I can see that IIROC have put some real work into this and have largely done as much as they can given the constraints they are operating under: they cannot rule against leveraged investment or unilaterally move outside of a transaction remuneration regime; this is the main securities regulator’s job, if not a government level responsibility.
IIROC have been handed a leaky boat to sail. How do you in fact make sure that leverage recommended is suitable for the client when suitability requirements are loosely designed to allow transactions to pass that are not in clients’ best interests? Trying to regulate the suitability of leverage is a contradiction in terms. It is and will continue to be a compliance nightmare.
Despite the best efforts of IIROC to regulate the “unregulateable”, they have not mandated the type of disclosure that would allow investors to properly assess the risks of leveraged investment if they were able to fully understand the disclosure. If you look at the communication handed out by institutions, they provide illustrations that do not include MER and transaction costs, under performance risks, or indeed the added premiums over and above prime that effectively crucify the investor over time. Ergo the illustrations of the benefits are unrealistic and as such investors are never aware of the true nature of leveraged investment risk. In this context the new guidance achieves nothing.
I did a whole series of blogs on this issue that illustrate a more real perspective of the risk of leveraged investment. IIROC have produced some nice sounding words but the disclosure is lacking and the reality of an industry forever pushing higher transaction returns from their advisors is at conflict with any meaningful management of leverage risk within a non best interests regime, and that is no oxymoron.
Regulators are ignoring many key issues that impact the risk of leverage and are bowing to financial institutions’ own assessment of leverage risk. Note the acquiescence over the many incorrect and misleading statements in industry communications (I deal with this in my blog posts).
I would also point out that regulators give the impression that regulations are tougher than they really are and give a false impression of the integrity of rules and regulations governing the recommendation of leverage. Note the following from IIROC’s Investor Bulletin:
IIROC requires the firms and representatives we regulate to meet strict supervisory and suitability obligations when they recommend, or become aware that their clients are using borrowing-to-invest strategies. Requirements include ensuring clients are fully aware of the risks…:
There is no discussion of the limitations of current suitability standards and their deficiency when it comes to making recommendations in a client’s best interests. Additionally, the regulators seem to be averse to emphasising the risk of leverage investment and of drawing a clear line in the sand with respect to whom leverage is appropriate. And again from IIROC’s Investor Bulletin:
It’s important to look at your whole financial picture if you are considering the use of borrowed funds to purchase securities. For instance, borrowing to invest may not be appropriate for an investor whose primary concern is preserving capital. That might include someone who is retired or nearing retirement, or who may need access to their money in the near future.
All we have in the above is a nuanced claim that it may not be suitable for those whose objective is capital preservation, which is a ridiculously low benchmark for recommending leverage. If you read the text of all the documents (including the guidance notes) you realise how ill defined the assessment of “appropriate” leverage really is.
How do you better regulate the suitability of the transaction without best interest standards and an increasingly pressurised conflict of interest environment? You cannot.