Since the client-focused reforms (CFRs) took effect just over four years ago, firms have struggled with ambiguity around some of the measures, which include more stringent requirements around know your client (KYC), know your product (KYP) and suitability assessments.
In a compliance review published in December, the Canadian Securities Administrators (CSA) and the Canadian Investment Regulatory Organization (CIRO) found ongoing gaps in industry adherence to the CFRs, particularly in the documentation of processes and suitability assessments. In response, the regulators released additional guidance on compliance and examples of best practices along with their findings.
In an InvestorCOM webinar on Wednesday, panellists said the regulators’ joint staff notice helps address the ambiguity that’s tripped up firms as they’ve sought to implement the CFRs.
“The principal practical takeaways from [the notice] for me … are the way that it dramatically sharpens the regulatory expectations around how firms are actually operationalizing KYP, KYP and suitability under the CFRs,” Nancy Mehrad, a securities lawyer and CEO of Registrant Law said. “I think what’s new that I saw was the level of specificity and the number of concrete examples that the CSA and CIRO give of what is good or what bad might look like under the CFRs.”
Mehrad joined several other panellists on the webinar to discuss the shortcomings identified in the review and outline how firms can close those gaps. The review, based on a compliance sweep of 105 firms that included a mix of investment dealers, fund dealers, exempt market dealers, fund managers and portfolio managers, found weaknesses in several areas, including compliance with KYP and the consideration of client costs in suitability assessments.
Firms have seen a lot of regulatory changes over the past several years, and the report’s findings demonstrate it’s been a challenge to keep on top of, said Kendra Thompson, founder of Epok Advice.
“In a period where we’re seeing so much other change and so much new technology, new process and new possibilities around data, I fear many firms have underestimated the priority that this needs [to be] within their roadmaps,” Thompson said.
Suitability analysis
One of the regulators’ findings was that costs and alternatives were not being captured as part of suitability analysis, emphasizing that there needs to be a documented assessment of a “reasonable range of alternatives” for clients to ensure their costs are considered.
“Reasonable range doesn’t necessarily mean infinite choice,” Mehrad said, clarifying later that it applies to choices within a firm’s product shelf. “It means a defined, repeatable and defensible comparison, and costs certainly can’t be treated as incidental. It has to be a visible part of the suitability analysis that regulators can therefore see, test and audit, and understand after the fact.”
The regulators’ review found that advisors aren’t being required to consider lower-cost alternatives available through the firm, Mehrad said, they have clarified their expectations.
“Where you have multiple series of the same investment that are available to a client, assuming that the client’s actually eligible, then the firm has to assess the impact of those costs in selecting one series over the other,” she said. “It also includes monitoring whether clients become eligible over time for lower cost series of the same investment.”
Parham Nasseri, president, InvestorCOM, asked Christopher Somerville, a partner at Affleck Greene McMurtry LLP, what happens if a regulator flags a firm for not considering a range of alternatives.
“Seek legal advice before admitting any failure to comply,” Somerville said. “There may be an argument that there was compliance, especially in an area that’s novel and developing.”
The regulators have set out principles-based requirements, but they’ve left it up to industry to decide how to implement them, he added, noting “there’s a lot of room for experimentation and a lot of room for customization.”
Based on their own circumstances and business models, firms are encouraged to build a compliance system that works for them, he said. “And if that can be demonstrated, then that’s what the regulator wants to see.”
KYP assessments
The review also found that many firms aren’t adequately documenting their KYP assessments, and some don’t have adequate processes in place to monitor for significant changes in securities, which could affect their suitability for certain clients.
Mehrad said firms first need to define what a significant change means for their firm.
“Without that definition, you’re left without a way to clearly demonstrate how you monitor your securities, or when a reassessment of KYP or suitability is going to be triggered,” she said.
A good definition will be principles based, but specific enough to be operationalized and reflect the firm’s business model and the type of securities they offer, she added.
“I think that’s really key, because once it is more specific to the firm, then it will be easier to operationalize effectively.”
The report gives 10 examples of significant change, including risk rating changes, costs and liquidity, she noted. “I think the best practice here isn’t obviously to copy them all, but to tailor them to your firm’s actual product shelf and how the firm’s products behave in real market conditions.”
When it comes to monitoring for significant changes, dealers have to be diligent and not get complacent about skipping things with “well-known names” that have been subject to deep dives in the past, Brian Driscoll, supervising portfolio manager with Designed Wealth Management, said.
“I think if you’re doing that properly, you will have a product shelf that is reasonably robust,” he said, and will provide advisors the information they need.
“If it’s on the shelf, why is it on the shelf? Who’s it appropriate for? What is the risk rating? That’s the information an advisor needs.”
Driscoll noted that smaller firms with fewer resources may struggle with KYP.
“The biggest challenge is that products are so diverse,” with some requiring in-depth analysis and others that only need a cursory review.
“There are some firms that have technology, some that don’t, some that have a full army of [chartered financial analysts] and others that don’t,” he said. “I think that you have to step back, look at your policies and procedures and processes that you have in place now. Maybe use this report as a checklist against that.”
However, “I would be worried about people who try and scrap what you’re doing and look for the next great thing before really getting a good, solid foundation,” Driscoll added.
He offered another caveat: “I really do think these days that technology is almost becoming a necessity. I don’t see how you can really look at the scope of product that we have available to us now without being able to use tools to screen it.”
Thompson noted that compared to similar markets, the Canadian industry has low industry adoption of a number of technologies including discovery tools, AI notes, CRM adoption and front-office collaboration technology that could make compliance with the CFRs easier.
“It’s my hope that the prioritization of these types of regulations and this type of change will help make a case for broader adoption around the tooling … because at the heart of our business is that conversation between the client and the advisor.”
Creating transparent and intuitive technology is essential for advisors, who are generally change resistant, and to increase access to the markets for average Canadians, she said.
Best practices
Given that there’s no one-size-fits-all way to ensure compliance with the CFRs, a starting point for best practices is to “know your own business, know your own business strengths and build around that,” Somerville offered. “The regulators will want to know that whatever policies you have in place fit the business that you have, the types of clients you have, the types of products you offer.”
Armed with the report’s findings, firms should start by conducting a thorough gap analysis of their processes, Mehrad said. “A lot of what they’ve identified is easy to address. And if you’ve got good systems already, tweaking is probably all that you’re going to need to do.”
Thompson said that “not having documented processes is a red flag,” particularly in the context of shifting vendors, shifting data and missing data. “Having to go chase that down means that you probably don’t have the workflow in place.”
Several panellists underlined implementation of the CFRs as an opportunity to build a better business. Mehrad noted that the report encourages “firms to build centralized systems and analyses,” something that can strengthen their compliance and reduce unnecessary duplication and administrative work.
That can go a long way to attracting advisors, she said. “At the end of the day, that’s going to make the life of the clients better too, because the advisor will have more time for his or her clients.”
Firms can think strategically about how to implement CFR best practices in a way that also drives growth, Thompson suggested.