Client Focused Reforms Part 1: KYC

This is a multi-part article addressing upcoming regulatory changes on Client Focused Reforms set out by the Canadian Securities Administrators. 

Ian Tam, CFA 26 January, 2021 | 12:48AM
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Financial Advisor with Client

Over the past few years, 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 CSA is the regulating body designed to protect investors from unfair, improper or fraudulent practices.

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.

Canadians face an incredibly large spectrum when it comes to the quality of investment advice. It doesn’t hurt to understand what the changes to regulations are, and for you to know your rights are as an investor. To make it simpler, we will address the changes in four parts. Today, we’ll discuss the ‘Know your Client’ part of the regulation, or KYC. In the coming weeks, we’ll address Know your Product, Suitability, and Conflicts of Interest.

Who’s Affected?
The regulations apply to advisors and advisory firms. In a nutshell, anyone licensed to sell investments to individuals (typically IIROC or MFDA licensed advisors) are subject to the rule changes, which means that if you have a financial advisor helping you choose investments, these rules apply to them. Ultimately, the rule changes aim to benefit you as an investor and result in a better experience, free from nasty surprises.

What’s Different?
Advisors are now required to have documented knowledge of not just your financial circumstances, but also your personal circumstances (for example, the nature of your business if you have one, the source of your wealth, etc.). Although it may seem invasive, this information adds additional colour to the amount of risk you can take, and ensures anti-money laundering checks are in place.

Additionally, your advisor must now also document your investment knowledge. This ensures that advisors do not place you in a ‘high-octane’ strategy if you yourself do not understand the risks involved. On the flip side if you are well-versed in risks, this will give them the confidence to place you in investments that fit your needs.

Finally, and most importantly from the investment perspective, the regulation stipulates that the advisor must also document your risk tolerance and risk capacity (together making up your risk profile).

Risk Tolerance Vs Risk Capacity
Risk tolerance alludes to your psychological characteristics as an investor. For example, how would you react to your portfolio falling by 40% over a day?

On the other hand, risk capacity refers to your financial situation and whether a worst-case scenario in the investments chosen will prevent you from reaching your financial goals based on your current level of assets and income.

Click here to learn more about the risk tolerance.

Most advisors have and will continue to use risk tolerance questionnaires to get a sense of risk tolerance, however the separation of risk capacity and risk tolerance is a new amendment. You may see an updated questionnaire or process if the prior one did not distinguish between the two. If your advisor notices discrepancies in answers, it is their job to clarify with you and the records of these conversations must be documented. Related to this but separate in the regulation is a requirement that your investment time horizon is also documented.

This information is continuously updated whenever there is a significant change in your circumstance, or at minimum once every 36 months for most investors. If your advisor has discretionary control over your assets (likely if you have a fee-based account), that requirement is upped to every 12 months.  

Your Checklist:
-When was the last time you filled in a risk tolerance questionnaire? If you can’t remember, contact your advisor.
-If your employment circumstances have changed (as many have during the pandemic), have a chat with your advisor to see if your risk profile has changed.
-Has your advisor contacted you in the last 12 months? If not, maybe time to check-in.

Questions to Ask Your Advisor:  
-What is my risk profile and risk capacity according to your files?
-Can you show me how my risk tolerance matches my current investments?
-How much am I paying in fees every year? 

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About Author

Ian Tam, CFA  is Director of Investment Research at Morningstar Canada. 

 

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