We identified promoting innovation and competition as cross-sector priorities in our 2017/18 Business Plan. We want financial innovation in our markets to thrive where it delivers good outcomes for customers in terms of value, costs and choice. We said we would monitor developments and review services providing automated investment services to help inform our regulatory strategy. We also announced our intention to review new entrants to the market in the future.
Our reviews
The first review looked at 7 firms offering automated online discretionary investment management (ODIM). This is where the client has given the firm responsibility to invest on the client’s behalf, within parameters agreed with the client, on an ongoing basis. At the time these firms represented over half of the firms in this particular market.
The second review looked at 3 firms providing retail investment advice exclusively through automated channels (auto advice), where customers do not interact with human financial advisers. The advice is given on a one-off basis (when the customer first engages with the firm). At the time of the review, these firms were the early entrants to this developing market. We plan to review further firms in this market later in this financial year.
We carried out the reviews to help us:
- better understand innovative services available to consumers
- consider the quality of suitability assessments undertaken in ODIM services
- consider the suitability of advice provided by the auto advice model
- understand the level of support and the quality of information provided to prospective customers
- examine firms' governance and oversight of their automated investment services
- make sure our supervisory work can address any harm or potential harm that may arise from these services
Our findings
Service disclosures
Our rules require firms that provide and intend to provide automated investment services to give appropriate information about their services, costs and associated charges in a clear way. This helps clients to understand the nature and risks of the service and the type of investment that is being offered, so that they can make informed decisions.
The service and fee-related disclosures at most ODIM firms in our sample were unclear. Some firms did not make clear whether their service was advised, non-advised, discretionary or non-discretionary. Some firms also compared their fee levels against peer services 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.
Firms are required to give appropriate information to customers in a clear way (COBS 2.2.1R[1]) (following the implementation of MiFID II, COBS 2.2A contains similar requirements which apply to firms carrying on MiFID business). This includes information about the firm and its services, designated investments and proposed investment strategies, execution venues, as well as costs and associated charges. For designated investments and strategies, this must include guidance and warnings about associated risks.
Firms must make sure that their fees are fair for the service being provided, transparent and disclosed appropriately. In addition to complying with COBS 2.2.1R[1], firms must make sure communications to clients are fair, clear and not misleading (COBS 4.2.1R[2]).
Suitability assessments
Automated investment services firms (like any other firm offering discretionary and/or advisory services) must undertake a suitability assessment to make sure that a personal recommendation or a decision to trade is suitable for each client. We reviewed firms’ services against the rules in COBS 9[3] (our reviews assessed firms against COBS 9. MiFID II came in to force on 3 January 2018. COBS 9A contains the suitability requirements firms carrying on MiFID business will be required to comply with now.) of our Handbook. We also considered our published non-Handbook guidance as well as the European Securities and Markets Authority’s (ESMA) guidelines on certain aspects of MiFID suitability requirements[4].
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 firms did not ask clients about their knowledge and experience at all, as they felt their service was suitable for all individuals regardless of their investment knowledge and experience. COBS 9.2.1R[5] and COBS 9.2.2R[6] require a firm to gain sufficient information about a client’s relevant knowledge and experience, financial situation and investment objectives to make a recommendation or take a decision which is suitable for the client.
Firms offering auto advice services use a ‘streamlined advice’[6] model to make a personal recommendation. Some services lacked adequate fact finding and 'know your client' focus, instead relying on assumptions about clients. In general, we were not satisfied with the strength of information gathering about clients' financial circumstances. For example, some services failed to request or gather adequate information about customers’ debt and other outgoings. Firms should consider how to improve the amount and quality of client information collected during the auto advice process.
We expect automated investment services to meet the same regulatory standards as traditional discretionary or advisory services. This means taking a proportionate approach to information gathering while maintaining the appropriate level of client protection.
In some cases, auto advice services recommended a different transaction to the one that took place at the end of the advice process. We saw examples where clients could disregard advice given by the automated offering without any safeguards or risk warnings to prevent or challenge this. This created uncertainty about whether the business was transacted on the advice of the automated offering, or on an execution-only or insistent client basis[7]. Sometimes an adviser intervened in the automated process without recording the nature of the intervention. In these instances it would be difficult for firms to show the suitability of the advice provided. Firms should consider how their processes and record-keeping might be improved to limit potential harm to customers[8].
Ongoing client relationship
If firms have ongoing relationships with clients, for example providing ongoing portfolio management, they need to maintain adequate and up to date client information. This helps to ensure that the client remains invested in a suitable portfolio service.
Most firms in the ODIM services sample were unable to show that they had adequate and up to date information about their clients when providing an ongoing service. Firms need to make sure client information is not materially out of date, inaccurate or incomplete when undertaking a decision to trade.
Filtering process
Firms providing ODIM services generally have provisions embedded in their online customer journey tools to filter out clients who were unlikely to have their needs met by the service. Firms that rely on such tools in their filter process should have appropriate systems and controls to make sure that the tools are fit for purpose and produce satisfactory results.
Vulnerable customers
In firms providing auto advice services there were weaknesses in identifying and supporting vulnerable consumers, with some offerings relying on the client to self-identify as vulnerable. Some firms had training material about vulnerability. However, firms should consider whether they could better identify vulnerable clients based on information captured from the automated advice offering and then provide appropriate follow up support.
Overall governance
There appeared to be little consideration of auto advice-specific risks in firms’ governance processes. For example, awareness of the need for adequate stress testing and cyber security was mixed (this included considerations such as testing around sales volumes, developing action plans to address losses of connectivity or other eventualities, and continuing to test systems past-launch). Firms should consider how their services could be affected by these factors and have processes to address them[8].
Management information for auto advice services focused on compliance, marketing and PR, operations and risk issues. Firms should consider how they review the outcomes produced by the service. This should include whether adequate testing of the offering has taken place, and the action that should be taken where unsuitable recommendations are identified.
There appeared to be confusion within some firms as to the nature of the auto advice service being provided. While some networks were able to show clear oversight of the auto advice proposition, other networks lacked clarity over how responsibilities were shared between the adviser and the network. Firms and their networks should consider reviewing their processes to ensure clear oversight over the auto advice proposition, as well as clear allocation of responsibilities.
Financial promotions
This review did not focus on financial promotions such as the presentation of future performance. However, we regularly talk to firms about how they promote their services, including ODIM and auto advice services. Firms must comply with rules on presentation of past performance information (COBS 4.5A)[9] as well as making sure that financial promotions are fair, clear and not misleading (COBS 4.2)[3]. Firms also need to comply with the new rule, introduced by MiFID II, on presentation of future performance information in communications and financial promotions (COBS 4.5A.14 (d))[12].
Conclusion
We provided feedback letters to the firms in our reviews. As a result many firms have made significant changes to their disclosures and suitability processes. We continue to work with firms individually to develop further improvements where necessary.
The market for both ODIM and auto advice services remains at an early stage, with a number of firms expected to launch services over the coming year. We continue to encourage innovation in automated investment services. While this is an evolving market, our rules on suitability of advice apply regardless of the medium through which the service is offered. Assessment of suitability is the firm’s responsibility[10] and our rules and principles apply equally to emerging automated offerings.
Next steps
We will continue to support firms through our existing units, for example, Project Innovate, Regulatory Sandbox and the Advice Unit. Our supervisors also work with colleagues in our Authorisations Division to make sure our findings are taken into account when considering new applications to enter the automated investment services market. Where we see poor practices that could cause harm to consumers we will take action using appropriate regulatory tools, including early intervention or enforcement investigation where needed.
Firms should consider FG17/8: streamlined advice and related consolidated guidance[11] which sets out, among other things, our expectations regarding streamlined advice and fact find processes.
We are committed to carrying out ongoing assessments of developing markets such as ODIM and auto advice. We expect existing firms and new entrants into the market to consider the issues in this article and take action where needed. Future reviews will include an assessment of how firms are complying with new requirements introduced by MiFID II and whether the cumulative impact of these important regulatory changes (together with PRIIPS) are working as intended.