The Canadian Securities Administrators (CSA) have worked on a broad, sweeping set of changes to regulation designed to better the experience of the investor. The changes in regulation, which touch on some of the same areas as Regulation Best Interest changes in the U.S., came into effect in December 2019. Firms and advisors have until the end of this year to implement the processes required to adhere to the new regulations.
Last week, we talked about upcoming regulatory changes around the Know Your Client (KYC) requirement. Today, we turn our attention to another key section of the reforms known as Know Your Product (KYP), and how this might affect you as an investor.
Though we are looking at different parts of the regulation in isolation, know that they are designed to fit together. An advisor can’t make a recommendation unless they know the details of it and can confirm it is suitable for you.
What’s Different with KYP?
Though KYP requirements are not new, the Client Focused Reforms have enhanced the knowledge requirements for advisors to ensure that they know multiple areas of a security before making a recommendation. These areas include a security’s risks, structure, liquidity, and potential impact of costs. As an investor, it is comforting to know your advisor cannot make a recommendation unless they have reasonable knowledge of the product they are recommending.
Additionally, advisors no longer recommend a security unless it has been approved by the firm. Remember though, that even though a security is approved by the firm, it does not absolve the advisor’s responsibility to ensure they are adequately versed and ensure that it is suitable for your account.
Monitoring and Transfers
The regulation stipulates that advisors must monitor the security for ‘significant’ changes. Though the guidance here is vague, we believe this means at the very least keeping abreast of performance, manager changes, fees, changes in mandate, and changes in risk level. This also means that if your circumstances change as an investor (for example if you lose your job) they should ensure that the security you are invested in is still appropriate given a change in risk profile.
Advisors are guided by the regulation on the amount of due diligence that is to be conducted on each security and explains that the more intricate an investment vehicle is, the more knowledge the advisor must have. For example, a plain vanilla mutual fund investing in long-only Canadian large cap stocks will require less due diligence than a fund that invests long/short using leverage and derivative instruments. Either way, investors should fully expect that the advisor should be able to explain in adequate detail and in language that you understand, the features and risks of the security they are recommending.
If you’ve changed advisors and have transferred your holdings to a new account, the KYC obligations extend to your new advisor. Your new advisor must take reasonable steps to understand the securities transferred in from your old account (within a reasonable time frame) and continue to ensure that those securities are suitable for your account.
Wait, so you’re saying that my advisor doesn’t do this already?
The reality is that Canadians face a broad spectrum of financial advice and not all advisors are created equal. It is very possible that your advisor is already doing all the necessary due diligence to ensure that the products you are invested in are suitable for your account. However, if that isn’t the case, these reforms will ensure a minimum enforceable standard that all advisors must adhere to, and hopefully level the playing field in terms of the quality of advice. Moreover, the regulations increase the amount of record keeping required by advisors and firms, so that in the unlikely event that there is a dispute, records are clearly on file.
Your Checklist:
-Look at your account statement and your current holdings
-Take note of any securities that you are not familiar with
-Ask your advisor about them. If you don’t understand something, don’t be afraid to ask.
Questions to Ask Your Advisor:
-How difficult would it be to sell all my positions today and get a reasonable price for them?
-Am I using leverage in any of my investments?
-(When getting an investment recommendation): If I hold this position for the next 5 years, how much will I be paying in fees, and where do those fees go?
This is a multi-part article series designed to inform investors on in-progress and upcoming changes to the regulations set out by the Canadian Securities Administrators having to do with Client Focused Reforms. Part 1 – Know your Client, Part 2 – Know your Product, Part 3 – Suitability and Part 4 – Conflicts of Interest
