Satisfying KYC requirements is a fundamental task that protects you and your clients. You can exceed those requirements by digging deeper into people’s investment preferences and values—and there’s no time like the present.
Regulators are pushing for enhanced KYC processes. CSA consultation paper 33-404 proposes you should know more than a client’s needs, objectives and time horizon. You should also ask about “applicable investment constraints and preferences, for example socially responsible investing and religious constraints.”
Yet there’s little guidance for advisors on how to collect and use that type of information. When asked about the CSA’s commentary regarding preferences, both MFDA and the B.C. Securities Commission pointed to current KYC requirements in emailed responses, saying those rules already require that advisors learn the essential facts about clients’ needs and objectives. IIROC said it doesn’t offer guidance on investor preferences.
The CSA’s specific mention of responsible investment (RI) is timely, however, given the rapid growth of the space. Between 2006 and 2015, Canada’s RI assets grew to $1.5 trillion, up from $460 million, says the Responsible Investment Association’s latest trends report.
Trouble is, “There are some grey areas when it comes to RI” because of how varied investors’ personal values can be, says Stephen Whipp, managing director of responsible asset management at Stephen Whipp Financial, Leede Jones Gable in Calgary, Alta.
If RI is one of your clients’ preferences, here are tips on how to address and act on that.
How firms approach RI integration
To determine whether RI is suitable for clients, look at how their values, needs and risk profiles intersect.
“We’ve had instances where we’ve said RI isn’t a fit,” says Whipp. But that decision isn’t made lightly: before getting an appointment at his firm, which is a member of the RIA, prospects must complete both a typical KYC questionnaire and investment values survey, he says. The latter form, which includes 41 questions, “allows us to have conversations about energy, human rights and animal testing that we otherwise wouldn’t have.”
The next step is to recommend a portfolio based on your findings. Stephen Whipp Financial, which is a discretionary manager, offers regular portfolios and several RI-based options. Those options include a fossil fuel-free offering as well as a portfolio that “stays away from all extractive industries, such as mining and forestry,” and also avoids U.S. banks, large pharmaceutical companies and major media. The firm also offers an engagement portfolio, focused around shareholder engagement.
To build the firm’s RI portfolios, it uses its own internal research as well as data from global research firm Sustainalytics, says Whipp. The portfolios typically hold individual companies and some funds in order to access strategies like currency hedging. Before adding any fund to a portfolio, the fund’s holdings are run through Sustainalytics.
Says Whipp: “If a client asks, ‘Why is that in my portfolio?,’ you have to be prepared [with] a solid answer” rather than defer to the portfolio manager. He tells clients, most of whom he meets with more than once per year, that the ESG scores in their RI portfolios are reviewed each quarter and whenever Sustainalytics makes updates.
If a company or fund’s ESG score drops, he says, that’s a particular issue for the engagement portfolio, which requires that companies raise their ESG scores over three-year periods through, for example, governance changes. If the opposite occurs, “it gets noted that we’re getting out of a particular company. It may take a few months to do that,” based on its valuation and place in a portfolio. There are also cases where a company’s ESG score may be fine, but if the firm refuses to set a carbon target, for example, then Whipp will boot them out of his portfolio.
Heather Cooke, deputy chief investment officer at Fiera Capital Corporation in Toronto, says her firm serves institutional clients as well as both private wealth and retail investors. Fiera incorporates RI in three ways: through integrating ESG analysis into existing strategies; offering ethical ESG funds; and creating more customized, thematic portfolios for clients where required.
Which direction a client chooses depends on “a needs assessment, and that’s encoded into an investment policy statement. If the conversation leads to a more customized, segregated solution, that’s also coded into clients’ statements,” says Cooke. These statements are used by compliance to review recommendations to investors.
Cooke says the compliance team doesn’t recommend a list of investments. Instead, Fiera’s portfolio management teams are provided with third-party ESG scoring data from organizations like MSCI to help them choose companies.
These teams monitor their holdings daily, taking note of changes in ESG ratings (these are infrequent, Cooke says). Fiera’s compliance team reviews its flagship portfolios on a quarterly basis. “If there’s anything we’re catching on our end, we let them know. And if there’s any news on specific ESG topics, we raise that with the portfolio manager.”
How much clients know about the RI investment process is taken case by case, says Cooke, who finds institutional clients tend to be more involved. The firm also offers a quarterly report that provides updates on how investment teams are incorporating ESG analysis, which can be used by managers to educate investors.
As the RI space grows, says Cooke, “Responsible investing, we believe, will be the new fiduciary standard.”
Katie Keir is Content Editor of Advisor’s Edge. Email her at Katie.Keir@tc.tc.