple, Nest Wealth and WealthBar − already provide platforms for financial advisers to use their services at a discounted rate.

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