KYP and the Power of the Peer
Why segmenting product shelves into peer groups can help meet regulatory challenges
The requirement for advisors to have enhanced KYP processes is ramping up with the client-focused reforms. Beginning in December, all investment recommendations made by an advisor must be filtered through a lens that considers reasonably available alternatives. Furthermore, this analysis must be documented for audit and compliance purposes.
With tens of thousands of products on many dealers’ shelves, this task may seem monumental to the advisor. Assuming that this exercise should also lead to a client conversation about recommending alternatives, there is a further risk that the client becomes overwhelmed and confused with data.
Recent regulatory guidance indicates that a mathematical — not simply anecdotal — analysis of alternatives will be required to remain compliant. This mathematical analysis of alternatives cannot be completed without a strong technology solution.
As with other principles-based regulations, the CFRs are not prescriptive about how this analysis should be performed. Many industry consultants, dealers and legal experts are using a peer group concept to help solve this challenge. By segmenting a dealer’s product shelf into logical peers or alternatives, the task of completing this analysis and sharing it with the client becomes much more manageable.
A good example of this peer concept in action is highlighted when reviewing alternatives for one of the most popular ETFs in the Canadian market. From a sample dataset of 1,100 ETFs available to Canadian investors, there are only 44 alternatives to this ETF based on peer filtering of product category, risk rating and currency. The advisor’s data analysis challenge has now been reduced by 95%! This analysis can be streamlined even more by peer rating each of the 44 ETFs based on the data variables above.
Approaching this analysis of product alternatives through the lens of a peer group delivers three significant benefits to the advisor. It ensures that she will remain compliant. It vastly increases her productivity by automating a very time-consuming compliance process. And perhaps most importantly, it simplifies recommendations by applying a consistent and mathematic process to evaluating alternatives for her clients.
The power of the peer extends beyond the advisor, streamlining the dealer’s due diligence and compliance processes. When products are compared with their peers using this rating process, the dealer can ensure that they are maintaining a “best interest” product shelf, which is foundational to the CFRs. The role of the surveillance team is also streamlined, enabling pre-trade recommendations to be categorized as green, yellow or red depending on their peer ratings. In a world where false positives consume enormous compliance resources, implementing a peer-based compliance process will counteract this trend.
New regulations can be viewed as an added burden to advisors’ and dealers’ workflows. But new regulations also force the industry to review processes and come up with innovative methods to remain compliant. The power of the peer is a great example of regulatory innovation that will ultimately serve the best interest of the client, the advisor and the dealer.