Know your product, or KYP, is a very simple phrase that many assume is table stakes for the exchange of products or services in any industry. When a consumer makes a major purchase such as a car, they expect the seller to have a complete understanding of the model being recommended. When a patient visits their doctor, they expect her to have deep knowledge on the treatment being prescribed. Most investors also have the expectation that their advisor has expert knowledge on investment recommendations.
The KYP requirement in wealth management, however, is uniquely challenging due to the quantity, complexity and rate of change of investment products. Car models might change every few years with less than 100 options to choose from. In the medical profession, there are approximately 20,000 approved drugs for doctors to prescribe. Comparatively, the investment industry has over 100,000 products available, with new products added weekly and material changes occurring every single day!
Another important KYP consideration is consumer education and knowledge. While global financial literacy is growing modestly, investor product knowledge remains very low. In a recent financial literacy survey by the OECD, the average financial literacy score across all participating countries was just 13.2 out of a possible 21. Despite Canada’s relatively impressive showing (we ranked 4th of 30 participating economies), the absolute scores indicate that financial literacy is low. The study noted that these results indicate “large groups of citizens are lacking the necessary financial literacy and financial resilience to deal effectively with everyday financial management.”
Not surprisingly, this combination of high product complexity and low investor knowledge draws regulatory scrutiny. The recent “best interest” compliance movements in both the U.S. and Canada include significant KYP requirements. The client-focused reforms coming into effect at the end of 2021 require both advisors and dealers to implement heightened KYP standards in two areas. Advisors are expected to consider a reasonable range of product alternatives when making an investment recommendation. Additionally, dealers are expected to take reasonable steps to ensure that securities made available to clients are assessed, approved and monitored.
The advisor KYP challenge is significant and best illustrated by considering a day in the life of an advisor. Assume the dealer offers a typical open product shelf with 35,000 investment products. If the advisor made five product recommendations each day, she would be expected to consider six data points for each recommendation (asset class, product type, fees, risk, performance and share class). This KYP analysis represents 1 million data points for the advisor, a virtually impossible human task. By leveraging technology to perform this product peer analysis, process 1 million data points and log the compliant results in an audit-ready record-keeping platform, her KYP obligation is solved in minutes.
Dealers that are implementing KYP processes for shelf management and monitoring face a similar data challenge. In the month of April alone, there were 40,529 changes to 67,069 investment funds (including mutual funds, ETFs and seg funds). During that period, there were also 801 new funds added and 253 deleted. Once you filter these changes for materiality or significance, there were 3,428 changes to monitor and assess — and dealers must take action if the changes impact product suitability.
While data on changes to investment funds is available from a variety of sources, the process of manually consolidating, scoring and managing each KYP change can become an exercise in data frustration. Some dealers, faced with this data complexity, have resorted to reducing their product shelf. While managing the quality of products offered to investors is an essential due diligence function, reducing product offerings for the sake of KYP is an unintended consequence of the regulation and unlikely to serve the investor’s best interest.
Processing large volumes of data and generating compliance insights for dealers and advisors is clearly a technology opportunity. Combining this analysis with the regulatory requirement to document KYP processes or “show your work” necessitates a robust technology solution. Advisors and dealers that take a leadership position on the new KYP requirements will build trust and competitive advantage with a more informed investor base.