The Robo Cop of Robo-Advice
Fintech is transforming the business models of Australian Financial Services (AFS)
18 July 2019
AFS licensees are now designing algorithms as a means to providing financial digital advice, which requires no direct involvement by human advisors. Digital advice can have cost benefits and makes professional financial advice more readily accessible by investors.
The Corporations Act 2001 (Cth) is technology neutral in that the obligations that apply to providing non-digital advice and providing digital advice are the same. The Australian Securities and Investments Commission (ASIC) recognises that how an AFS licensee complies with the obligations imposed on them will vary according to the nature, scale and complexity of their business. To assist providers of digital advice operating in Australia, ASIC has published Regulatory Guide 255 − Providing digital financial advice to retail clients (RG 255).
AFS licence requirements
Fintech businesses that carry on a business of providing financial services (e.g. digital advice) in Australia must either obtain an AFS licence or become an authorised representative of an AFS licensee unless an exemption applies.
As part of any AFS licence application by a digital advice provider, ASIC may request information about the level of human review or involvement in relation to the personal advice generated by the algorithm used in the business. On the other hand, existing AFS licensees wanting to provide digital advice will need to consider whether their current AFS licence will allow them to do so and whether they have the required resources and processes in place.
ASIC has stated that the obligations set out in their Regulatory Guides apply equally to non-digital advice and digital advice. However, in RG 255, ASIC sets out its position in relation to certain issues that are unique to the provision of digital advice.
Meeting the organisational competence obligation
AFS licensees are required to maintain competence to provide the financial services covered by their AFS licence and to ensure that any representatives are adequately trained and competent to provide those services. Since algorithms are being used to generate digital advice, these training and competence criteria do not apply to digital advice only businesses. In these circumstances, AFS licensees providing digital advice are required to have at least one responsible manager who is able to demonstrate that they have undertaken a combination of training, qualification and experience to satisfy their organisational competence obligations.
Monitor and test algorithms
AFS licensees have an obligation to establish and maintain adequate risk management systems. ASIC considers that this obligation requires an AFS licensee that provides digital advice to regularly monitor and test the algorithms that underpin the advice provided. Some steps that ASIC expects AFS licensees to take in order to comply with this obligation include:
- Have appropriate system design, test strategy and changes to the algorithms documentation;
- Have adequate resources in place to monitor and review the performance of algorithms (e.g. adequate number of people within the business that understanding the algorithms used and to regularly review the quality of the advice provided); and
- Have appropriate internal procedures to ensure the steps above have been followed (e.g. sign-off processes).
Providing scaled advice in the best interest of the client
AFS licensees have an obligation to act in the best interests of the retail clients when providing personal advice ('best interests duty'). Digital advice only providers are unable to limit the scope of their advice ('scaled advice') through conversations because there is no natural personal directly involved in providing the advice. In these circumstances, ASIC emphasises that any client communications by product advice providers are user-focused and clear are provided at the right time in the decision-making process.
In RG 255 ASIC sets out some steps that digital advice providers should adopt when providing scaled advice in order to satisfy the best interests requirement. These include, for example:
- Clearly explaining to the client the scope of advice (i.e. what services the tool does and does not provide) and requiring clients to actively demonstrate that the advice being sought is within the scope of the digital advice model;
- Informing the client about the key concepts, risks and benefits associated with the advice being provided throughout the advice process;
- Filtering out clients for whom the advice being provided is not appropriate; and
- Informing the client how they can withdraw from the advice being provided and any associated costs.
Other obligations that digital advice providers must turn their attention to include:
- Adequate compensation arrangements (e.g. professional indemnity insurance) for compensating clients for losses suffered as a result of any breach of their obligations under Chapter 7 of the Corporations Act. ASIC notes that when assessing the adequacy of compensation arrangements digital advice providers should consider the potential for widespread losses in the event that the algorithm is flawed; and
- Cyber security and privacy considerations given that digital advice involves the collection and use of personal information which may give rise to additional obligations under Australian privacy laws.
While fintech operators seek to disrupt existing business models, it is important for those operators to consider how they existing regulations might apply to them. In many cases, those regulations may not easily apply to new technologies.
Helpfully, ASIC has in RG255 provided guidance on how digital advice providers can satisfy the AFS licensing requirements. These licensing requirements were imposed without the knowledge of how technology would come to disrupt the provision of financial services in the future.
Technology is not only disrupting business but regulation as well. The challenge is for regulators to keep up with fintech advancements to allow new products to be developed whilst having regard to the regulatory objectives.