President of Pascal WealthTech weighs in on the limitations of traditional KYC process, and how going beyond helps client engagement
With the client-focused reforms coming into full force, advisors and wealth firms across Canada have found themselves answering to a higher standard of client care. In order to respond properly, firms are having to revisit and re-examine the old reliable tools of financial services – and that includes the traditional KYC process.
“The traditional KYCs are very helpful mainly in understanding the client’s level of financial knowledge, their goals and their objectives. And they ask about risk tolerance, but usually in a fairly superficial way,” says Mark Doyle, Executive Vice President, Client Experience. Pascal offers a digital platform that provides tools to help advisors strengthen client relationships.
While the client-focused reforms are largely aimed at ensuring that advisors give appropriate investment advice that’s consistent with their client’s risk profile, Doyle argues that the standard KYC process fails to address the client’s true risk tolerance, often resulting in them being put in the wrong financial products and assessed with inappropriate risk levels.
“As an advisor, you need to understand how clients make decisions, their cognitive biases, and their behaviours that don’t necessarily work for them,” Doyle says.
This is where behavioural finance comes in. A field of study that marries behavioural psychology with finance, it offers advisors a way to expand their field of vision, letting them recognize patterns such as overconfidence, risk avoidance, and anchoring that pull them away from being the rational profit optimizers that economic theory assumes all human beings are.
Aside from recognizing that humans can be irrational, behavioural finance acknowledges that people can shift in their thinking over time. Rather than being permanently overconfident, for example, someone could be euphoric and have a high risk appetite when markets are good, and then do a 180 and become risk-avoidant when the situation turns.
“Traditional KYC gives you a snapshot at a point in time, when really what you want is a risk range,” Doyle says. “Otherwise, you’re going to get caught off-guard when a client reacts drastically to a downturn.”
Beyond that, Doyle says advisors and clients don’t necessarily define risk the same way. While advisors tend to view risk through quantitative lenses like portfolio volatility and downside risk, clients tend to think in more qualitative and harder-to-measure terms, like minimizing feelings of regret or confidence that they’ll live comfortably in retirement. That disconnect can lead to significant misunderstandings that, over time, can lead to sub-optimal portfolio structures and an erosion of trust.
While traditional financial advice has tended to revolve around telling clients what’s good for them, Doyle suggests that advisors can engage with their clients more productively by pointing them in the right direction. That includes highlighting certain potentially unhelpful behaviours, and nudging their thinking if possible. To help set the stage for those kinds of conversations, Pascal offers a solution called InvestorEQ.
“Our InvestorEQ behavioral finance tool is all about helping with client engagement,” Doyle said. “It gives suggestions on how to talk to clients depending on each one’s investor type. Our framework classifies clients into one of eight different personality types … everyone’s different, so you don't want to approach every client the same way.”
Rather than just focusing on know-your-client, Pascal’s engagement philosophy centres on “client know yourself.” In other words, by helping clients learn about themselves, advisors can foster better and stronger relationships that will last for the long-term.
“Relationships are not about sending them lots of market commentary. I think clients really do want to understand themselves better, and they need to know that the advisors trying to understand them and help,” Doyle says. “Advisors’ communication needs to be more collaborative rather than prescriptive.”
A major advantage of collaborative, behaviour-based KYC, he stresses, is that it helps garner clients’ buy-in on investment recommendations and financial plans later on. That means they’re more likely to stick to the plan when times get tough.
That’s not to say that behavioural KYC will replace traditional financial KYC. As Doyle explains it, the traditional KYC questionnaire helps advisors collect crucial data such as clients’ financial knowledge and priorities, but behavioural KYC is needed to ask better questions and understand them in a much fuller way.
“Most advisors don't read their clients properly because they don't really understand them. Once you understand how they think and the client recognizes that you've cared enough to ask, that helps build their trust in you,” he says. “I truly believe investors want partnerships with advisors who’ll help them throughout their lives … People won't fire you because of performance. They'll fire you because you don't care.”