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Short circuit: Will advisers pay the cost of robo-advice failure?

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Fears are mounting that the rapid rise of robo-advice has outpaced the regulator, risking unsuitable investment recommendations that advisers will ultimately have to pay for.

The FCA has committed to launching a new robo-advice unit as part of the Financial Advice Market Review.

The unit will be an extension of its ongoing Project Innovate to help firms launch new technology-backed services.

But there are concerns from within the financial services industry that these tools are becoming more prevalent without the appropriate regulatory scrutiny at a time when advisers are under increasing pressure to demonstrate suitability.

Money Marketing understands the regulator has voiced concerns that Project Innovate started out working separately from the rest of the FCA.

So are consumers adequately protected from the rise of the robots? Or should the FCA hit the brakes before investors get seriously hurt?

Understanding the risks

So nascent is the market for robo-advice services in the UK, the Financial Ombudsman Service has yet to receive any complaints from consumers.

But in places like the US and Australia, automated offerings have a much longer history.

Since 2005, the US has allowed broker-dealers to make investment analysis tools available to investors. Last month, the Financial Industry Regulatory Authority published a report on digital investment advice, noting such tools “will likely play an increasingly important role in wealth management”.

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However, Finra also noted concerns around the suitability of investment recommendations, such as fears that automated services may seek to “average” contradictory responses on topics like risk tolerance.

The Securities and Exchange Commission issued a similar warning last year. It said: “While automated investment tools may offer clear benefits — including low cost, ease of use, and broad access — it is important to understand their risks and limitations before using them.

“Investors should be wary of tools that promise better portfolio performance.”

Financial software firm eValue founder and strategy director Bruce Moss says US authorities are increasingly concerned robo services may be too simplistic in their approach.

He says: “Finra is a much more relaxed regulator than the FCA, but what they are beginning to see is some of those US firms are not asking enough questions.

“If you take any of those US models to the UK they will immediately fall over completely because they don’t ask enough questions about risk or capacity for loss.

“They basically ask very few questions, and then they recommend an investment or an asset allocation or a portfolio. They are cutting corners aggressively.”

Moss says online services put the focus on making interaction as quick and easy as possible, but says this limits the opportunities to do in-depth investigation.

He says: “There is a tremendous tension with these robo services. You have to go through all the steps that you would normally, but the problem is consumer engagement.

“But if you send someone a very long email to take them through that process they might not be all that engaged and actually finish it, let alone pay attention to it.

“Traditional advice firms are put through the meat grinder while a new generation of firms may not be doing things in such a thorough way”

“So the temptation is clearly to try to cut corners wherever possible so they can make it as  quick and easy as you can.”

Nutmeg, which is planning to enter the advice market through a mix of online, telephone and face-to-face services, has previously warned the FCA has been “too open-minded” on robo services.

Policy executive Frankie Evans said: “Is there going to be the right statutory protections for the consumer on robo-advice as it stands? We’re not completely confident on that.

“It would be useful if the FCA could give more information about how it’s going to protect the consumer from lousy or badly updated or uninformed systems. Because if you have one mistake in the system, you could be advising 200 people in the space of five hours.”

Storing up problems

Finance and Technology Research Centre director Ian McKenna is concerned some robo-advice services are failing to meet suitability requirements.

McKenna questions the approach from the FCA on robo-advice, particularly as it is about to embark on a huge review on suitability covering 700 advice firms and 1,000 client files.

He says: “Things are seemingly unbalanced here. There’s a huge amount of pressure on traditional advice firms at the moment, putting them through the meat grinder on suitability, while you have a whole new generation of firms who may or may not be doing things in such a thorough way as the regulator requires.

“I don’t think the FCA has ever said it is going to look at things differently for automated advice firms. So the issue is whether more of these automated advice firms are storing up some considerable regulatory problems for the future.”

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He adds: “There is no shortage of stuff from the FCA on suitability. In fact, there is an extensive canon of documents from the regulator on what they expect, but when I look at some of these automated advice propositions coming to the market, I question whether they have read all that stuff.

“I can’t equate what are the FCA’s expectations are of traditional advisers with what I’m seeing coming to the market.”

The Lang Cat principal Mark Polson says the mechanics of offering an automated service do mean flawed systems can rapidly affect more customers.

But he says: “Most of what these guys are offering is very simple and very constrained. It seems to me the level of jeopardy in terms of telling someone to do their Isa before they start doing other savings doesn’t seem too dangerous to me.

“The jeopardy is more around whether there is something in the risk-profiling process that moves people into the wrong portfolios.

“But a lot of these systems have got those bases covered off. They are not completely stupid – these systems have been set up, at least in part, by people who already give advice.”

Polson argues robo-advice does not necessarily mean execution-only, with some advisers taking up white-labelled offerings from the likes of Parmenion, to complement their own work.

Online firm Fiver A Day founder Al Rush says his clients use a front-end robo-advice service, with Rush then manually verifying outputs.

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In total, Rush estimates he approves three-quarters of applications.

For the remainder he goes back to the client to discuss whether a client has additional savings, with just one in five of those meriting further investigation before being approved.

He says: “I have set the threshold quite high because whatever people say about robo-advice, the bottom line is it’s still my name on the business, and I don’t want any nasty surprises.”

Footing the bill

Polson says were a robo-advice business to collapse, it is advisers who would be likely to foot the bill through the Financial Services Compensation Scheme.

He says: “If there’s a claim on the FSCS because a robo-business is found to have done the wrong thing, then it’s undeniable that it would fall on advisers in the same way.”

Law firm Clarke Willmott financial services litigation partner Philippa Hann says: “The FSCS makes sure everybody in that pot shares in that pain. It’s this kind of scenario where the good are paying for the bad where I can understand why many people might think it’s unfair.”

But she adds: “FCA acting chief executive Tracey McDermott has already said the FSCS should consider whether to calculate the levy on a different basis.

“It’s clear that arises out of the difficulty the regulator is facing with some of these new and innovative businesses.”

The FSCS is to carry out a review of its funding model by the end of 2016. A spokesman says where claims against robo-advice firms will fall will be considered as part of the review.

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Comments

There are 8 comments at the moment, we would love to hear your opinion too.

  1. If you want to pilot the robo guidance nonsense then you should pay an increased levy and have increased PII to cover the cost of its inevitable failure.

  2. Expressed within our FAMR response, we stated that the costs of regulation of robo advice should not be borne by those who refuse to offer it for the reasons given above and compensation likewise should not be levied on advisers.

  3. Julian Stevens 5th May 2016 at 11:13 am

    Whatever goes wrong, the adviser community will end up paying to sort it out. That’s the way British FS regulation works ~ we pay to support the regulator and we pay for the consequences of its wrong turns.

  4. advised, non-advised, regulated, non-regulated – it does not seem to matter – if someone complains to the FCA they will take responsibility and we will pay for it. Its a joke if it wasn’t so unfunny!

  5. Any compensation resulting from Robo-advice should be referred to the nearest ATM.

  6. Really easy solution. Create a separate class of Robo Adviser for FCA & FSCS. Those and ONLY those in this arena pay for the mistakes of their own.

    • James Hurdman 10th May 2016 at 1:51 pm

      Spot on Marty Y. Maybe there is a concern that if they did this and all the robo advice firms went belly up then there would be nobody, other than PI insurers, to pick up the bill.

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