Digital Wealth-Compliance Considerations
By Philip Hanssens, Chief Compliance Officer, Fidelity International
Philip Hanssens, Chief Compliance Officer, Fidelity International
Trust Gap
The lack of human interaction makes it harder to gain investors’ trust and to generate confidence that automated decisions are taken in their best interest. Incumbents may have an edge with the advantage of a smaller trust gap. Established brands benefit from existing connections and relationships with regulators, clients, and the wider industry. Further assurance can typically be drawn from the availability of customer services support and explanatory videos that are signposted along the digital customer journey.
Robo Advice and Suitability
Under the banner of digital wealth management or robo-advice, I include both automated online discretionary investment management (auto DIM) and automated investment advice (auto advice),but I exclude automated execution-only services.
In the case of auto DIM, the client gives a firm responsibility and discretion to invest on their behalf on an ongoing basis. This investment will typically be done in a range of asset classes embodied in index or exchange-traded funds, following parameters agreed between the parties at the outset and using an automated, rules-based, investment process. In the case of auto advice, the customer receives personalised non-binding investment advice, on a one-off or periodical basis, through an automated channel without interaction with a human financial adviser. The customer then has discretion to act on this advice or not.
Both auto DIM and auto advice require a firm to gather information about a client and to perform a suitability assessment including the evaluation of a client’s knowledge and experience, financial situation, financial and psychological tolerance for investment risk, investment objectives, capacity for loss and chosen investment time horizon.
This will allow the firm to respond with a matching solution in terms of, e.g. expected risk, return and/or volatility. This is not the case for execution-only services where the investor is owed a duty of best execution and appropriateness for the transactions he/she instructs but not one of suitability.
Regulatory Response
Various regulators welcome financial innovation and competition in a drive to deliver positive outcomes for customers in terms of value, costs, and choice. Auto DIM, for example, can make portfolio management accessible to a larger group of retail investors thanks to the lower minimum initial investment and the generally lower costs of the service compared to traditional separately managed accounts. In addition, auto DIM can offer an alternative for investors currently using execution-only services. Compared to execution-only services investors using auto DIM enjoy a higher level of regulatory protection and receive more guidance during the course of the service.
Essential features of a successful and trusted digital wealth offering will include: 1) fair, clear, and not misleading financial promotions, 2) a reliable and easy to use service that is value for money, 3) solid privacy, security and data governance, 4) suitable investment advice and suitable portfolio management decisions; and 5) fair, clear, and not misleading disclosures of the nature of the services provided, of associated risks as well as of related costs and charges. These also happen to be regulatory requirements that point to the importance of robust compliance and governance as an essential pillar of any offering. Good compliance is indeed good business.
Regulators expect automated investment services to meet the same regulatory standards and duty of care as traditional discretionary, advisory or execution services. This involves collecting, maintaining and updating meaningful and proportionate quality information about the client and offering appropriate level of client protection.
Regulators have set out their expectations in terms of the computer-based algorithms, decision trees, and other online tools used to support auto DIM offerings. Tools must be programmed to select an investment solution that is suitable for the customer rather than a proposition, or choice of products that are most profitable to the product manager regardless of the input provided.
Firms should only use algorithms and online tools if they can supervise them effectively and test their investor outcomes, economic assumptions, predictions of estimated returns, and confidence levels. Automated client onboarding should not merely replicate the questionnaires used for a traditional offering but in addition: 1) note and follow up on conflicting or unclear answers, 2) prevent customers from adopting or staying in an investment solution that is not suitable, 3) offer adaptive and personalised questions that take into account previous answers and a client’s personal situation. A policy needs to be in place covering client information, detailing how clients can keep records up-to-date including notifying the firm of changes to their situation themselves.
Firms must address the risk of gaming, which involves a client navigating the onboarding process and questionnaires with an end solution in mind which may not necessarily be suitable for this particular investor. Another pitfall is where at the annual advice review, an investor is recommended a change which he or she fails to act upon. In these scenarios, there is a risk an investor may end up with an investment solution which is, or which is no longer, suitable. A firm will then have to consider remedial action including disinvestment after a set period of inaction by the investor.
The future of digital wealth is bright, but compliance hurdles need to be navigated carefully.
Regulatory Response
Various regulators welcome financial innovation and competition in a drive to deliver positive outcomes for customers in terms of value, costs, and choice. Auto DIM, for example, can make portfolio management accessible to a larger group of retail investors thanks to the lower minimum initial investment and the generally lower costs of the service compared to traditional separately managed accounts. In addition, auto DIM can offer an alternative for investors currently using execution-only services. Compared to execution-only services investors using auto DIM enjoy a higher level of regulatory protection and receive more guidance during the course of the service.
Essential features of a successful and trusted digital wealth offering will include: 1) fair, clear, and not misleading financial promotions, 2) a reliable and easy to use service that is value for money, 3) solid privacy, security and data governance, 4) suitable investment advice and suitable portfolio management decisions; and 5) fair, clear, and not misleading disclosures of the nature of the services provided, of associated risks as well as of related costs and charges. These also happen to be regulatory requirements that point to the importance of robust compliance and governance as an essential pillar of any offering. Good compliance is indeed good business.
Regulators expect automated investment services to meet the same regulatory standards and duty of care as traditional discretionary, advisory or execution services. This involves collecting, maintaining and updating meaningful and proportionate quality information about the client and offering appropriate level of client protection.
Regulators have set out their expectations in terms of the computer-based algorithms, decision trees, and other online tools used to support auto DIM offerings. Tools must be programmed to select an investment solution that is suitable for the customer rather than a proposition, or choice of products that are most profitable to the product manager regardless of the input provided.
Firms should only use algorithms and online tools if they can supervise them effectively and test their investor outcomes, economic assumptions, predictions of estimated returns, and confidence levels. Automated client onboarding should not merely replicate the questionnaires used for a traditional offering but in addition: 1) note and follow up on conflicting or unclear answers, 2) prevent customers from adopting or staying in an investment solution that is not suitable, 3) offer adaptive and personalised questions that take into account previous answers and a client’s personal situation. A policy needs to be in place covering client information, detailing how clients can keep records up-to-date including notifying the firm of changes to their situation themselves.
Firms must address the risk of gaming, which involves a client navigating the onboarding process and questionnaires with an end solution in mind which may not necessarily be suitable for this particular investor. Another pitfall is where at the annual advice review, an investor is recommended a change which he or she fails to act upon. In these scenarios, there is a risk an investor may end up with an investment solution which is, or which is no longer, suitable. A firm will then have to consider remedial action including disinvestment after a set period of inaction by the investor.
The future of digital wealth is bright, but compliance hurdles need to be navigated carefully.
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