Chapter 5 Regulating robo-advice

Question 1

What are robo-advisors?

Answer 1

Automated financial product advisors

Question 2

What do robo-advisors do?

Answer 2

Helping customers choose investments, banking products and insurance policies.

Question 3

What are hybrid robo-advice services?

Answer 3

Combining automation with human advisors

Question 4

What are 4 trends that appear to cause the growth of robo-advice firms?

Answer 4

1. Increased transparency of investment advice
2. Increased accessibility through relatively low fees or the absence of a required minimum amount of capital
3. Enhanced customer experience via internet - and mobile app-based services
4. Use of exchange-traded funds (EFTs) to build diversified portfolios

Question 5

How does a robo-advice service work?

Answer 5

Robo-advisors take the form of automated structured questionnaire for assessing individual customer risk appetite and knowledge level, then allocating a risk profile based on the assessment and making investment proposals in accordance with that risk profile.

Question 6

What are the benefits of robo-advisors? (7)

Answer 6

1. They are cheaper
2. They offer higher performance as traditional advisors and reduce emotional and cognitive biases that humans have
3. They utalise passive investment strategies selected by an algorithm, providing higher returns at a lower price and thus beat active manager
4. They are more inclusive (no high net wealth threshold)
5. Better availability during weekends
6. Reduce the need for geographic proximity
7. Rebalance investor portfolios more efficiently by using algorithms

Question 7

What are the risks of robo-advisors and based on which paper? (4)

Answer 7

ESA paper

1. Consumers having limited access to information and/or limited ability to process that information
2. Flaws in the functioning of the tool due to errors, hacking or manipulating of the algorithm
3. Legal disputes arising due to unclear allocation of liability
4. The widespread use of automated tools

Question 8

When does a duty of care arise, also name the leading case?

Answer 8

Hedley v. Byrne

The duty arises generally as a result of the client having reasonably relied on the skill and judgment of the advisor.

Question 9

What kind or liability arises in a data-processing or calculation tool where customer is provided access to?

Answer 9

Duty to ensure that the system was properly designed and configured.

Question 10

What kind of liability arises when the computer program gives intelligent advise?

Answer 10

Is the advise reasonable and careful?

Question 11

What is another important question that should be asked to determine the duty of care and therefore liability and why?

Answer 11

How is the system presented to the user? If a user is led to believe that the automated advisor is exercising some form of intelligent judgment, and reasonably relies on that, then the duty assumed by the provider in respect of the advice would be assessed on that basis, regardless of how simplistic or mechanistic the system might actually be.

Question 12

What kind or questions should regulators be asking to assess robo-advice services?

Answer 12

1. Has the robo-advisor obtained access to reasonable sources of
   data, and are there any concerns that the inability to obtain data,
   particularly regarding products, will bias the rankings and matching
   in a way that disadvantages consumers in relation to intermediaries
   and sellers?
2. Where there are gaps in data, what are the strategies that the roboadvisor considered to address those gaps, why did the robo-advisor
   choose the strategy(ies) that it employed, and was the choice
   reasonable?
3. Does the regulator have the authority, whether formal or informal,
   to increase access to data and thereby improve the quality of the
   robo-advice?

Question 13

What are 3 benefits that the ESA report identified of automated advice?

Answer 13

1. Reduced costs for both consumers and financial institutions
2. Easy access to more products and services to a wider range of consumers and wider client base for financial institutions
3. Improved quality of the service provided

Question 14

What is a nuance made by responders to the ESA in terms of cost reduction?

Answer 14

The significant costs that arise from the continuous testing, maintenance and marketing of automated tools; the main benefit will not be the cost reduction, but the additional revenue streams.

Question 15

Under which directive is consumer information and thus also for robo-advice covered?

Answer 15

MiFID II (Markets in Financial Instruments Directive)