Financial advice from robots a while off, but technology will deliver innovation

To celebrate Out-Law's 15th birthday we are looking ahead to the big changes facing business in the next five years. Read more and follow our celebrations on Out-Law and on Twitter.

We can expect some very effective automated advice solutions to become available within the next five years to address part of the advice gap that currently exists so long as there are some changes to the regulatory regime.

Some forms of automated advice are already available on the market, and other financial services firms are actively exploring the concept. The Financial Conduct Authority is alive to these developments and is engaging with firms through Project Innovate. The regulator will have a major role in facilitating further innovation in the area of automated advice in UK as will regulators in other jurisdictions.

The growing prominence of robo advice

With the rise of financial technology (fintech) over the last few years we have seen a number of new business models address gaps in financial services markets through product and technology innovation. Financial advice is no different and changes in regulation, from those introduced by the Retail Distribution Review through to the pensions reforms have all had a role to play in creating opportunities for solutions to be developed that focus on servicing the clients for whom the traditional financial advice model is less suitable.

Robo advice is a term that arose in the US to describe computer algorithms that offer financial advice. It involves automating most of the delivery of information about financial product selection to consumers online.

No single business model exists for providing robo or automated advice. For example, existing model let clients choose to manage some portion or all their own investment portfolios or have the company manage them instead, and to create investment portfolios for single goals, such as retirement or college education.

While some solutions may have overcome the regulatory barriers to using robo advice tools, there are still a number of issues to be addressed which the FCA is closely monitoring.

One of the predominant issues over which there remains confusion, despite the FCA having issued guidance on what constitutes retail investment advice, is the circumstances in which automated advice tools can be classed as information or guidance tools and when they cross the line into the provision of regulated advice.

Further issues such as how to deal with customers who do not provide sufficient information for automated tools to provide appropriate and compliant responses and the adequacy of internal controls to supervise robo advisers are also being grappled with by firms.

However, the FCA, together with the Treasury, has recognised the need to look at ways of improving access to financial advice for consumers and is actively exploring the role robo advice can play in that.

Figures obtained by Out-Law.com show that the appetite in the market for greater regulatory clarity on the use of robo advice solutions. Since launching Project Innovate in autumn 2014 up until 19 August this year, the FCA received 39 requests from companies for assistance on how to implement robo advice systems, technology or services via its Innovation Hub – the main mechanism the regulator has so far developed to help support innovation in financial services.

Not every company that applies for assistance via the Innovation Hub gets it, but we can extrapolate from earlier FCA figures disclosed by the regulator's director of competition Mary Starks that approximately a third of the 39 requesters are likely to have been, or will be, given informal steers on how to progress their robo advice plans.

The FCA has subsequently confirmed that it has to-date helped more than 175 businesses across all areas of financial services innovation through the Innovation Hub in the first year of its operation.

A robo advice case study

Some companies have already found ways to progress their robo advice plans despite the regulatory issues.

LV= launched its automated advice service, LV= Retirement Wizard, in June 2015. The tool "provides people at retirement with a fact find and fully tailored regulated report for just £199", the company told Out-Law.com. Clients that use the service can speak to a LV= independent financial adviser "at no extra cost".

"Once the report is issued an adviser will call the customer to check they are happy with it and nothing needs tweaking, again included in the £199," an LV= spokesperson said. "The customer then has a couple of options they can take the advice and act on it themselves or they can instruct LV= to arrange the products for them.  If they chose the second option there is a flat arrangement fee of £499. These costs compare very favourably with traditional face to face advice."

The company said the FCA was consulted during the development of its Retirement Wizard but that that regulatory engagement pre-dates the autumn 2014 launch of Project Innovate. The Retirement Wizard tool is a response to the "advice gap" that exists in the UK, the company's spokesperson said.

"We see low cost, fully regulated, automated advice as playing a key part in closing that gap," they said. "We believe through this we can bring affordable financial advice to people who’ve never experienced it before."

The regulatory regime and changes required

Under the FCA's regulatory regime it is companies that are authorised to undertake certain regulated activities. The regulator does not approve individual products or services. This means it is left to firms to interpret existing rules and guidance when developing innovative new products, services and business models.

In the case or robo advice, it is likely that firms offering robo advice solutions would already have permission to advise on investments and would not require further authorisation from the FCA. Where that is not the case they would have to apply for authorisation.

As demonstrated by the LV= example, and particularly with subsequent developments with the creation of the Innovation Hub and latest plans to develop a regulatory sandbox, the FCA does operate a doors open policy through which firms can discuss their innovations with the regulator.

However, further changes to the regulatory approach can help support the automated advice market in the coming years.

Firstly, there needs to be a rethink about how the issue of the output from automated advice tools is classified. The discussion should be moved on from whether the output constitutes information, guidance or regulated advice.

There will never be a bright line separating these concepts and the regulator will never be able to tell businesses definitely where the thresholds lie. Regulation should recognise this and focus more instead on transparency and warnings as consumer protection mechanisms.

Regulation also needs to address how to stop the risk of clients failing to provide robo advisers with sufficient information to use the tools appropriately. It is impossible for human financial advisers to provide effective investment advice to clients that do not disclose their appetite for risk and other necessary details to help in the provision of regulated advice. Software and systems are becoming smarter, but they rely too on data to produce an output. This should be reflected in the regulatory regime.

In addition, like there has been already in Australia many years ago and other countries, there will need to be a robust discussion on how best to compel people to save for their retirement. The auto-enrolment regime is a start, but compulsion is the next step to relieve the reliance people will have on the state in old age. Automated advice solutions will have a part to play in opening up the retirement savings market to more of the public.

John Salmon and Luke Scanlon are experts in financial services and technology law at Pinsent Masons, the law firm behind Out-Law.com