Robo-advisors have the potential to democratize financial advice, but they also pose their own set of risks to investors, which may require regulatory intervention, suggests a new paper from European regulators.
The Joint Committee of European securities, banking and insurance regulators, known as the European Supervisory Authorities (ESAs), published a discussion paper on Friday that examines the automation of financial advice and whether regulators need to do anything to help support the potential benefits, and mitigate the risks, of automating advice.
The paper aims to define the concept of advice automation and explores the possible benefits and risks posed by this phenomenon to both investors and the financial services sector. For example, the paper finds that robo-advisors can lower the cost of advice to consumers, increase the availability of advice and may improve its consistency by avoiding many of the behavioural biases that can affect human advisors.
At the same time, the paper warns that automated advice may amplify existing risks — such as conflicts of interest, a lack of transparency around fees and suitability concerns — that exist in traditional advice models but may not be mitigated as effectively online as they can be in face-to-face situations, during which investors can talk to a human advisor who can explain things. In addition, automated advice models may be more vulnerable to technology failures, programming errors, or the misuse of personal data, the paper notes.
For the financial services sector, the obvious benefits of automated advice include expanding firms’ ability to provide advice to a large customer base at a lower cost than they can in a traditional model. Some of the risks for firms that are set out in the paper include the legal liability and reputational risk that could follow a technical failure or a cyber breach.
In addition, the paper notes that it may not yet be clear how to assign liability in situations in which robo-advisors are partnering up with traditional financial services institutions to provide automated advice.
In the paper, the Joint Committee of the ESAs — which is comprised of the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) — reports that it expects the recent growth of automated advice to continue in the future.
The Joint Committee of the ESAs also says that it intends to assess the feedback it has received on its discussion paper to determine whether any regulatory and/or supervisory action is required in this area.
“Financial innovation is important and, at its best, contributes to economic growth. However, this can only be achieved and sustained where consumers have confidence in such innovations. Our role as European Supervisory Authorities is to monitor new financial activities and to take action where appropriate,” says Steven Maijoor, chairman of the Joint Committee of the ESAs, in a statement.
“In this discussion paper, we recognize that markets are evolving and we want to open up the debate about this potential shift in the way financial institutions interact with consumers,” he adds.
The deadline for comments is March 4, 2016.