Technology lawyers and regulatory lawyers are increasingly being asked by clients to advise upon and accurately confirm a new, innovative application’s compliance with complex legal rules and regulatory frameworks.
However, the global corporate shift to enhanced online marketing and the delivery of services has fostered an expectation from online consumers for a simplified user experience. This is not always suitable for more complex services or engagement models. Lawyers therefore need to adopt a more creative mind-set in order to understand the user experience (UX) design goals and then suggest ways to ensure underlying applicable rules or principles are satisfied.
The necessity of this approach can be applied to the increasing adoption of ‘robo-advisors’. Robo-advisory describes an automated platform designed to offer retail clients financial planning services without human interaction. It ascertains a client’s financial profile and objectives through an online survey and then provides (typically one-off) advice.
Online discretionary investment management (ODIM) use decision trees to group clients according to their stated objectives and risk appetite and then invests on their behalf on an ongoing basis.
The robo-advisory market is predicted to result in assets under management reaching US$2 trillion by 2020. One United States-based start-up, Betterment.com, claims to be built on “Nobel Prize-winning research” and has US$13.5B assets under management.
An important development arose earlier this year; the UK Financial Conduct Authority (FCA) published the results of its review of the state of the retail robo-advisory market and they were not impressed. Among their chief concerns were that robo-advisors did not clearly articulate fee structures and failed to gather sufficient information on clients’ financial positions.
To address the FCA’s concerns, the legal advisors supporting financial investment innovators should encourage them to proactively adopt a “compliance by design approach in order to ensure they are not under-estimating or under-addressing regulatory safeguards—including those introduced by Markets in Financial Instruments Directive (MiFID II).
Automation is the future of finance
Automation can create a virtuous circle driven by competition which provides real benefits to end users. John Finch, Chief Information Officer of Refinitiv, the renamed Financial & Risk business of Thomson Reuters, explains the potential: “I truly believe we are experiencing the quickest and most transformational change in our time with technology driving much of this. AI, robo-advice, machine learning and more are opening a wealth of opportunity that can be a step-change for our customers. These technology developments won’t replace humans—–I see the ’A’ in AI as ‘augmented’—i.e. supporting human endeavor. In this context, AI makes people smarter, simplifying and automating work—’smarter humans with smarter machines’. This means we’ll always need to consider the ethics, compliance and governance of algorithms and associated technology”.
While large investment managers have used technology to automate their portfolios for some time, it is only recently that individuals could avail themselves to these technologies directly without interacting with a human advisor.
Robo-advisors are encouraged, but rules for human advisors equally apply
Both the FCA and the Financial Industry Regulation Authority have adopted a progressive and supportive approach to automated investment services. However, the FCA’s recent review should enable legal advisors to persuasively remind client firms that their responsibilities to users are no less and the rules and principles apply equally to them.
“The FCA’s review of the robo advisory referred to their recent guidance on streamlined advice,” said Manisha Kimmel, Chief Regulatory Officer, Wealth Management at Refinitiv . “In that guidance, they made no distinction between automated and more traditional financial advisory services. In fact, they highlighted some of the key challenges automated services might have in ensuring that their offering met the needs of their target markets”.
While lower-cost app-based investment services enable much greater accessibility, the findings highlight the critical importance of designing automation and technology to adhere to the regulatory requirements.
Is “compliance by design” the answer?
Compliance by design refers to the approach of embedding regulatory compliance within the planning and operation of services. Lawyers could actively help clients identify regulatory obligations and design a practical and robust approach that effectively implements requirements within the operating model will help avoid costly remediation. Moreover, this ensures that the services can be marketed (and scaled) more broadly as meeting the varying levels of different national regulatory requirements is challenging.
Here are some of the compliance gaps with robo-advisors that the FCA identified which lawyers could help with:
Suitability and filtering
Automated tools must apply effective methods to determine users’ financial circumstances and investment objectives, as well as how much they actually understand the investing process. Robo-advisors should ensure they are not overly focusing on speed of the user journey and only collecting a shallow level of information. For example, ODIM services should have an effective mechanism to identify and filter out clients for whom its services would be unsuitable. These results should be constantly reviewed for gaps and any actionable findings implemented.
Transparency through disclosures
To ensure clients make informed decisions, automated services must clearly explain the structure of their charges and the nature and risks of any investments. The necessary information still needs to be presented on-screen in a comprehensible way, including any required guidance and warnings about related risks.
Governance and security
Automaton itself creates new risks. Lawyers should work with firms to proactively identify and address the unique risks arising out of their specific online operating models. Systems resilience and disaster recovery for example should be rigorously and regularly assessed and effectively managed. Lawyers should work with firms to ensure regular reviews of front-end services and back-end operations on a range of quality control dimensions as to how well their services are serving users.
A good user experience manages complex needs and functionality
Robo-advice services emphasize their algorithmic ability to help clients spread risk and improve opportunity by suggesting how to reinvest dividends, time the market and rebalance portfolios. However, human investment advisors must probe very creatively to correctly ascertain risk appetites and long-term financial needs, so their successor algorithms take care to ensure they correctly and fully understand them or may risk applying at greater velocity the wrong risk profile. There is also a real risk that while decision trees can work well with general needs, they cannot readily take account of users’ unique circumstances. It will be interesting to learn in time how many investment configurations these services are actually offering in practice.
Ultimately, lawyers can help clients to appreciate that ’compliance by design’ as standard operating procedure will help ensure they identify and address gaps to create the best possible customer-centric experience that clients and regulators will view as a competitive advantage.
