Regulatory Update: 'Automated Investment Services - Our Expectations'

Posted: 25th May 2018

Background

The FCA published a statement on 21st May 2018 outlining its expectations of firms providing automated online discretionary investment management (ODIM) services and retail investment advice through automated channels.

The statement reminds firms of the regulator’s rules and expectations, including that those rules in relation to suitability and advice apply equally to services regardless of the medium through which they are offered.

The FCA conducted two separate reviews, the first review looked at seven ODIM providers (at the time this represented over 50% of firms in this market). The second review looked at three auto advisers providing retail investment advice exclusively through automated channels.

Key Findings

In the FCA Business Plan 2018/19, the regulator identified promoting innovation and competition as a cross sector priority. The FCA are seeking to achieve this objective by allowing financial innovation to thrive, providing it delivers good customer outcomes. The FCA also noted that they are committed to monitoring ongoing market developments in this regard.

The key findings from their review are as follows:

Service disclosures

• The service and fee related disclosures at most ODIM firms in the sample were unclear. It was also unclear whether the service provided were advised, non-advised, discretionary or non-discretionary.
• Some firms also compared their fee levels against their peer services in a potentially misleading way. For example, they compared a non-advised, non-discretionary service with a discretionary service solely on the basis of cost without explaining the differences in the service provided.

Suitability assessments

• 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 auto advice services lacked adequate fact finding and ‘know your customer’ focus, instead relying on financial assumptions about the client. For example, some firms failed to gather sufficient information in relation to a customer’s outgoings.
• In some cases, auto advice services recommended a different transaction to the one that occurred at the end of the advice process.
• Some clients were able to disregard advice given by the automated offering, without any safeguards or risk warnings to prevent or challenge this action.

Ongoing client relationship

• Most firms in the ODIM sample were unable to show that they had adequate and up-to-date information about their clients when providing an ongoing service.

Vulnerable customers

• Auto advisers exhibited weaknesses in identifying and supporting vulnerable consumers, with some offerings relying on the client to self-identify as vulnerable.

Overall governance

• 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.

Regulatory next steps

Where the FCA observes poor practices that could cause harm to consumers they have committed to act using the appropriate regulatory tools, including early intervention or enforcement investigation if required.

The regulator will carry out ongoing assessments of developing markets such as ODIM and auto advice. They expect existing firms and new entrants into the market to consider the issues in this article and act where needed. Future reviews will include an assessment of how firms are complying with the new requirements introduced by MiFiD II and whether the cumulative impact of these important regulatory changes (together with the Packaged Retail and Insurance-based Investment Products (PRIIPs)) are working as intended.

Ultimately, the regulator expects automated investment services to meet the same regulatory standards as traditional discretionary or advisory services.

Consideration for firms

The FCA has provided specific feedback to individual firms, which has resulted in changes to disclosure and suitability assessments.

Focus areas moving forwards will include ensuring that individual firms improve their record keeping processes in relation to recording customers outgoings and expenditure. Firms will need to ensure that a client’s holistic financial position can be evidenced and appropriately factored into the decisioning process. Where assumptions are used, these should be robust and validated. Firms should also consider whether their fees are fair for the service being provided, transparent and disclosed appropriately to the customer and ultimately ensure that client communications are fair, clear and not misleading. Firms may also be well advised to analyse various approaches to digital conduct risk associated with online journeys.

It is fair to say, that the market is still in a growth phase, with a number of firms due to launch services over the coming year. It is also clear the regulator is trying to ensure it does not stifle innovation but also maintains and promotes the importance of ensuring good customer outcomes within the automated investment sector.