European Supervisory Authorities not to introduce guidelines about robo-advisors

There will be no extra regulatory burden for firms offering robo-advisory services, as per an announcement  by the three European Supervisory Authorities (ESAs) – EBA, EIOPA and ESMA, published earlier today.

The ESAs have presented a summary of the results of their monitoring exercise on automation in financial advice, which has revealed that the overall number of firms and customers involved in this area is still quite limited. As previously identified risks have not materialised and considering the limited growth of the phenomenon, the ESAs believe that no immediate action is necessary.

Let’s recall that in December 2015, the three European Supervisory Authorities published a Discussion Paper (DP) on Automation in Financial Advice, which described the phenomenon whereby advice is provided to consumers without, or with little, human intervention and providers rely instead on computer-based algorithms and/or decision trees.

In the DP, the ESAs identified risks of automated advice to consumers and financial institutions in respect of:

• consumers having limited access to information and/or limited ability to process that information;
• flaws in the functioning of the tool due to errors, hacking or manipulation of the algorithm;
• legal disputes arising due to unclear allocation of liability; and the widespread use of automated tools.

Another report on the topic published in 2016 concluded that the identified risks were also accurate, but the likelihood and impact of the materialisation of these risks can vary substantially. The 2016 Report also stated that the proliferation of automated advice, often referred to as robo-advice, was still at an early stage.

In July 2017, ESMA published a Consultation Paper with proposed draft guidelines for automated or semi-automated financial advice or portfolio management. When developing the guidelines, three main areas where specific needs of protection may occur have been identified:

• The information that should be provided to clients on the investment advice and portfolio management services when these services are provided through an automated tool;
• The assessment of the suitability (with a focus on the use of online questionnaire with limited or without human interaction);
• The organisational arrangements that firms should implement when providing robo-advice.

A follow-up survey on the evolution of “automation in financial advice” in the securities, banking and insurance sectors was done in March 2018 with NCAs (national competent authorities).

The responses from the NCAs indicate that the European market in ‘automation in financial advice’ seems to be growing, although not very rapidly. The overall scale of the market appears to be still quite limited. In terms of the development of automation in financial advice, while it appears that the phenomenon is still prevalently focused in the securities sector, some NCAs have noted that insurance and banking products are being distributed through automated tools in their jurisdiction.

In particular, with regard to the products offered:

•  Securities – Several NCAs noted that intermediaries are mainly offering ETFs and mutual funds, AIFs, and for a few firms signal-following in CFDs;
• Insurance products – Some NCAs noted that intermediaries are offering life insurance products; non-life insurance; travel insurance, foreign health insurance, car insurance, personal liability insurance, supplementary dental insurance, occupational disability insurance, pension products.
• Banking products – Few NCAs noted that intermediaries are offering mortgages and private loans.

The main barriers that prevent the robo-advice industry from further development are:

• Cultural/psychological barriers – In particular some NCAs noted that lack of digital (financial) literacy of consumers may be considered one barrier to the development of ‘robo-advice’.
• Regulatory barriers such as the complexity of existing applicable regulation, such as MiFID II/MiFIR, IDD, GDPR, PRIIPs (especially for smaller firms); the lack of “digital identity” and European harmonization between digital procedures for identity identification; the lack of a consistent legal definition of “advice” across the three sectors.

On top of that, firms still find it challenging to correctly profile clients and understand their objectives when there is no face-to-face interaction. Also, in an online environment it can be challenging to ensure that the customer understands both the advice and the features (such as the costs) of the product.