The final steps of the client relationship model, phase 2 (CRM2), may now be in place, but securities regulators have signalled they have no plans to stop there. They have proposed further changes that threaten to shake up the Canadian investment industry in even more fundamental ways.
The final, most significant elements of CRM2 - thoroughly revamped cost and portfolio performance reporting to clients - came into force in mid-July, marking the end of a three-year implementation time frame for the new rules. Although the investment industry may believe that the worst is over regarding fundamental regulatory reform, securities regulators and provincial governments are contemplating new measures already.
In late April, the Canadian Securities Administrators (CSA) published a consultation paper that sets out a series of proposed "targeted reforms" that aim to address regulators' ongoing concerns about client/advisor relationships. Regulators continue to be concerned about the large information gap that exists between most clients and their advisors, among other things. Indeed, several recent surveys have revealed that 40%-60% of Canadian investors are unaware of how much they pay for investment advice; many believe they pay no fees at all.
Regulators also are worried that clients lean too heavily on their advisors for financial advice and that, despite that reliance, clients aren't getting value for their money. And the regulators are concerned that conflicts of interest, rooted in the compensation system, are too pervasive and not well managed by advisors or their firms.
Division over best interests
Amid these concerns that investors aren't being well served, the CSA proposes reforms that the regulators agree are necessary, including measures to enhance the regulation of conflicts of interest, bolstering suitability standards and know your client/product (KYC/KYP) requirements, and more tightly prescribing the titles that advisors can use, among other proposals.
The CSA (with the exception of the B.C. Securities Commission [BCSC]) also is considering whether a statutory best interest standard is warranted. Such a standard would be an additional overarching obligation for dealers and advisors both to put their retail clients' interests ahead of their own and to resolve any conflicts of interest in favour of the client.
The idea's strongest proponents, the Ontario Securities Commission (OSC) and the Financial Consumer Services Commission of New Brunswick, maintain that the proposed targeted reforms alone won't be enough, as they can't possibly address every investor protection concern that may arise. These regulators believe that a general principle requiring the investment industry to prioritize investors' interests also is needed. The regulators also believe such a principle would bring regulatory reality in line with most investors' beliefs, which is that advisors already are required to act in their clients' best interests.
However, the BCSC has indicated that it does not believe a statutory best interest standard is necessary. Although the BCSC shares the concerns of other regulators about the client/advisor relationship, that regulator says these issues can be addressed best through the proposed package of targeted reforms, which would enhance advisor proficiency, improve due-diligence standards and regulate advisors' titles.
According to the CSA paper, regulators in the other provinces also have varying levels of discomfort with the idea of imposing a best interest standard. However, they still are participating in the consultation to explore the idea.
In the meantime, the self-regulatory organizations - the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada - also are looking beyond CRM2. In particular, the SROs (along with the OSC) have indicated that they intend to examine compensation-related conflicts of interest at the various dealers under their respective oversight. This will feed into the regulators' deliberations about a possible best interest standard and the targeted reforms. IIROC also says that its review will help the SRO decide whether it needs to take further steps to clarify its existing standards on managing conflicts of interest and prioritizing clients' interests.
In addition, in late June, the CSA signalled that it intends to publish a consultation paper this autumn that will propose eliminating the practice of fund managers paying dealers and their reps for mutual fund sales, which is done through trailer fees and other embedded commissions. Instead, dealers would charge investors directly for services rendered.
Both of these major initiatives (best interest and mutual fund fee reform) are in their early stages. But regulators are coming around to the idea that disclosure alone isn't sufficient to resolve some of the long-standing concerns regarding retail investor protection.
Historically, disclosure has been the underlying foundation of investor protection in Canada. Now, however, with the prospect of these further reforms, regulators are moving toward adopting the position that investors need more than transparency to ensure that they are fairly treated by the investment industry and adequately protected by the authorities that oversee it.
"Our proposals for enhancing the client/advisor relationship and our consultation on mutual fund fees are necessary changes to address conflicts, and will complement the transparency achieved through CRM2," says Maureen Jensen, chairwoman and CEO of the OSC. "The proposed reforms aim to align the interests of firms and advisors with those of their clients better and address conflicts that can result in investors not getting the outcomes they deserve."
This development is welcomed by investor advocates, who have long argued that disclosure will never be enough to ensure proper investor protection. As a result, they champion the sorts of tougher reforms that now are under consideration by the CSA. For example, the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) supports a ban on potentially conflicted compensation structures (such as trailer fees) and the adoption of a "meaningful" best interest standard.
"We're seeing several major initiatives all coming to the fore more or less at the same time, but that's not surprising. They're all interconnected facets of the same central theme: transitioning from an investment industry to an investment profession," says Neil Gross, executive director of FAIR Canada.
"The transition is essential," he adds, "and, really, it can't be done piecemeal. [This transition] is like putting up a teepee - the key components all have to be put in place at the same time because they support each other and give the structure its strength and integrity. I imagine most regulators see this, so I'm hopeful they'll soon do what they must to make sure the transition can, and does, occur."
Yet, the industry is not ready to give up on the idea that transparency should remain the cornerstone of investor protection. The initial reactions of industry trade groups, such as the Investment Industry Association of Canada (IIAC) and the Investment Funds Institute of Canada (IFIC) strongly oppose the idea of adopting a best interest standard. IFIC, in particular, also has pushed back on a possible ban on embedded commissions, arguing that investor choice will be reduced if such a ban is implemented.
On both of these issues, the IIAC and IFIC argue that the regulators should give the CRM2 reforms time to work before they decide that further changes are warranted. These industry trade groups also argue that if regulators determine that further reforms are necessary, the changes should be incremental, not fundamental.
"We believe the regulators will proceed carefully, with well-intentioned efforts to forge practical and cost-effective post-CRM2 reforms, relying as much as possible on the existing IIROC rule framework," says Ian Russell, president and CEO of the IIAC.
The CSA does acknowledge that measures such as CRM2 and the new point-of-sale disclosure regime for mutual funds may address some of the regulators' concerns with the state of client/advisor relationships. Indeed, the uncertain value of these reforms is one of the central issues for the regulators that are unsure about imposing a best interest standard.
To that end, the BCSC is leading a CSA project that will investigate the impact of the CRM2 reforms and the point-of-sale mutual fund disclosure reforms. However, given that the first set of new annual cost and portfolio performance reports that clients will receive under CRM2 won't be delivered until 2017, an assessment of these initiatives is likely to be a couple of years away.
There's also an added political dimension. In Ontario, an expert panel is in the midst of reviewing financial planning regulations on behalf of the provincial government. That panel already has recommended introducing a best interest standard for providers of financial advice as part of the panel's preliminary recommendations for reforming the regulation of financial planning. The panel's final recommendations are due by the end of 2016, and may serve to reinforce Ontario's commitment to some form of a best interest standard.
With both the provincial regulators and the SROs working on so many fronts - coupled with the prospect of government action in Ontario - the regulatory landscape may well evolve in a way that pushes the investment industry well beyond CRM2 in the years ahead.
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