With the Financial Conduct Authority encouraging the development of automated advice, this is an area of increasing importance for the financial services sector. We review the current regulatory environment and key considerations when setting up an automated advisory service. We also analyse the US perspective, which provides some valuable insight on the future of robo-advice in the UK.
Encouraging automated advice: a regulatory priority
The provision of advice is one of the seven core priorities identified in the Financial Conduct Authority (FCA) 2016/2017 business plan. The FCA recognises the increasing need for consumers to have access to appropriate, affordable advice and guidance at all stages of their lives. Automated advice can drive cost-efficiencies and help deliver quality advice more consistently.
The FCA encourages firms to provide automated advice, acknowledging its advantages in the Financial Advice Market Review (FAMR). In May 2015 the FCA set up a dedicated team, the Advice Unit, to help firms developing automated advice models to get to market more quickly. The FCA has also signaled that later this year it will be developing a set of publicly available tools and resources, including a set of standardised testing scenarios for firms to use to gauge the effectiveness of their automated advisory models.
The outlook from the United States
The FCA is not the only regulatory body considering the potential regulatory implications of providing automated advice. In the United States, the Financial Industry Regulatory Authority (FINRA) has published a report of digital investment advice which firms seeking to develop a US offering may find particularly helpful. The FINRA report outlines regulatory principles and effective practices in five key areas:
- Governance and supervision of algorithms: including assessing the methodology of digital tools and the quality and reliability of data inputs, as well as ongoing evaluation such as testing the tools to ensure they are performing as expected, and determining whether models used by a tool remain appropriate as market conditions change.
- Customer profiling: including assessing both a customers’ risk capacity and risk willingness, and addressing contradictory or inconsistent responses in customer-provided information.
- Governance and supervision of portfolios and conflicts of interest: including determining the risk, return and diversification characteristics of a portfolio that is suitable for a given investor profile, and mitigating – through avoidance or disclosure – conflicts that can arise through the selection of securities for a portfolio.
- Rebalancing: including providing descriptions of how the rebalancing works and procedures that define how the tools will act in the event of a major market movement.
- Training that enables financial professionals to understand the key assumptions and limitations of individual digital investment advice tools: including determining when use of a tool may not be appropriate for a client.
Key considerations on automated advisory services
There is clearly an appetite for a more developed automated advice industry but what are the key considerations when entering this market?
- The opportunities provided by the FCA’s Project Innovate and the Regulatory Sandbox: This space is open to both new and existing businesses, and so providers should consider using it when developing their automated advisory products.
FCA’s Project Innovate
The FCA has set up a‘safe space’ in which businesses can test automated advice products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of pilot activities. The purpose of this ‘safe space’ is to help deliver more effective competition in the interests of consumers by (i) reducing the time and, potentially, the cost of getting innovative ideas to market, (ii) enabling greater access to finance for innovators, (iii) enabling more products to be tested and potentially introduced to the market, and (iv) allowing the FCA to work with innovators to ensure that appropriate consumer protection safeguards are built in to their new products and services.
- Be clear whether you are providing guidance or advice: One of the major areas of concern, recognised by the FCA, is that market participants intending to provide guidance (not a regulated activity) could accidentally start providing advice (a regulatory activity generally requiring prior FCA authorisation). Guidance involves providing information whereas advice involves an element of personal recommendation in addition to the information. A personal recommendation involves, in broad terms, presenting information in such a way that it involves a judgment on the merits of an investment.
- A balanced approach to engagement: Not all consumers are happy to receive automated advice. Some prefer to receive advice face-to-face. A number of hybrid models are being developed which provide the option to speak to an adviser at some point during the automated process. Even if advice is provided by advisers face-to face, there is still scope for using automated advice to help inform the advisers.
- The cost of setting up may come down: Many advisers see the costs of setting up an automated advisory service as a significant barrier to entry. Part of this is the Financial Services Compensation Scheme (FSCS) levy, which is imposed on advisors in order to create a compensation fund for consumers who invest in or via a business which is a member of the scheme and which enters bankruptcy. To address this concern, the FAMR recommended that the FCA consider making the FSCS levy more predictable for advisers and to consider whether it is possible to design a levy that better reflects what is driving costs for the scheme. This is an issue with which the FCA will be engaging with market participants over the summer.