February 8, 2018

Why robo and regulation go hand in hand

David is a freelance journalist who writes about personal finance, technology and innovation.

Smart Platform blog
Pity poor Fabio. The brainchild of researchers at Heriot-Watt University, the “shopbot” lasted just a week at the Scottish supermarket where it was employed to help customers.

Exiled to the cold meats aisle after annoying shoppers with useless advice on where to find products, Fabio has just been fired after failing spectacularly in a pulled pork promotion. 

Still, maybe Fabio should count his blessings: had he been employed in financial services, where advisers must be authorised and their work is tightly regulated, the robot and its employer might now find themselves facing disciplinary action from the Financial Conduct Authority (FCA). The chief City regulator takes a dim view of firms that fail to treat customers fairly, let alone those offering poor quality advice.

Joking aside, there’s a serious point here: while the scope for exploiting new technologies in financial services is enormous, the stakes are higher than in other industries. Robo-advice has much to offer but any failure has the potential to cause significant consumer detriment. For regulators, that requires some difficult judgements. 

Credit where its due: the FCA has a reputation for supporting innovation that has seen regulators from all around the world asking its advice on how to manage the possible trade-off between technological advancement and consumer protection. For example, its sandbox initiative enables unauthorised firms to secure a limited level of authorisation so they can test innovative products in a live environment. Its Advice Unit offers ongoing guidance to firms on technology and compliance.

In part, this approach reflects the FCA’s mandate to promote competition, which is a relatively unusual brief for a financial regulator. It sees supporting innovation as an important part of ensuring that conditions are right for competition, and all the benefits that brings to consumers, firms and the broader economy. 

But the FCA’s attitude is also informed by concerns that recent reforms to the UK’s regulatory regime, though implemented with the best interests of consumers in mind, have had the counter-productive effect of pricing many people out of good quality financial advice. The regulator has high hopes that the robo-advice model might help close the “advice gap” identified in the Financial Advice Market Review of 2016, which found large numbers of consumers unwilling or unable to pay for independent financial advice

In these contexts, the FCA is engaged in a constant balancing act. It must continue to ask itself whether its regulatory approach is preventing innovators exploiting the potential of technology to improve outcomes for more consumers, or whether it is being too laissez-faire, and therefore exposing customers to undue risk. 

Last year certainly saw the regulator working hard to establish greater certainty around its policing of robo advice. A consultation published last August set out very clearly where the FCA sees the boundary between a service offering guidance to consumers and one that is offering regulated advice. It has also helpfully expanded on materials setting out the letter of the law with a series of case studies that give robo advisers a much better idea of what the rules mean in practice (largely drawing on the real-life work conducted by its Advice Unit). 

The FCA is due to publish further guidance on robo-advice this year, but the current direction of travel is clear. The regulator’s view of what falls outside regulated advice – and therefore where firms are not required to be authorised or to comply with suitability requirements – is pretty limited. Most robo-advice is going to fall into the regulated advice category.

For businesses such as Wealth Wizards, which have secured full FCA authorisation and built compliant technologies, that may not be problematic. However, for other firms – both new entrants and financial services incumbents – compliance costs may present a potential obstacle to developing their own commercially viable robo-advice propositions. Some may choose to white-label existing services while others will consider alternative options. 

These aren’t easy questions to resolve, either for firms themselves or the regulator. The FCA’s intent continues to be to support technologies such as robo-advice that have a clear consumer benefit, but it is also grappling with its responsibility to protect consumers (and to remain compliant with supra-national regulation such as the European Union’s revised Markets in Financial Instruments Directive, MiFID II). 

How might the regulator evolve its approach next? Well, one option would be to relax the rules that make it difficult for firms to cross-subsidise different sales channels – for example, to help firms fund robo-advice offers from their face-to-face revenues. Another would be to return to the vexed question of charging – do the rules requiring advisers to charge fees rather than operate on commission need re-addressing for the robo-advice market?

The solutions aren’t necessarily straightforward, but new business models – technology-driven or not – require new thinking from all stakeholders, including regulators. The FCA’s ability to adapt in the face of innovation has so far been exemplary, but the imperative to evolve regulation as new technologies emerge isn’t going to go away any time soon.

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