The imposition of a fiduciary standard on financial advisors in Canada is looking more likely. Higher standards are already in effect in the U.K., where all registrants must act honestly, fairly and professionally in accordance with the best interest of their clients, and in Australia, which has a qualified statutory best interest standard
More recently, a financial media firestorm erupted in the U.S. as their Department of Labor (DOL) released the final version of its Fiduciary Rule that will impose a best interest standard on those providing advice with respect to many retirement plans. Some have wondered why the Securities and Exchange Commission has been missing on this file. The reason is that the DOL oversees employee savings plans and they have been proactive in managing apparent conflicts of interest among brokers who were advising on the rollover of employer managed plans to broker-managed accounts. The equivalent in Canada would be an advisor advising on a Locked-In-Retirement-Account (LIRA) which had previously been managed by a portfolio manager. If and when the fiduciary rule survives several legal challenges, the small and midsize 401(k) plan market stands to be revolutionized in the U.S.
The new regulations will likely accelerate a number of challenging trends that advisors are facing, not just in the U.S. but in Canada as well. Morningstar, a Chicago-based rating agency, has thoroughly studied the effect of these new DOL rules and concluded that they will drive three primary trends. Firstly, it will shift customers away from commission based arrangements to fee based ones; Secondly, robo-advisers will likely pick up a large percentage of the $600 billion in low-net-worth IRA balances in the U.S. that are now being managed by full service wealth managers; Lastly it could lead to a significant increase in the use of passive investment products.
In October of 2012, the Canadian Securities Administrators (CSA) published a number of reports beginning with a Consultation Paper, The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients. The CSA has taken the view that the current Canadian registrant regulatory framework requires improvement and seeks to introduce a fiduciary standard in order to address issues they have identified in the client-registrant relationship, “including to better align the interests of registrants with the interests of their clients, to improve outcomes for clients, and to clarify the nature of the client-registrant relationship for clients.”
According to the financial press there is some apprehension among non-fiduciary advisors that their reputation may be tarnished if they are perceived as acting in their own interest. The requirements may cause an unintended focus on fees, particularly as the media has demonized the practice of charging commissions and deferred sales charges (DSC). Although it isn’t the intention of the regulations, some advisors may find themselves forced into a fee-based compensation structure and a relatively limited product selection. Advisors are divided on the implications for investment management fee structures, as those who are already fee-based see the new rules as formalizing an inevitable market shift and some commission-based advisors are concerned that commoditizing their services puts them at risk of being undercut by cheaper automated advice services. The impact of technology, irrespective of what happens on the regulatory front, will continue to make it cheaper and easier for investors to get investment advice that’s not conflicted. That is a trend that will have a big impact on the investment industry over time.
The reforms under consideration also include amending rules to require firms and advisers to respond to identified material conflicts of interest in a manner that prioritizes the client’s interest, increases the requirement for an adviser to understand a client’s financial circumstances and risk profiles which may be extended to better quantify loss aversion, and limiting titles that can be used by advisers. Advisors are also concerned about the burden of internal scrutiny and compliance due to the increasing volume and scope of regulations which is leading to a feeling of being monitored rather than supported by their firms. At the end of the day, the burden of having to document all aspects of the advisory consultations could add an unintended toll on an advisors’ ability to work effectively on behalf of their clients. Both the proposed targeted reforms and proposed regulatory best interest standard, if introduced, would apply to all advisers, dealers and representatives, including those who are members of IIROC and the MFDA.
With so much at stake the CSA has sought further comments on the proposed regulatory action. They have confirmed that no final decision on the implementation of a best interest standard will be made without a thorough review of the comments received following their recent public consultation and discussion. The most recent comment period closed on August 26. Even within the CSA there have been concerns about the proposed legislation as the BCSC noted, “given the current regulatory and business environment, imposing an over-arching best interest standard may not be workable and may exacerbate one of the investor protection issues identified, that being misplaced trust and over reliance by clients on registrants. Further, the introduction of a regulatory best interest standard over and above the proposed targeted reforms is vague and unclear and will create uncertainty for registrants.” This leaves open the possibility that some provinces, most notably Ontario and New Brunswick, may proceed with best interest standard legislation on their own.