Advanced technologies – advanced focus on investor protection

Dorsum-blog-about-suitability

End of May 2018, the European Securities and Markets Authority (ESMA) has published its Final Report on the guidelines on certain aspects of the MIFID II suitability requirements (the “Guidelines”)[1].

ESMA was already last year in the Consultation Paper emphasizing, that the purpose of the Guidelines “is to enhance clarity and foster convergence in the implementation of certain aspects of the new MiFID II suitability requirements, replacing the existing ESMA guidelines on the same topic, issued in 2012.”[2] One of the novelties is the particular focus on robo-advisory.

Suitability is fundamental…

Since MIFID regulation exists, suitability assessment is one of the core issues of investor protection. In order to ensure a suitable recommendation, to provide investment advice or portfolio management in the best interest of the client, information on the financial situation, investment objectives and knowledge and experience of the client shall be obtained.

Ideally, clients should understand and experience, that the enhanced information need – obtaining more information from and providing more information to the client – is to their benefit. Suitability evaluation and shaping an investment profile should result in investments matching the needs and circumstances of the client, and be means of building trust between the investment firm and the client.

…also in case of robo-advice

The rapid growth of advanced technologies also in the field of investment services has caused the regulator and the responsible authorities to devote particular attention to this issue.

Robo-advisory means computerized service – provision of investment advice or portfolio management through automated or semi-automated systems.

The Joint Committee of the European Supervisory Authorities has already in 2015 issued a discussion paper on automation in financial advice, pointing out the main risks to consumers, like lack of information, reduced opportunity to seek clarification or missing awareness of the processing of information by the tool.[3] The Guidelines intend to address the enhanced risk and lead the way strongly for the market by including significant guidance on how to fulfill investor protection objectives and seek compliance with suitability requirements in case of robo-advisory. This covers the following:

  • Additional information:
    • on the extent and availability of human involvement/interaction,
    • on the fact that given answers have direct impact on recommendations and undertaken investment decisions,
    • on sources of information used to generate advice,
    • in form of regular update.
  • Effective written disclosure:
    • emphasize relevant information, with help of design features,
    • consider necessity of additional and/or explanatory information.
  • Proper and reliable suitability assessment:
    • information collected through questionnaire shall be sufficient to assess suitability and prepare statement of suitability,
    • clear questions and clarification if necessary,
    • human interaction is available if necessary,
    • inconsistent responses can be filtered,
    • counterweight risk of client’s overestimation of knowledge and experience.
  • Supporting organisational arrangements:
    • policies and procedures, staff training.

 

Hybrid solution as the golden middle way?

By including specific reference to robo-advisory and formulating requirements whose fulfillment can elevate such services to achieve legal compliance, an important step has been made on the regulatory side in facing the future.

Recently the Financial Conduct Authority[4] has expressly formulated its support to the development of this market and at the same time stressed the fundamental importance of suitability:

“We continue to encourage innovation in automated investment services… While this is an evolving market, our rules on suitability of advice apply regardless of the medium through which the service is offered. Assessment of suitability is the firm’s responsibility and our rules and principles apply equally to emerging automated offerings.” [5]

Human involvement can make the difference, and as mentioned above, it is also an important asset according to ESMA.

Hybrid robo-advisors combine computerized recommendations with on-demand advice from a human being.[6] Hybrid advisory involves human interaction, the client has still an advisor relationship, which could provide the ideal balance between the benefits and risks of robo-advisory: maximising user experience in a flexible, cost- and time efficient manner and at the same time taking advantage of human support to achieve a proper and extensive suitability assessment. The advisor acts as assistance and fulfills a monitoring role beside the digital automated advisory system.

As a result, investors can have access to comprehensive, high quality information, may be able to use the received information properly and provide a realistic estimation when completing questionnaires.

This again strengthens the business relationship and helps to build trust.

 

[1] “Final Report – Guidelines on certain aspects of the MIFID II suitability requirements, 28 May 2018, ESMA35-43-869

[2] Consultation Paper – Guidelines on certain aspects of the MIFID II suitability requirements, 13 July 2017, ESMA35-43-748

[3]Joint Committee of the European Supervisory Authorities Discussion Paper on automation in financial advice, 4 December 2015, https://www.eba.europa.eu/documents/10180/1299866/JC+2015+080+Discussion+Paper+on+automation+in+financial+advice.pdf

[4] https://www.fca.org.uk/

[5] “Automated investment services – our expectations”, published by the FCA on 21.05.2018,  https://www.fca.org.uk/publications/multi-firm-reviews/automated-investment-services-our-expectations?twitter

[6] “Robo Advisors vs. Human Financial Advisors: Why Not Both?” MyPrivateBanking Aug.24, 2016, http://www.businessinsider.com/hybrid-robo-advisors-will-manage-10-of-all-investable-assets-by-2025-2016-8

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