Analysing digital investment management and automated investment advice provides interesting insight in the trends in the wider fintech space.
Luna De Lange, a Partner and Data Protection Officer at KARM Legal Consultants from KARM Legal Consultants, and Akshata Namjoshi, Fintech Lead at KARM Legal Consultants, offer their views and assessment. KARM Legal Consultants have offices in both the United Arab Emirates (UAE) and Malta.
Digital Investment Management and Automated Investment Advice, often colloquially termed as ‘Robo-Advisory’, is a specialised arm of wider personal investments which has, quite recently generated immense traction, due to its benefits of reducing the costs their client would incur through limited or no human interaction.
The analysis of big-data facilitated by Artificial Intelligence (AI), has empowered robo-advisors in this field to succeed in merging their customers’ personal information – financial goals, risk tolerances and timeframes – with the right asset allocation to qualify their clients’ needs.
A number of platforms, namely; Betterment, Wealthfront in the US and Sarwa in the UAE have successfully tested models with asset allocation, portfolio and investment management – at the behest of algorithms and are thus performing phenomenally well with their clients.
From a legal perspective though, there are a host of differing aspects one must consider, i.e. “Could all investment services based on algorithms be considered robo-advisors?”, “Who is liable in a scenario where an algorithm advises erroneously?” and “Where and with whom does the fiduciary duty rest?” Under most legislations, investment advisers, like other fiduciaries have an affirmative duty to avoid misleading their clients by acting in the utmost good faith, fully and fairly disclosing all material facts and employing reasonable care.
Whilst the concept of fiduciaries have been woven into legal systems after years of jurisprudence, there has been no consensus on the manner in which each regulator shall adopt, approach and respond to their integration and regulation. The United States Securities and Exchange Commission (SCE) has, through the issuance and bringing forth of multiple guidance notes and enforcement actions, clarified their stance on what role an ideal robo-advisor should play, while stamping out any potential malpractices.
On the other hand, in Hong Kong, the Securities and Futures Commission (SFC) has mandated the requirement for “online advisors” to have on hand a “suitably-qualified person” who shall test, review, and ensure the reasonableness of advice provided on their platforms. These guidelines so issued, further require firms to provide their clients with “clear, easy to read” explanations on the manner in which the clients’ investment is being generated and how the algorithms are being used.
Within the UAE, the Abu Dhabi Global Market (ADGM)’s financial regulator has provided for detailed guidance to regulate robo-advisory services, a key identification to make thereunder being that of whether – a robo-advisor is only providing investment advice or if it is also managing assets for their client portfolio. The ADGM has further provided extensive guidance on the disclosure requirements and portfolio rebalancing questionnaires which must be sought from clients.
Further, as robo-advisory is arguably more data-driven than other financial services, and relies quite heavily on big data and algorithms to perform the numerous functions a human typically would – they are required to retain heightened levels of security, to protect their data pipelines, to prevent intrusion and to avoid breaks in the data chain which could cause inadvertent allocation behavior from the algorithms the data facilitate.
Robo-advisors must first and foremost, strive to adopt pseudonymisation, robust firewalls and principles of least privilege while handling their clients’ personal data, all of which prevail as the best practices for financial service firms who robo-advise.
Whilst the implementation of these best practices ensure the mitigation of the risk of front-end unsecure access, firms must further standardise and develop common, firm-wide and cross-border data sharing and retention policies further securing their clients data.
In the case of robo-advisory, what will always change the narrative is the means of giving investment advice; and the treatment and control by robo-advisors over client money. Advising on client money is a heavily regulated activity in most jurisdictions and therefore, there exists a very fine line between using algorithms for outcomes and outcome-based persuasion to “invest”, even if it is by way of merely showing the preferred or top-rated investments. Does that mean everyone using algorithms should be licensed as a robo-advisor? DEBATABLE. But, a good lawyer in that position might scream “Caveat Emptor” and run, but a smart lawyer will hopefully increase the font size of the disclosure documents.