Asimov's First Law - of Robo-Advice?

1. Background

1.1 Robo-advice provides consumers with financial advice or investment management tools with minimal human intervention based on artificial intelligence or algorithms.  

1.2 On 21 May 2018, the FCA published a statement on automated investment services and auto advice, together commonly referred to as “robo-advice”. The statement set out, in summary, that the FCA expects firms providing such services to meet the same regulatory standards as traditional discretionary or advisory services to ensure the protection of consumers.

2. Development of Robo-Advice

2.1 Robo-advice has the potential to offer consumers easily accessible asset management and advisory options at a low cost. Consumers can invest using robo-advice platforms from as little as £1. To an extent, it is that accessibility and the concomitant risk of harm to consumers that has placed robo-advice squarely on the regulator’s radar. This is highlighted by the recent attention given to robo-advice by the FCA. 

2.2 In a speech given by Bob Ferguson on 11 October 2017 in his capacity as the Head of Department of the Strategy and Competition Division of the FCA, he stated that “robo advice is clearly one route through which disruption and competition can be boosted — delivering economy and efficiency and reaching underserved consumers.” In December of 2017, HM Treasury’s paper, the UK Investment Management Strategy II, acknowledged that “by providing advisory services directly to consumers with little human advisor assistance, robo-advice helps asset management firms to bring down investment management costs.”

2.3 The Financial Advice Market Review made recommendations to improve access to financial advice, in part by lowering costs and increasing availability of financial advice to consumer. In this context, the 2018/2019 FCA Business Plan stated that “technological developments in the advice market, through ‘robo’ or automated advice models, are offering consumers new ways to access investments. These can potentially lower the cost of advice and so extend it to those who currently decide it is unaffordable.”
 
3. FCA’s Statement

3.1 On 21 May 2018, the FCA published a statement of its expectations (Statement) of automated investment services. The Statement followed a review of:

• seven firms offering automated online discretionary investment management (ODIM) services, which is where the client has given the firm responsibility to invest on the client’s behalf, within parameters agreed with the client, on an ongoing basis; and
  
  
• three firms offering retail investment advice exclusively through automated channels (auto advice), where customers do not interact with human financial advisers. The advice is given on a one-off basis when the customer first engages with the firm.

3.2 The FCA states that whilst it is keen to promote innovation, innovation should provide consumers with good outcomes in terms of value, cost and choice and that it expects firms providing automated investment services to meet the same regulatory standards as traditional discretionary or advisory services.

3.3 For firms providing ODIM services the FCA’s review found that:

• the service and fee-related disclosures for most firms were unclear while some firms compared their fee levels against peer services in a potentially misleading way;
  
  
• some firms did not make clear whether their service was advised, non-advised, discretionary or non-discretionary;
  
  
• many firms were not properly evaluating a client’s knowledge, experience, investment objectives and loss. Rather, firms were assuming their service was suitable for all regardless of their investment knowledge and experience; and
  
  
• most firms were unable to show that they had adequate up-to-date information about their clients when providing an ongoing service.

All the above were identified as potential breaches of the FCA’s Conduct of Business Rules (COBS).

3.4 Firms providing ODIM services should thus ensure:

• they provide appropriate information to customers in a clear way including information about the firm and its services, designated investments and proposed investment strategies, execution venues, costs and associated charges (in accordance with COBS 6.1);
  
  
• communications are fair, clear and not misleading (in accordance with COBS 4.2);
  
  
• they gain sufficient information about a client’s knowledge, experience, financial situation and investment objectives to make a recommendation or take a decision which is suitable for the client (in accordance with COBS 9);
  
  
• client information is not materially out of date, inaccurate or incomplete when undertaking a decision to trade (in accordance with COBS 9.2.5); and
  
  
• appropriate systems and controls are in place when using tools to filter out clients who are unlikely to have their needs met by the service.

3.5 In respect of firms providing auto advice services, the FCA found:

• in general, it was not satisfied with the strength of information gathered about clients’ financial information and charged firms to improve the quality of client information collected during the auto advice process; 
  
  
• weaknesses in identifying and supporting vulnerable customers, with some firms relying on the client to self-identify as vulnerable;
  
  
• little consideration of auto advice specific risks in firms’ governance processes, such as the need for adequate stress testing and cyber security; and
  
  
• while some networks were able to show a clear oversight of the auto advice proposition, others lacked clarity over how responsibilities were shared between the adviser and the network.

3.6 Firms providing auto advice services should thus ensure they:

• consider how to improve the amount and quality of client information collected during the auto advice process (for the purposes of COBS 9.2);
  
  
• consider whether they could better identify vulnerable clients based on information captured from the automated advice offering and provide appropriate follow up support;
  
  
• consider how their services could be affected by risks specific to the provision of auto advice; and
  
  
• review their processes to ensure clear oversight of the auto advice proposition and a clear allocation of responsibilities.  

3.7 The FCA reminded firms that the rules set out in COBS 9 on suitability of advice apply regardless of the medium through which the service is offered. The FCA will continue to work with firms to develop further improvements where necessary. However, where it sees poor practices that may cause harm to consumers, it will take appropriate action using regulatory tools such as early intervention or enforcement investigation.

3.8 Firms providing ODIM and auto advice may also find it useful to consider the European Securities and Market Authority’s (ESMA) final guidelines on suitability under MiFID II published on 28 May 2018 (ESMA Guidelines), which specifically address how firms that provide robo-advice can go about assessing suitability.

4. International Approach

4.1 Several other regulators and organisations have also tackled issues regarding robo-advice. The European Banking Authority published a report on 3 July 2018 on Prudential Risks and Opportunities Arising for Institutions from Fintech (EBA Report). The EBA Report notes that “robo-advice could possibly raise conduct-related risks, potentially leading to consequences such as regulator fines and customer redress and harming”.

4.2 The Securities and Exchange Commission (SEC) in the US published a guidance update in February of 2017 that found similar issues to what the FCA has identified in the Statement. Like the FCA, the SEC also reminded robo-advisers of their obligation to provide only suitable investment advice and to ensure that risks and fees are properly disclosed. Australia and Canada have also published guidance on how firms providing robo-advice can comply with their existing rules.

4.3 Also in February of 2017, the International Organisation of Securities Commissions, of which the FCA is a member, published a research report on financial technologies that identified risks in robo-advice (IOSCO Report). The IOSCO Report identified several risks inherent in robo-advice such as the risk that clients may not understand the services or products offered and that investments may be unsuitable due to behavioural biases.

4.4 As mentioned above, the ESMA Guidelines also shed light on how a firm can assess suitability when providing robo-advice. The ESMA Guidelines set out 12 general guidelines regarding assessing suitability which, for example, require firms to:

• inform their clients clearly and simply about the suitability assessment and its purpose which is to enable the firm to act in the client’s best interest;
  
  
• establish, implement and maintain adequate policies and procedures (including appropriate tools) to enable them to understand the essential facts and characteristics about their clients; and
  
  
• collect all necessary information about the client’s knowledge and experience before providing investment advice or portfolio management services.

4.5 The EBA Report comments that “if robo-advice services are provided across jurisdictional boundaries, compliance with the regulatory and legal requirements of multiple jurisdictions could be another challenging area for institutions that could affect legal and compliance risk.” Due to the growth of international response and the possibility for providing robo-advice cross-jurisdictionally, we may see further international regulatory collaboration on addressing these issues.

5. Conclusion

Robo-advice has the power to change consumers’ experiences and make investment management and advice more accessible. However, it is clear from the FCA’s Statement that the regulator expects firms operating in this area to comply with its rules in much the same way as more traditional firms do, especially in so far as the rules relate to consumer protection issues such as treating customers fairly, assessing suitability and ensuring adequate and clear disclosures.

If you require further information on anything covered in this briefing please contact Nandini Sur or Andy Peterkin, or your usual contact at the firm on 020 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, July 2018