Against a backdrop of regulatory changes worldwide, our own Canadian Securities Administrators have set out to improve the standard of conduct for investment advisers. The goal is to improve the experience for retail investors through a sweeping set of changes known collectively as the Client Focused Reforms (CFRs). These new rules, which come into effect at the end of this year, will have an impact on many advice-giving firms in Canada, and consequently, the retail investor receiving advice.
At the heart of these reforms by the CSA – the umbrella group for provincial securities regulators – is something called a suitability determination. Essentially, this means ensuring that the investments you are being recommended line up with your investment objectives and risk profile. In a market where fees for advice are often included as part of the commissions paid to advisers, it may seem intuitive that this advice is sound and backed by a robust process. However, the spectrum of financial advice given in Canada is broad. Moreover, the depth and quality of said advice can often vary with the amount of assets you have available to invest. It is the hope that these reforms will level the playing field for all investors receiving advice in a few ways.
Before making a recommendation, advice givers will be required to have completed “Know Your Client” documentation, which includes crucial information about your personal and financial circumstances. Though the idea is not new, the CFRs go further here by specifying that both risk tolerance and risk capacity must be captured. The point is to not only record your attitudes toward risk (in other words, tolerance) but also your financial ability to withstand losses (capacity). This information will likely continue to be captured via questionnaire, however the additional requirement in the regulation stipulates that the adviser reviews the results with you in the event that your answers are inconsistent with what they know about your situation. Advisers will be required to update this information for you once every 36 months for most accounts, once every 12 months if they have discretionary control over your account, or if they are aware of a significant change in your financial circumstances.
Advisers must also be able to demonstrate knowledge of the investment(s) that they recommend. This includes documented knowledge of fees (and the impact of fees), performance, risk, and consideration for liquidity. Moreover, before a suitable recommendation can be made, the adviser must also document that they’ve considered a reasonable range of alternatives available from the firm’s own product shelf. These must be products (including third-party offerings) that the firm has assessed, approved and is actively monitoring for “significant” changes. In concept, this would mean that products being recommended to you have gone through two layers of scrutiny: once by the firm at a broad level, and once again by the adviser in the context of your financial objectives.
The CFRs also hope to address the sale of proprietary products. These funds are managed and sold through the distribution channel of the same firm. In Canada’s vertically integrated market, “in-house” products are widespread. The CFRs pinpoint proprietary products as material conflicts of interest, which can be addressed by the firm through conducting regular comparisons of said products with others in the market to ensure that they are competitive. In relation to this, advisers must also disclose to prospective clients whether they deal exclusively in proprietary products so that investors are acutely aware of the universe of products being recommended.
Though the changes are detailed and nuanced, the hope is that all Canadian retail investors benefit from a higher minimum standard of conduct. The rules themselves are not prescriptive, leaving the onus on firms to interpret rules and adopt appropriate processes. What remains to be seen, though, is how firms will actually implement the rules and to what degree regulators are prepared to review and enforce this new standard.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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Ian Tam, CFA