Many auto advisers and automated discretionary investment managers risk poor outcomes for customers by falling short of FCA expectations.
By Nicola Higgs and Brett Carr
The Financial Conduct Authority (FCA) has issued a statement outlining its expectations of firms providing automated online discretionary investment management (ODIM) services and retail investment auto advisers (auto advisors). The FCA uses its statement to remind firms that the regulator’s rules, including those in relation to suitability and advice, apply equally to services regardless of the medium through which they are offered. Current providers and planned new market entrants should heed the warnings and the learnings of this statement.
What was the FCA analysing?
The FCA conducted two reviews:
- The first review looked at seven ODIM providers (at the time these firms represented more than half of the firms in this particular market).
- The second review looked at three auto advisers (being three of the early entrants to this nascent market).
Why did the FCA conduct these reviews?
The FCA identified promoting innovation and competition as a cross-sector priority in its 2017/18 Business Plan. The FCA is seeking to achieve this objective by allowing financial innovation to thrive, when such innovation delivers good outcomes for customers. The FCA committed itself to monitoring the resulting developments.
What did the FCA find?
Service and fee-related disclosures were often unclear or misleading
- Most fee-related disclosures at ODIM firms were unclear. It was also unclear whether the services provided were advised, non-advised, discretionary, or non-discretionary.
- Some firms compared their fee levels against peer services in a potentially misleading way; for example, they compared a non-advised, non-discretionary service with a discretionary service solely on a cost basis, without explaining the difference in the nature of the service.
Under the FCA’s rules, firms must provide clear information about their services, costs, and associated charges, if they provide — or intend to provide — automated investment services.
Suitability was often not adequately addressed
- Many firms offering ODIM services did not properly evaluate a client’s knowledge and experience, investment objectives, and capacity for loss in their suitability assessments.
- Some firms did not ask clients about their knowledge and experience at all, as they felt their service was suitable for all individuals regardless of their investment knowledge and experience.
- Some auto advice services lacked adequate fact-finding and “know your client” focus, instead relying on assumptions about clients.
- In some cases, auto advice services recommended a different transaction than the one that occurred at the end of the advice process.
- The FCA found examples of clients being able to disregard advice given by the automated offering, without any safeguards or risk warnings to prevent or challenge this action. This created uncertainty about whether the business was transacted on the advice of the automated offering, or on an execution-only or insistent client basis. Sometimes an adviser intervened in the automated process without recording the nature of the intervention.
The FCA reminds ODIM firms and auto advisers that they (like any other firm offering discretionary and/or advisory services) must undertake a suitability assessment to ensure that a personal recommendation or a decision to trade is suitable for each client.
As discussed in a recent Latham & Watkins Client Alert, the Commission Study of the EU Market in Retail Investment Products advises that all robo-advice platforms should be complemented with the availability of human advice (i.e., as differentiated from technical assistance). The availability of human advice is especially important if the client is completing the suitability self-assessment when being on-boarded and when receiving a recommendation (i.e., before execution occurs). This recommendation follows observations of overconfidence in investors when answering the automated questions, as well as the provision of unreliable information (including investors who are rejected by the platform, who will attempt to circumvent the suitability process by starting the self-assessment again and altering their answers).
Information collected and maintained about ongoing clients was often inadequate
- Most firms in the ODIM services sample were unable to show that they had adequate and up-to-date information about their clients when providing an ongoing service.
FCA rules require that when firms have ongoing client relationships, they need to maintain adequate and up-to-date client information.
Vulnerable customer identification was often inadequate
- Auto advisers exhibited weaknesses in identifying and supporting vulnerable consumers, with some offerings relying on the client to self-identify as vulnerable.
Governance processes often needed improvement
- There appeared to be little consideration of auto advice-specific risks in firms’ governance processes. For example, firms demonstrated inconsistent awareness of the need for adequate stress-testing and cyber security (including considerations such as testing around sales volumes, developing action plans to address losses of connectivity or other eventualities, and continuing to test systems post-launch).
- Some networks lacked clarity about how responsibilities were shared between the adviser and the network.
What do the FCA’s findings mean?
The FCA provided specific feedback to individual firms, and many of them have had to make significant changes to their disclosures and suitability processes as a result.
The market for both ODIM and auto advice services remains at an early stage, with a number of firms expected to launch services over the coming year. However, as a recent Latham & Watkins Client Alert highlights, customer adoption is minimal.
The FCA continues to encourage innovation in automated investment services, and is clearly trying to strike an appropriate balance between facilitating innovation and ensuring a good level of consumer protection. Therefore, although this is an evolving market, the FCA asserts that its rules and principles apply equally to these emerging automated offerings. However, where the regulator sees poor practices that could cause harm to consumers they will take action using appropriate regulatory tools, including early intervention or enforcement investigations where needed.
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