Actuarial Post: Even Robots must be regulated
This article was originally commissioned for Inner Workings, a monthly column written by Tom Murray, in the June 2018 edition of the Actuarial Post.
The FCA have started their review process of firms providing retail investment advice through automated channels. They are trying to see how they can best regulate the new area of auto-advisers. Whilst it is still early days in this market, it is only at the evolutionary stage and there were only three firms examined, the potential for significant harm if they get it wrong is very great. The challenges for the FCA are great in trying to control an aspect of the industry that is only beginning to take on shape.
Much of the regulation in financial services that has been introduced over the last decade and a half is designed to ensure that the adviser market delivered high-quality, independent advice to consumers. Financial product consumers are a particularly vulnerable market segment, as many have little understanding of the complex products that are on sale in the financial sector nor how to consider their needs over the long time-scales generally involved.
The biggest regulatory change was the Retail Distribution Review (RDR), a mammoth piece of regulation that fundamentally changed the way advisers were remunerated by their clients and by doing so fundamentally changed the way services were offered. The RDR was very specific about the independence and range of the advice that must be available from anyone who touted him or herself as a financial adviser and ensured that those who worked off a lesser range of the market or were linked to specific providers had to clearly identify to the client the fact that the advice being given was restricted.
This kind of holistic, market-wide advice however is an expensive proposition, and therefore RDR had the unfortunate side-effect of pricing many lower and middle-income earners out of the market for advice. This meant leaving those who were most in need of good advice for their small investment pots completely adrift from it. This conundrum, i.e. those who could not afford to withstand any losses were the very ones priced out of the advice market, was much discussed at the time. It has become very clear that the use of artificial intelligence or auto-advice, was going to be a key factor in giving access to the lower paid to the type of financial advice that heretofore could only have been afforded by a commission system, whereby the provider paid the adviser for the advice at the risk of bias being involved in the sale.
And so, the march of the robots began. But there are a couple of key areas where caution needs to be exercised, as the ability of auto-advisers to provide the right advice needs to be carefully monitored.
In the first place, the suitability of the advice given depends on both the quality and the quantity of the information supplied to the algorithm. Insufficient data provided will mean that the auto-adviser is making recommendations based on insufficient knowledge of the customer’s circumstances, which naturally could cause problems. But the quality of the information provided is also key. If the questions are not clear enough there is a danger of the customer either giving incorrect answers or being guided towards specific answers that don’t reveal the full truth of his or her personal situation. In either case, the result will be that the advice given will almost certainly not meet the needs of the customer and will leave the company open to the challenge of having mis-sold at a later stage.
Secondly, auto-advice services may be advising customers incorrectly as bias can just as easily be built into these services as it can be shown by a human adviser. To ensure that this is not the case, providers of auto-advisor driven services will have to regularly monitor and test the advice being given to ensure that the systems are operating in the interests of the customer and not in the interests of the service provider. If the FCA is to succeed in ensuring that there is a level playing field between advisers and auto-advisers, it will have to hold them both to the same standard.
The FCA has found a number of problems with the existing services being provided by auto-advisers. Inadequate fact finding has resulted in a poor ‘know your client’ focus. As understanding the client and his or her needs is essential to the provision of good financial advice, it appears that some of the players in the market have a long way to go yet. They also found multiple problems with the quality of the data gathered and the accuracy of it. Many auto-advisers have a simplistic approach to the issue and are not paying attention to the FCA’s warning that they expect auto-advisers to “meet the same regulatory standards as traditional discretionary or advisory services”.
The FCA have promised to keep up the reviews and work to improve the standards of auto-advice. Without this, we will never get the type of holistic automated advice that will truly be able to replace an adviser in the field and allow low and middle-income earners to get the advice they need and deserve.