Investment research firm calls on IIROC to provide more-granular guidance so as to avoid 'check-the-box' exercises
As professionals within Canada’s investment industry prepare for stricter know-your-client (KYC) and know-your-product (KYP) standards in advance of the client-focused reforms taking effect, Morningstar Canada is urging one of the industry’s two self-regulatory organizations to provide more specific guidance around client risk profiling.
In comments submitted to the Investment Industry Regulatory Organization of Canada (IIROC), the research organization acknowledged that IIROC’s guidance on the know-your-client and suitability determination for retail clients offers a clear delineation between risk tolerance and risk capacity. Beyond that, the guidance mentions numerous processes that must be in place in assessing a client’s risk profile.
However, the authors of the comments said IIROC members would find great utility from “more-granular guidance around the components of a risk profile.”
Aside from incorporating an additional reference to time horizon in Section 2.03.05 of the guidance note for emphasis, Morningstar Canada asserted that the guidance should include other elements beyond risk tolerance and risk capacity, including but not limited to:
- Risk need - the amount of risk a client might be expected to take on to meet specific financial goals;
- Risk aversion - an individual’s disinclination or dislike toward risk;
- Risk composure – the likelihood that clients in a perceived crisis will act in a way fundamentally different from their rational self; and
- Risk perception - a client’s judgment of the severity of risk in association with the broader economic environment.
“The fear in only referring to risk tolerance and capacity is the potential to limit collection of KYC information to bare minimums that may turn a questionnaire into a ‘check the box’ exercise, which is not the intent of the KYC process,” Morningstar Canada said.
While IIROC’s guidance broadly captures elements of a risk profile, the commenters noted that it does not spell out which inputs will contribute to a client’s risk tolerance, as opposed to their risk capacity. To avoid any misunderstanding or ambiguity, Morningstar Canada suggested the use of more-explicit examples or explanations could be of value.
For example, while questions that concern a client’s acceptance of a drop in portfolio value generally fall under risk tolerance, it said an exception has to be made in cases where a client has to withdraw money during this period, which would make it a risk-capacity issue.
“We appreciate that the regulation is not designed to be prescriptive but feel guidance to help clarify a common and more complete understanding is important,” Morningstar Canada said.