CFRs: 5 changes you need to know about

Raising the bar for clients

With the Canadian Securities Administrators’ (CSA) client-focused reforms (CFRs) on track to be fully implemented by the end of 2021, change is in the air, particularly with the conflict-of-interest provisions already having taken effect in June. Both IIROC and MFDA rule changes are expected to be implemented along the same timeline. What does this mean for Advisors?

The overall goal of the CFRs is to create a new, higher standard of conduct that will put clients’ interests first. Essentially, it could be viewed as a codification and enhancement of industry best practices that many firms and Advisors may already be incorporating – from gathering detailed client information to demonstrating product comprehension, revealing potential conflicts and putting clients’ interests first.

Importantly, think about the CFRs as both substantive rules (what you can/can’t do) – and disclosure requirements. Together, they work as a whole package to closer align client and Advisor interests, which will ultimately help increase trust, and build deeper relationships in the process. So, if you’re not already, start considering the reforms with every interaction now.

Here’s a high-level overview of 5 relevant changes, and what you need to know to be prepared for them:

1. Enhanced Know-Your-Client (KYC) requirements – the goal here is to gain a better overall understanding of clients’ goals, assets, liabilities, risk profile, liquidity needs and time horizon, with a prescribed minimum timeline for updating the information through regular, meaningful conversations.
2. New Know-Your-Product (KYP) rules – for the first time, Advisors are explicitly required to understand the products they recommend, which must be from a “firm-approved shelf” that must be reviewed by the firm on a regular basis. Before making a recommendation, they’ll need to demonstrate that they understood and considered a range of appropriate alternatives, and document a suitability assessment in plain language.
3. Enhanced Suitability requirements - these require Advisors to put their clients' interests first, ahead of other factors such as direct or indirect remuneration, when making a suitability determination. Advisors must also consider the potential and actual impact of costs, concentration and liquidity on returns, and a reasonable range of alternative investments available at their firm. Suitability is now to be determined on an overall portfolio analysis basis, with prescribed triggering events to reassess suitability.
4. Enhanced Material Conflicts of Interest provisions – already in effect but now enhanced, this is intended to ensure conflicts are identified and addressed in a manner that is in the best interest of the client. Clients must be provided with written disclosure at account opening and in a timely fashion thereafter detailing material conflicts of interest and how they are addressed in a way that puts clients’ interests first. Potential conflicts of interest include selling both proprietary and non-proprietary products, various types of remuneration and incentive plans, referral arrangements, personal financial dealings and outside business activities.
5. Record Keeping and Compliance systems – to comply with the new CFRs, firms will need to review and amend procedures as necessary to implement policy changes and internal controls. Advisors will also have to maintain proper records of their investment decision-making process.

“Showing your work” will be key

These reforms will fit differently for Advisors with different business models. As a result, each investment dealer will have to adapt, and will need to identify current gaps to enhance internal controls and record-keeping processes as a means of establishing evidence of compliance. For Advisors, it’s important to “show your work” when making a recommendation such that it’s clear enough for an objective outsider to review a comparison of similar products. It’s not simply enough to comply – you have to demonstrate compliance to a reasonable third-party standard.

Firms are expected to offer training and instruction on this front, which will be vital so there is a general understanding of the new protocols and requirements, particularly for KYP and suitability. For example, if you’re receiving direct or indirect compensation for recommending a product (both proprietary and third party), there may be a misperception that you’re suggesting it because of a compensation differential. In this type of situation, a comprehensive product review comparison will now be required to demonstrate it’s the right fit for the client. The work can also help dispel any misgivings by showing that you’ve truly considered products on your firm’s shelf. Moving forward, the expectation is a reduction in suitability-related complaints – typically the highest in volume – and more successful client outcomes as a result.

Another scenario to be addressed is the explicit disclosure of whether you’re selling only proprietary products, non-proprietary, or a combination thereof – as there’s a big potential conflict, particularly if differential compensation exists. Where only proprietary products are sold, the Advisor need only consider alternatives that are available through the firm For internal control purposes, firms could address offering only proprietary products by conducting periodic reviews of non-proprietary products and evaluating whether their products are competitive. Those Advisors with a mixed selection will need to demonstrate that both types of products are subject to the same robust KYP and selection processes and documentation. This includes letting clients know about any potential liquidity constraints.. If the client wants to cash out quickly, are they going to be able to accomplish this and, if so, will it be at a reasonable price?

A continuous process

Though the new CFRs are expected to raise the general industry standard, there will no doubt be nuances for every practice. The good news is that the CSA has established a straightforward process for addressing questions and uncertainties, meeting regularly with industry associations and maintaining a rolling FAQ where new queries are added to a public forum. (The last was published March 31, 2021). IFIC also has a committee that reflects members’ questions, such as application of the new rules in particular circumstances. Like any major reform, it’s a process that will benefit from ongoing improvements, discussion, and additional guidance.

For more insights to enrich your practice, contact your BMO Global Asset Management Regional Sales Representative.