Automated services are feeling the pressure to clarify their offerings after an FCA review
A slew of robo-advice firms have sprung up in recent years, with many promising to deliver financial advice at a cheaper cost than face-to-face financial planners.
However, a review released last week by the FCA suggests the market is having some teething troubles.
The review highlighted a number of shortcomings around suitability, fee disclosure and the identification of vulnerable clients.
Some robo-advisers are now moving towards offering fully regulated advice, as opposed to simply guidance or information, but will the findings of the FCA’s review cause them to change tack?
Robos under fire
The FCA reviewed seven firms offering online discretionary investment management services and three firms giving automated advice.
It found service and fee-related disclosures at most online discretionary investment management firms in its sample were unclear.
Some firms did not make clear whether their service was advised, non-advised, discretionary or non-discretionary. Others also compared their fee levels with their peers 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.
Finance & Technology Research Centre director Ian McKenna says robo-advisers are still unclear on the services they offer because it is a relatively new market.
He says: “It is like anything else that is new; everybody is learning and doing so at a tremendous rate. The feedback I am picking up is that it is taking longer for new organisations going through the authorisation process.
“The review highlights the need for robo-advisers to understand every element of the regulations that are required for financial advice and also recognise that they are going to be held to the same high standards that traditional advisers are.
“Perhaps in their haste to get to market some of these robo-advisers did not take on board the points of the relevant regulation, but they are going to have to in the future.”
The review also highlights shortcomings in suitability assessments, with many firms failing to properly evaluate a client’s knowledge and experience, investment objectives and capacity for loss. Some failed to ask about clients’ knowledge and experience at all, as they felt their service was suitable for all individuals.
Regarding streamlined advice models, the FCA says that some automated advice services lacked adequate fact-finding and know-your-client focus, instead relying on assumptions. In some cases, robo-advice services recommended a different transaction to the one that actually took place.
Most firms in the online discretionary investment management services sample were also unable to show they have adequate and up-to-date information on clients. Weaknesses were also found in automated advice services identifying and supporting vulnerable consumers, with some relying on the client to self-identify.
A path through the trees
The FCA clarified the respective differences between advice and guidance following the Financial Advice Market Review, with new rules effective this January.
Combined with the FCA’s Advice Unit, set up to assist companies wanting to bring automated advice models to market, this should have made it easier for robo firms to develop their DIY services into regulated advice. Therefore, it seems surprising that firms still seem to be unclear on where they are in this journey.
Tom Kean, director, Thameside Financial Planning
This is exactly the kind of reaction most of us were expecting. We get rudderless guidance from our regulator and yet are expected to get it right first time.
The FCA needs to accept that the organisations they try to regulate come in all shapes and sizes, and are simply trying to find a solution to the problem of the regulator’s making: namely the advice gap.
Some will do it well and some won’t, but I think we all need to accept times change and some form of automated advice is here to stay, so let’s get it right with a clear steer from the FCA.
LEBC public policy director Kay Ingram says the review highlights the need for robo-advisers to be clearer on the type of advice they give. She feels that firms not meeting regulatory standards need to act quickly as they have been given a “get-out-of-jail-free card” by the regulator.
She says: “The key thing is the consumer. It must be crystal clear to them if they are getting advice or not. If you are not giving a personal recommendation, then you cannot call it advice.
“In many cases robo-advice is simply a means of garnering assets under management. It is a far cry from fully regulated advice, which takes account of all of a consumer’s circumstances and advises on their best course of action.
“This may include doing nothing, making no investment and instead building up a rainy-day fund, paying off debt or protecting income in the event of death or ill health. Few robo-advice models would offer consumers these outcomes. In that regard, they often do not meet the standards of regulated advice as highlighted in the FCA review.
“Similarly, attitude to risk needs to be informed and moderated by capacity for loss. Assessing capacity for loss requires an understanding of the consumer’s knowledge and experience, and helping them explore what particular risks they could be exposed to. An online questionnaire alone is not sufficient. The FCA is right to point out these deficiencies in the robo-advice sector.”
Law firm TLT partner Michael Isaacs says that, as it is a limited review, it is difficult to extrapolate it across the whole sector.
He says: “The FCA has for some time sounded a bell about the need to ensure that streamlined advice models meet existing regulatory requirements and deliver the right outcomes for customers.
“The issues themselves are not new but the FCA recognises that we are still in the early stages of an evolving robo-advice market.
“This is part of the FCA’s approach to encourage innovation and encourage firms to get it right. It is not intended to be punitive. It is not naming and shaming. The focus is very much on the positive benefits of innovation while helping firms avoid the pitfalls.”
So what impact will the review have on robo-advisers?
Both Nutmeg and Moneyfarm say they will not be making any changes to their propositions following the review. Scalable Capital says it does not wish to comment.
The FCA is right to point out these deficiencies in the robo-advice sector
Evestor chief executive Anthony Morrow says he is comfortable with the findings and that it is “business as usual” for the firm.
He says: “There are clearly robos out there that don’t give advice at the moment and are going to have to make the decision whether they want to now, but obviously that introduces additional costs as well as additional risks. I am sure there will be some big decisions going on.
“They might go down the guidance route in response, but it will be a shame if they do. Personally, I hate guidance because it provides a second-class service to the very people who need help. You either give advice or do execution only. Anything in between is just a cop-out.
Lee Robertson, chief executive, Investment Quorum
I I hope the review does not put robo-advisers off going into full advice as the more entrants we have the better.
They have to prove their model works and that they can attract clients of higher value, and not just have thousands that are costly to run. New robo-advisers will be looking to see what the early ones did.
The review is bound to have an impact on moving to full regulated advice, which is expensive to deliver. Some firms will struggle with their propositions, how they charge and how they differentiate them.
“I hope it does not put off new entrants. I am sure that those businesses that are looking at launching might have to do a bit of rethinking following the FCA’s announcement.”
Nutmeg chief investment officer Shaun Port believes the regulator needs to do more to highlight best practice. He says: “We have been talking to the regulator about issues like suitability since 2011, so this is not really anything new to us.
“As we have been around since 2012 our implementation of the rules may be different to other firms. So it is good that the regulator is coming in and being clear about what is good, but we would like to see more done about what is best practice.”
Port is disappointed that the whole industry has not adopted the spirit as well as the letter of the Mifid rules around costs and charges. “When it comes to costs and charges we have been disappointed by the way the sector has implemented Mifid II rules,” he says. “We believe we have built a gold standard in the way we are transparent about costs.”
While McKenna does not think robo-advisers will be put off going down the regulated advice route, he does believe they will now have to up their game.
He says: “Traditional advisers now have a level playing field. Robo-advisers are going to be judged and treated just like anybody else now, which means they are going to have to question whether they are advised or non-advised. It will not stop robo-advisers going into full advice but it will mean they have to significantly raise their standards.
“For robo-advisers, the cost of attracting customers is significant, so they will partner with advice firms rather than compete with them. The FCA had to allow things to develop to a certain stage in order to be able to judge whether new entrants were meeting the same standards, but now they have given the clearest possible indication that if it applies to a traditional adviser, it applies to them.
“It will make some areas more challenging, such as increasing the cost of building these businesses.”
Closing the advice gap
Altus consultancy director Kevin Okell believes that by not confronting the advice gap the FCA had failed to see the bigger picture affecting consumers. He says: “The review makes my blood boil and completely misses the point about what robo-advice is about.
“It feels like a review of a regular adviser business. The FCA should have rewritten the rules to reflect the problem of the advice gap following the RDR. Robo-advice is aimed at providing service to the mass-market consumers caught in the advice gap who can’t afford face-to-face advice but really still need to be saving.
“We are going to have a generation of people who are poor coming to retirement. It won’t be until we see pensioners going to food banks that we finally wake up.”
Ingram says LEBC’s “bionic” advice service, which combines human and automated elements in a hybrid model, is the key to addressing the advice gap.
She says: “The traditional face-to-face bespoke way is not affordable to enough people. Robo-advice would only work well without human intervention if all consumers had simple requirements, were knowledgeable about investment risk, taxation and product wrappers and behaved totally rationally all of the time.
“Some firms have simply decided they cannot service everybody and just take on a few high-net-worth clients. We could have taken that view and ramped up fees like everyone else, but we think advice is important to the individual and the economy.”
Robos can expect the level of scrutiny to increase
The recent announcement from the FCA seems to have set a number of issues running again. Most people are commenting on digital distribution and the shortcomings around suitability, fee disclosure and identifying vulnerable clients.
Interestingly, the issue actually seems to be twofold: the ongoing struggle of some digital engineers to understand the whole advice and guidance spectrum, alongside the regulation of automated decision-making and artificial intelligence.
Understanding the implications of AI is already high on the agenda of UK and EU regulators. Currently, there is no prescribed set of rules for AI in financial services; it is only the outputs that are regulated, in exactly the same way a human financial adviser is judged.
Firms using AI can reasonably expect the level of scrutiny to increase. Robo-advisers will be expected to demonstrate how the AI application works and complies with regulatory requirements and the firm’s risk appetite.
In line with accountability regimes, supervisors will expect firms to have clear lines of responsibility and accountability, including an identified owner for each AI application with responsibility for reviewing and approving AI algorithms, in line with clearly defined testing and approval processes. They should also be responsible for initiating the review and updating of applications.
In respect of guidance, the current rules are too ambiguous for firms to develop services that they can be confident will not breach financial advice rules. The regulations permit limited personalisation of the consumer’s circumstances, diminishing the benefit of the guidance being provided.
There is little consistency regarding how guidance services should be delivered, or standards to ensure that consumers receive a professional service. Consumers would benefit from regulated financial services firms and the government’s new combined guidance body adopting similar terminology and outcomes.
There is, therefore, a need to develop a framework for financial guidance that should ideally be developed with the government to ensure common standards are adopted where appropriate.
Peter Smith is global head of industry policy liaison at Tisa