The law of unintended consequences

The law of unintended consequences

The law of unintended consequences The comment period for the Canadian Securities Administrators’ Consultation Paper 33-404 ended on September 30, but there seems to be no end to the conversation about it in our office.

By now, you have no doubt read numerous articles about the elimination of embedded fees, the Best Interest Standard and the standardization of titles. But what consumes my thoughts is the potential interpretation of the Know Your Product obligations – specifically, the obligation for a representative to “understand the specific structure, features, product strategy, cost and risk of each product their firm trades or advises on.”

In principle, this makes a lot of sense. Advisors should be able to help clients pick the best investments for their specific situation, and how can you possibly do that if you don’t know all the products available to you? Right now, I know most advisors do offer a limited product shelf, choosing to focus on only two or three different fund companies. But how does one ensure these are the best?

My dealer, IPC Investment Corporation, currently has 20,222 fund codes on its product shelf as of the beginning of October, with more being added every day. It is impossible and unreasonable for any advisor to “know” all of those products. I fear that, in order to comply with the KYP obligations, many dealers will be forced to drastically limit their product self.

The CSA acknowledged this possibility themselves in the paper, asking, “Will this requirement cause any unintended consequences? For example, could this requirement result in firms offering fewer products?”

Indeed, some dealers might prefer this. The reduced data entry and compliance costs should appeal to every dealer. However, a limited product shelf would favour the bigger funds and fund companies at the expense of the smaller firms/funds. It could also limit product innovation and generally homogenize client offerings.

A limited product shelf could also make those funds that do remain on the firm’s product shelf so big as to make it impossible for them to manoeuvre in and out of secur­ities, reducing the chance for active managers to outperform their benchmarks.

I’m certain this is not what the regulators have in mind. I can’t imagine how this would affect our IIROC cousins, where the current investment universe is even larger.

My practice focuses on socially respon­sible investment [SRI] solutions. I worry that a limited product shelf would not include these types of mutual funds or would limit the SRI offerings to one or two token options – not enough to build full fossil-fuel-free or SRI portfolios.

On a related note, in their expanded Know Your Client obligations, the CSA indicates that an advisor should understand the client’s “investment constraints and preferences – for example, socially responsible investing and religious constraints.”

Adding SRI questions to the KYC form is nothing new. Australia has done it since at least 2009, and the Responsible Investment Association here in Canada has been pushing for it since 2009 as well.

A 2014 client survey by NEI Investments shows that 92% of Canadians believe that it is important to choose investment products that are consistent with their values, yet a full 52% of Canadians are not familiar with SRI. Given that most clients rely on their advisors for information and recommendations (7 in 10, according to the study), I see these mandatory questions as a way to hopefully bridge the gap between what clients want and what advisors ultimately recommend.

According to the 2015 Canadian Responsible Investment Trends Report, there is $1 trillion in mainly institutional money (including the CPPIB) that has embraced SRI. Unfortunately, it will take enhanced regulation for retail advisors to finally open the conversation with their clients. So while the CSA may help encourage new demand in SRI products through the KYC obligations, there may be fewer SRI investments left to satisfy that need due to the unintended conse­quences of KYP obligations.


Ryan Colwell is a Certified Financial Planner with IPC investment Corporation/C&C Planning Group in Georgetown, Ontario.