Amid growing concern about inappropriate leveraging, securities regulators published draft guidance Wednesday on the suitability and supervisory issues associated with leveraged investing.

The Investment Industry Regulatory Organization of Canada (IIROC) published a notice requesting comments on draft guidance concerning the responsibilities of dealers and registered reps when they recommend that clients use borrowed money to invest, or when they become aware that a client intends to make an investment with money borrowed from a third-party source.

The notice indicates that IIROC’s compliance exams have turned up an increasing number of cases where “inappropriate leveraging strategies” have been recommended to clients. And, it says that they have uncovered several situations where clients were not provided with sufficient information to properly understand the risks associated with leverage strategies, or the details of the debt servicing obligations that clients had taken on as a consequence of using leverage.

The guidance outlines the obligations contained in the existing IIROC rules and other securities regulations and suggests best practices that may be adopted to help ensure that dealers are able to properly supervise client accounts that employ a leverage strategy.

It notes that, in addition to performing a suitability assessment, dealers must provide proper disclosure of the risks associated with leveraging.

IIROC says it expects all dealers to have sound policies and procedures on borrowing-to-invest strategies recommended by the firm and its reps. “These policies and procedures must detail how it will evaluate the risks related to particular recommendations, how suitability will be supervised and how evidence of supervision will be maintained,” it says.

Firms’ supervisory frameworks must capture margin account loans as well as off-book leveraging strategies, including new and existing client accounts, it says. And, dealers need to consider whether limits or other controls will need to be established to monitor and supervise the leveraging activity of their reps.

“Having sound policies, procedures and controls together with an effective supervisory regime will create an environment where leveraging strategies are properly assessed and approved, where appropriate, and where unsuitable leveraging strategies are detected and prevented,” it says.

It also notes that additional issues arise when reps recommend a leveraging strategy where the loan is off-book. “These can be more difficult to detect and/or supervise,” it says, adding that dealers “must have adequate systems and controls to flag accounts that involve recommended off-book leverage and ensure they are properly supervised.”

Dealers should have controls designed to identify accounts that may be funded through the use of undisclosed off-book leverage not recommended by the rep, it adds.

The notice also says that IIROC’s compliance department will be focusing on the review of leveraging practices as part of its examinations. In particular, it will be examining off-book leverage practices, to ensure dealers are addressing their suitability obligations and supervisory requirements appropriately.

Comments on the proposed guidance is due by October 4.