In this second Financial Law Insight in our FinTech Series, we look at the proposed robo-advice class exemption released by the Financial Markets Authority for consultation on 21 June 2017, including:
The Financial Markets Authority (‘FMA’) is consulting on a proposed class exemption that would remove the key legal barrier to offering robo-advice, with effect late this year. However, the detail of the exemption is open for discussion, and some of the potential conditions of the exemption could have far-reaching effects on the viability of automated advice models – so now is the time to have your say.
In effect, the key legal barrier to providing personalised robo-advice to retail clients is the need for that advice to be provided by a natural person.
As noted in our first June 2017 FinTech Series Financial Law Insight,although the Financial Services Legislation Amendment Bill (‘Bill’) will, once in force, facilitate robo-advice, the Bill is not likely to be in force until the first quarter of 2019 at the earliest.
In our earlier article, we outlined the two options for robo-advice potentially available under current law, which are:
As foreshadowed in our earlier article, the FMA has now picked up the regulatory challenge posed by robo-advice under current law and has released a consultation paper (‘Paper’) outlining the terms of a potential class exemption which will enable personalised robo-advice services to be offered to retail clients.
The Paper outlines a class exemption from the requirement under the FAA that personalised advice to retail clients be provided by a natural person. Advice generated by a robo-advice tool (either through a website or a mobile app) will be treated as advice given by the entity responsible for the tool (under the Bill, this would be the ‘financial advice provider’).
The exemption is intended to come into force ‘by late 2017’, and (through transitional arrangements under the Bill) will remain available to providers until they transition to the new regime.
The FMA notes in the Paper that making robo-advice available prior to the Bill coming into force will mean that consumers have the benefit of this service at an earlier stage, and may help address the current advice gap.
However, the exemption will be subject to a number of limits and conditions.
What are the catches?
The FMA wants to ensure that an appropriate balance is struck between:
The FMA notes the potential for robo-advice to cause poor outcomes due to the limitations of algorithms and lack of consumer understanding of automated advice, and for a larger number of consumers to be affected by any issues due to the scalability of robo-advice platforms.
To address these concerns, the FMA is proposing the following limits and conditions:
Limits on the exemption
The FMA is proposing to include limits both on the types of robo-advice services that can be provided (financial advice and investment planning, but not discretionary investment management services) and the products that can be advised on (by limiting it to those the FMA considers to be easy to exit).
At the product level, advice will be able to be given in relation to KiwiSaver schemes and other managed funds, listed equity securities and debt, Government bonds, general insurance products, and savings products and credit contracts (other than mortgages).
The FMA is also considering whether to include personal insurance products (e.g. life, health, and income protection insurance), but has concerns that personal insurance may not be able to be easily exited, and notes that there may be significant consequences if material information is not disclosed. The FMA proposes to address these issues, if personal insurance products are included, by imposing a value cap ($100,000 per product) and / or a duration limit (one year or less), unless the contract can otherwise be cancelled easily.
No distinction will be made between ‘category 1’ (more complex) and ‘category 2’ (less complex) products for the purposes of the exemption.
The FMA also sets out other potential limits that it does not propose to impose, but which it could consider. The limits noted are an investment limit per client (with $100,000 per client given as an example) or a limit on the total amount of investment products that can be advised on by a provider through robo-advice (with $5m given as an example).
Conditions of the exemption
The FMA is proposing to impose the following conditions on the exemption:
The FMA proposes to apply the conditions proportionately to the size and scale of the service offered, and will publish an information sheet to explain the exemption and provide guidance on the conditions.
Although not conditions of the exemption, all other obligations under the FAA (including conduct obligations) will still need to be complied with, as well as the requirement to register on the Financial Service Providers Register and to belong to an approved dispute resolution scheme.
It is inevitable that robo-advice will play an increasing role in the delivery of financial advice, with consumers already able to access offshore platforms. We applaud the FMA for taking up how best to regulate robo-advice under the current regulatory regime.
We particularly like the FMA’s proposal to allow providers flexibility in incorporating the required disclosures into the robo-advice tool in the way that the provider believes will be most user-friendly and easy for consumers to understand. This will allow providers to word the disclosures in plain English and to make use of pop-ups and videos, and to stagger the disclosures throughout the information collection process as the provider sees fits.
However, we see significant issues with any suggestion that limits should be imposed on the total amount of investment products that can be advised on through robo-advice, particularly when the example given is so low ($5m total). Any limit of this nature would severely impact on the viability of a robo-advice service, reducing the likelihood of industry reliance on the exemption, and seems hard to rationalise on a principles basis.
We support the inclusion of personal insurance products as a permitted product. We see the proposed conduct and filtering obligations as a natural restriction on the types of products that will be advised on – that is, if a product is too complex for a provider to discharge its obligations in relation to that product, it will be unlikely to be feasible to include it in a robo-advice tool.
Interestingly, the FMA notes in the Paper the increased regulatory burden that would be imposed on providers if the requirements under the proposed exemption differ materially from the requirements that will apply under Bill – but does not propose any solution to this. This could be seen as a suggestion that the just-announced Code Working Group appointed to draft the new code of conduct under the Bill should pay attention to the FMA’s proposals, and make a submission now to address any concerns. However, as the Code Working Group will not be formally established until 1 August, this timing will not work if that was the plan.
The drafting of the final exemption notice will be key to the usefulness of the exemption (the Paper only sets out the proposals, with the drafting of the actual notice to follow). In particular, we will be interested to see the way that the drafting deals with the FMA’s proposal to apply the conditions of the exemption proportionately to the size and scale of the service offered. In light of this flexibility, and the proposal not to prescribe the required disclosures to clients, we anticipate that the content of the information sheet to be released by the FMA in conjunction with the final exemption will be crucial to providers’ ability to rely on the exemption (and enthusiasm for doing so).
Although the FMA notes that any provider that does not fit within the exemption can apply for an individual exemption, good reasons will need to be given as to why modifications are appropriate for the provider’s service proposition. In other words, the class exemption may actually prove problematic for bespoke services on a case-by-case basis.
So what next?
Truly personalised robo-advice services are on the near horizon. The proposed exemption can be seen as a reward to the industry for actively engaging with the regulator to achieve an outcome that can benefit both providers and their clients.
However, the proposed exemption needs to be workable in practice. Providers should critically review and test the proposed exemption against their advice models, to flush out any issues while the exemption is still taking shape, and be wary of the details when the draft exemption becomes available.
Submissions close on 19 July 2017.
The FMA is seeking feedback on almost all aspects of the proposed exemption – in addition to the 28 specific consultation questions included at the end of the Paper, a further 21 invitations to provide feedback or input are included throughout the Paper.
The FMA also notes in the Paper that it can only grant an exemption from the FAA if satisfied that, among other things, the statutory test is satisfied (being that the costs to comply with the obligation the exemption will apply to would be unreasonable or would not be justified by the benefit of compliance) and measures are in place to help mitigate the risks arising from the advice service being delivered digitally and protect consumers.
Although this will ultimately be the FMA’s decision, any insight that industry can provide on the costs of incorporating a human adviser into robo-advice processes, and the ways that service models build in safeguards to mitigate the risks associated with robo-advice, will be an important factor in determining the outcome.
The extent to which the FMA emphasises it is seeking feedback throughout the Paper is particularly interesting, suggesting a degree of uncertainty as to what is best. It is certainly a complex area, and the drafting of the Paper suggests there may still be further movement in what has been proposed.
Start a conversation
If you would like a specific briefing on the proposed exemption, assistance with drafting a submission, or more information about the Bill or the regulation of financial technologies generally, please contact Catriona Grover on +64 4 498 0816, David Ireland on +64 4 498 0840, Tom McLaughlin on +64 4 498 0886, Nick Summerfield on +64 9 915 3357, Karen Mace on +64 4 496 5941, or email the team at email@example.com.