stock market down
iStock / samxmeg

Over the past decade, regulators in most developed Western economies have turned their focus from post- to pre-trade compliance activities. While these regulatory changes come with cost, they can also represent opportunity.

In Canada, point of sale amendments were introduced in 2015 followed by client-focused reforms in 2021. In the U.S., Regulation Best Interest (Reg BI) was introduced in 2020 with an accelerating agenda over the past four years. In the U.K., the Financial Conduct Authority introduced Consumer Duty in 2022.

Each of these pre-trade regulations is primarily focused on the client’s best interest and requires advisors to introduce new compliance practices prior to the trade. They set forth a standard of conduct that financial professionals must provide to their retail customers when making recommendations of securities or investment strategies involving securities.

This new regulatory framework has imposed significant resource challenges on wealth firms and advisors’ sales and disclosure practices. In the U.S., Reg BI is considered the most significant wealth reform since the 1930s, with Deloitte and the Securities Industry Financial Markets Association estimating that industry startup costs could exceed US$3 billion.

The “best interest” label often evokes the knee-jerk response, “Who wouldn’t act in the client’s best interest?”  However, according to a JD Power report last year, only 6% of polled Canadian investors said they received a comprehensive level of service and advice from their wealth management professionals.

Comprehensive advice was defined as personalized guidance from an advisor that addresses all financial and wealth management needs; demonstrates an intimate understanding of the client’s lifestyle and goals; puts the client’s best interests first; includes a financial plan; ensures clients understand the fees they pay; and is an integral part of the client’s life. This data is aligned with the regulatory view that there is plenty of room for improvement on the client best interest journey.

While there has been plenty of industry opposition to these new regulations, there are also notable examples of leading firms and advisors leveraging well-designed pre-trade processes and technology to drive value across their wealth ecosystem.

The disclosure or elimination of conflicts of interest arising from the sale of proprietary products and non-transparent sales incentives is considered low-hanging fruit by regulators.

Another key best interest element is the consideration of a reasonable range of product alternatives when making a recommendation. Matching client suitability with the optimal investment is an essential step in the product diligence and planning process. Our data support better outcomes when this is accomplished using technology: a client firm increased the quality of investment recommendations (measured by performance, cost and risk) by 29% over a two-year period — clearly a best-interest outcome for their clients.

Clients expect this degree of diligence and engagement from their advisors, particularly younger clients who have elevated expectations resulting from their interactions with non-financial companies including leading online vendors. Their expectation is that wealth advice is relevant, personalized, timely, seamless and outcome-oriented. As a growing proportion of this demographic is represented among clients, winning strategies will incorporate these pre-trade engagement opportunities.

Strong pre-trade compliance technology has also driven asset growth for advisors and firms. In a recent InvestorCOM case study, 739 U.S. advisors recommended over 14,000 401(k) rollovers in the U.S., generating US$8.2 billion in new assets and US$113 million in fees over a 12-month period. This compliance growth opportunity is three times the industry average and represents the largest organic asset growth opportunity for the firm. By leveraging digital pre-trade technology, this firm now has visibility into this remarkable growth opportunity.

Another Canadian client compares pre- and post-trade data to identify compliance gaps. Such a gap, defined as any trade not supported by a pre-trade disclosure, represents less than 10% of the seven million trades executed annually by the firm. The replacement of the proverbial “needle in the haystack” approach to post-trade compliance, while eliminating false positives, has transformed their compliance function, resulting in massive compliance resource savings.

All new regulations, particularly those that introduce new processes such as pre-trade, represent a heavy lift for our industry. Firms that embrace such regulations have identified important opportunities to drive value for their clients, advisors and firms.

David Reeve is CEO of InvestorCOM Inc., a compliance technology provider to the wealth management industry.