advisor and client meeting

The North American wealth industry is rapidly evolving from a sales-oriented model to a professional service model. One of the significant drivers of this change is regulation.

In Canada, the client-focused reforms (CFRs) will create a heightened standard of “best interest” conduct for advisors and their dealers. A similar regulation in the U.S. — Regulation Best Interest (Reg BI) — also imposes new standards of conduct on advisors dealing with retail clients. Both the CFRs and Reg BI are principles-based, and most wealth firms are interpreting the new rules, developing compliance strategies and evaluating technology solutions that support their plans.

Without diving too deep into the regulations, there are a couple of common themes that will have a lasting impact on our industry. The first and perhaps most significant change is that compliance is moving from post-trade to pre-trade.

Prior to the new regs, compliance processes focused primarily on reviewing trading activity – which can be inefficient and offers limited opportunity for remediation. One of our clients describes this challenge as “driving your car while looking through the rear-view mirror.” New best interest standards will materially change this model.

Advisors who make recommendations to their retail clients are now expected to evaluate reasonably available product alternatives and monitor products that they recommend for significant changes. Dealers will be expected to implement processes and technology that capture adequate and consistent documentation of these activities supported by robust pre-trade compliance reporting. A leading regulatory legal expert described this as “moving beyond the email bug hunt.”

The other important theme in the new regulations brings back memories of a saying from math class from years ago — “Show me your work.” Advisor attestation indicating that their compliance activity is complete will not suffice. Regulators will expect an advisor’s analysis to be documented and sufficiently thorough to support the rationale for their recommendations to clients.

Let’s take a look at one of the new regulatory requirements — the evaluation of reasonably available alternatives when making a product recommendation. Consider a typical dealer with an open product shelf of 35,000 investment products. Assume that for each product recommendation, an advisor evaluates six product metrics: cost, risk, performance, time horizon, share class and fund series. If the advisor makes five product recommendations each day, that is equivalent to processing 1 million data points — a virtually impossible task for a human!

These new regulations are profound — in the U.S., Reg BI is considered to be the most significant wealth reform since the 1930s. In Canada, the CFRs take a different approach to best interest, but they are founded on similar principles.

The successful implementation of these regulations will be a heavy lift for many firms. As with most regulatory challenges, technology will be an essential component of any compliance strategy. Digitizing this enormous volume of data will build new capabilities for industry leaders. A strong pre-trade compliance process has the potential to dramatically reduce the escalating cost of post-trade compliance while positioning a firm as a best interest leader. Advisors’ productivity will increase as they leverage tools to deliver higher standards of service. Best interest regulations were designed as investor protection measures, but ultimately, they could serve the best interests of advisors and their firms as well.