Canadian regulators are contemplating amendments to investor-protection regulations to redefine the relationships between clients and securities advisers, dealers, and representatives.
Key insights
- In 2018, the Canadian Securities Administrators released a package of “client- focused reforms” to amend the existing NI 31-103, Registration Requirements, Exemptions, and Registrant Obligations, as well as its CP 31-103CP
- The proposed new regulatory regime responds to investor-protection concerns that have been the subject of consultation since 2004, and match worldwide trends towards strengthened regulations for investor protection
- The proposed reforms will require registrants to carefully review existing conduct and practices to check for and then address any gaps, and ensure compliance with the revised standards across the enterprise
Client-focused reforms introduced in June 2018 would amend the existing National Instruments (NI) 31-103, Registration Requirements, Exemptions, and Registrant Obligations, as well as its Companion Policy (CP) 31-103CP. A Canadian Securities Administrators (CSA) Staff Notice published separately in September 2018 also announced the CSA’s policy decision to prohibit most forms of embedded commissions on investment fund sales. Together, this package of related amendments is intended to better align the interests of registrants and clients, improve outcomes for investors, and clarify the relationship between clients and registrants.
Comments on the proposed amendments to NI 31-103 closed in October 2018, and it is expected that, in later 2019, the CSA will release potential updates to the proposed amendments and further guidance on timing of implementation.
When the proposed NI amendments were introduced, CSA Chair President and CEO of the Autorité des marchés financiers Louis Morisset commented that they “strengthen the fundamental obligations that registrants owe their clients and are essential to investor protection.”1 The CSA has also commented that the reforms demonstrate “a shared commitment by the CSA, as well as the Investment Industry Regulatory Organization of Canada and the Mutual Fund Dealers Association of Canada, to changes that would require registered firms and individuals to promote the best interests of clients and put clients’ interests first.” 2 The proposed amendments have further evolved since they were first introduced in response to industry feedback and advocacy.
Key provisions
The current proposed amendments focus on relationships between advisers and dealers, on one hand, and their clients, on the other, in the following five key areas:- Know-Your-Client (KYC): Existing KYC requirements would be amended to establish a set of client information that a registrant, whether adviser or dealer, must collect including the personal and financial circumstances, investment needs and objectives, investment knowledge, risk profile, and investment time horizon of any investor. Registrants would also be required to take reasonable steps to obtain client confirmation of the accuracy of information captured on KYC forms, and to review and update KYCs regularly or when a significant change occurs.
- Know Your Product (KYP): A new KYP requirement would be implemented, setting out the responsibility of registrants to take reasonable steps to ensure they understand a security before offering it to clients, including how that security compares to comparable securities available for purchase. Registrants must also approve, monitor, and reassess the securities they offer.
- Suitability: While the proposed amendments fall short of including new fiduciary obligations on the part of registrants to clients, the existing suitability obligation would be significantly increased, specifically by establishing a requirement to put the client’s interest first when making a suitability determination. The amendments set out a list of factors that must be considered when determining suitability, including a shift towards “portfolio-based” rather than “trade-based” suitability.
- Conflicts of Interest: The proposed amendments move to a “best interest” standard for conflicts of interest. For registered dealers, this includes a requirement to address all conflicts of interest between the firm, its employees, and clients.
- Relationship Disclosure Information: The amendments would update disclosure obligations to require registered dealers to make publicly available any information that a reasonable investor might view as important in considering whether to become a client. Registrants would also be required to enhance existing disclosure requirements regarding restrictions on the products or services they offer, including whether a product is proprietary to that registrant.
Enhanced focus on “suitability” at the core of proposed reforms
The package of proposed reforms would bring about significant change to “suitability,” or the requirement that investments match an investor’s needs and investment objectives. While earlier consultations on the client-focused reforms raised the possibility that a fiduciary “best interest” standard would replace existing suitability standards, ultimately the CSA chose not to pursue this outcome. Instead, the CSA has proposed to enhance existing suitability requirements by introducing a requirement that registrants put their clients’ interests first when making a suitability determination. This moves away from trade-based suitability to a broader, “investment action-based” suitability, explicitly requiring registrants to consider certain factors, including costs and their impact, in making suitability determinations.
This package of related
amendments is intended
to better align the
interests of registrants
and clients, improve
outcomes for investors,
and clarify the relationship
between clients and registrants
“If the revised regulation comes into force as currently drafted,” comments David Petiteville, Director, Regulatory Solutions at RBC Investor & Treasury Services “implementing and communicating new practices that stem from these changes will be critical for advisers and dealers alike. The first step will be to review existing conduct and practices, as well as relevant guidance from the regulators, to determine what, if any, changes will be required as a result.”
“We also expect that fund managers and others offering securities may experience an uptick in questions from dealers and advisers on the KYP front,” Petiteville adds “as the new KYP requirement means dealers and advisers have increased obligations for ensuring their understanding of specific securities before those products are suggested to clients.”
Changes built on a long history of consultation
Implementing and
communicating new
practices that stem
from these changes
will be critical for
advisers and
dealers alike
The changes outlined in the package of reforms respond to longstanding investor-protection concerns. In 2004, the Ontario Securities Commission published a concept paper outlining a “fair-dealing model” intended to align securities regulation with the business practices within the financial services industry. The move to ban embedded commissions was first outlined in a 2012 discussion paper followed by a series of public consultations culminating in a 2017 CSA publication summarizing discussion to date. Once final reforms are approved, the CSA has indicated it will set out a phased implementation schedule for registrants to meet.
The comment period resulted in the submission of approximately 135 comment letters from a range of market participants and industry bodies highlighting topics for further consideration. The Investment Funds Institute of Canada (IFIC), for example, noted that the proposal could be enhanced by addressing three key concerns including: preservation of choice for investors; a balance between the cost to investors and the value of the advice and products they receive; and the potential use of disclosures as a more workable approach to mitigate conflicts of interest in the best interests of clients.3
Once final reforms are approved, the CSA has indicated it will set out a phased implementation schedule for registrants to meet. While the amendments are presently in draft form, they are the result of significant efforts and consultation by the CSA, and final reforms will likely look very similar to the current draft.