Securities regulators may have stepped back on several matters, but the Canadian Securities Administrators’ (CSA) revised client-focused reforms (CFRs) represent a leap forward in raising standards and enhancing industry credibility.
On Oct. 3, the CSA published a package of reforms designed to enhance client/advisor relationships – most important, by explicitly requiring firms and their reps to act in clients’ best interests, both when tackling conflicts of interest and when assessing the suitability of investment recommendations.
Some proposals will introduce new requirements for the industry; others will enshrine existing best practices into the securities rules.
“We believe that, taken together, [the changes] will result in a new, higher standard of conduct,” stated the CSA’s notice outlining the new measures.
These proposals, first put forth by the CSA in June 2018, attracted an avalanche of feedback: 117 of 135 submissions to the regulators came from industry voices. Much of the industry response pushed back on the regulators’ proposals.
In response, the CSA revised its CFR plans significantly. The regulators are abandoning proposed restrictions on referral arrangements, scrapping requirements that would have made comparison shopping among firms easier for prospective clients, adding a materiality condition to new conflict rules and dropping a proposed ban on reps serving as trustees or holding power of attorney for clients.
Despite changing the proposals to make them more palatable to the industry, the CSA is not backing down from its underlying conviction that protection for retail investors needs improvement.
The CSA’s response to the feedback on the initial proposals stated the changes to its 2018 proposals aim to address the industry’s concerns about the cost of compliance without sacrificing improvements to investor protection.
In doing so, the regulators are pushing back against the industry argument that there’s no need for reforms at all and that the regulators should focus instead on enforcing existing requirements. The CSA also dismissed the familiar industry claim that reforms will create unintended negative consequence and eschewed another common tactic: dragging out the process with endless consultations.
The CSA’s reforms are slated to take effect by the end of this year. The requirements will be subject to a two-year transition period that will see certain provisions phased in by the end of 2020 (such as the new conflict-of- interest requirements) and the rest (including reforms to suitability, know-your-client and know-your-product [KYP] rules) taking effect by the end of 2021.
The CSA’s approach to implementing the CFRs will be similar to the process followed for the client relationship model reforms, in that the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) will revise their rules to adhere to the CFR requirements, which will exempt registered firms and their reps from complying with the CSA’s specific rules.
Having IIROC and the MFDA implementing their own versions of CFRs adds complexity to the reform process, but should also alleviate some implementation burden by enabling those self-regulatory organizations (SROs) to tailor the CSA’s requirements to specific business models.
The CSA notes that some new CFR requirements reflect an effort to codify existing best practices among SRO-registered firms, thereby levelling the playing field between SRO-registered dealers and dealers not registered with an SRO.
“One objective is to reduce the potential for regulatory arbitrage across registration categories and business models,” the CSA stated.
Both IIROC and the MFDA confirm they will adopt changes to their own rules on the same timeline as the CSA – which means conforming to conflict-of-interest requirements by the end of 2020 and having the rest of the rules in place by the end of 2021.
Industry trade groups support the CSA’s pared-down reform effort for the most part.
“These changes go a long way to better align the standard of conduct across the industry with investors’ expectations,” stated Katie Walmsley, president of the Portfolio Management Association of Canada, in a statement following the release of the CSA’s rules. “While many of these obligations have always existed for portfolio managers, the scope of the amendments will ultimately impact all retail investors by enhancing transparency requirements, client communication and the management of conflicts of interest.”
The Investment Funds Institute of Canada (IFIC) also publicly backed the CSA’s effort by releasing a statement in which Paul Bourque, president and CEO of IFIC, was quoted: “We support the regulators’ harmonized approach to finding the right balance between achieving the investor protection goals of the CFRs and the associated regulatory burdens.”
In particular, IFIC endorses the revisions regarding suitability, KYP requirements and narrowing the conflict-of-interest rules to material conflicts of interest.
As Walmsley notes, “It is clear that the amendments are intended to provide more versatility, respecting the realities of the market and reflecting different registration and client categories vs the earlier ‘one size fits all’ approach.”
Nonetheless, the CSA still views certain practices – such as recommending proprietary products, using compensation and incentive schemes to drive sales, engaging in paid referral arrangements, accepting third-party compensation (a.k.a. embedded commissions) and holding products that pay embedded compensation within fee-based accounts – as behaviours that pose inherent conflicts of interest, even if the regulators aren’t prohibiting these practices outright.
The CSA also declared that disclosure by itself isn’t enough to alleviate conflicts: “Not only does disclosure sometimes fail to mitigate the risks related to conflicts of interests, but, in some cases, disclosure of conflicts may aggravate the potential risks to the client’s interest.”
The regulators haven’t dictated precisely how industry firms should resolve these issues. Instead, the CSA is leaning on the “professional judgment” of industry firms and reps in ensuring they adhere to the broad, principles-based standard of “clients’ best interests” when faced with conflicts.
The CSA also noted that the CFRs aren’t its final effort to enhance retail investors’ protection. The regulators still are working on a policy to address the major investor-protection issues arising from embedded commission structures. The CSA also intends to review matters such as industry proficiency standards and the use of business titles and designations, and to revisit referral arrangements.