Robo-Advisers and Investor Protection: A View from Switzerland
My recent article ‘An Examination into the Investor Protection Properties of Robo-Advisory Services in Switzerland’ investigates the extent to which information provided by Swiss-based robo advisers (RAs) on their websites has been conducive to retail investor protection. RAs are investment firms that provide portfolio management and investment advice services using algorithms and digital platforms. The term ‘robo’ connotes the presence of artificial intelligence making decisions on the provision of investment services (eg, recommending investment products to clients). In their purest form, the services of RAs are fully automated and delivered online without the need for any corporate officer or employee to interact directly with the clients. It is often the case, however, that robo-advisory services involve some form of human interaction such as offering customer services via a phone call or e-mail.
RAs have become an increasingly influential, disruptive force in the asset management industry. Assets under the management of RAs reached US$ 1.1 trillion in 2020. With an estimated yearly growth of 26 percent, the industry is expected to manage US$ 2.75 trillion in 2024.
This investigation relied on data collected from the websites of RAs registered in Switzerland. An internet search was conducted in the months of April and May 2019. Eleven RAs were identified and included into the study. Text data were gathered from the RA websites, using the same questionnaire for each website, categorised and analysed manually. Concentrating on RAs’ information disclosure to customers, the analysis was structured around three themes: (1) providers, services and products; (2) use and disclosure of automation; and (3) product selection criteria.
As reported in section II of the article, RA websites contained information about the investment service provider, including the RA’s corporate address, place of incorporation, governance structure and contact information. However, the nature of the service provided was poorly explained. Most RAs presented themselves as asset managers, yet the service ‘asset management’ or ‘wealth management’ was very often defined unclearly. It was not obvious whether advice-giving was included in the service provided or the extent to which asset management was conducted on a ‘discretionary’ basis. Whereas the RA websites sufficiently explained the investment products available and the benefits of investing in these products, these websites drew far less attention to the risk of capital loss arising from such investments.
Evidently, automation and artificial intelligence constitute the hallmark of robo advice and raise a number of questions. What specific processes in the RA’s business model have been automated? Do these models allow for human interaction? To what extent do RAs disclose the use of algorithms to their clients? Findings reported in section III of the article suggest that portfolio design and rebalancing functions have largely been automated. However, the extent to which the determination of the client’s profile had been automated was unclear. All RAs provided for human interaction in the form of customer services. In a few cases, human-made investment advice was also offered. Although one third of these websites explicitly acknowledged the use of algorithms, disclosure on the algorithm’s type and governance was absent from the RA websites.
From the vantage point of protecting clients, the criteria used by RAs to select investment products constitute a crucial factor to the extent that product selection can be driven by various motivations. RAs may look at the client’s characteristics as a basis for selecting products. Yet such selection may, in theory, also be driven by the RA’s ‘self-interest’ or ‘opportunism’, such as where a RA selects a product only because it pays the RA a commission or kickback. It is thus necessary that RAs openly explain to their actual and potential clients the bases or criteria for product selection. The article reports that most RA websites clearly identified the client’s risk profile as the key driver for product selection. The stated goal was to match the product with the risk profile of the client. The majority of RA websites also stressed that their product selection decisions were not motivated by fees, commissions or any kickbacks offered to them by product producers.
Part of the shortcomings identified in the article are expected to be remedied, following the recent entry into force of the Swiss Financial Services Act (FinSA). FinSA—in force since 1 January 2020—has created new conduct obligations that investment advisers and asset managers must discharge, including obligations on information disclosure, appropriateness, suitability and conflict of interest. Compared with the standards required by the Market in Financial Instruments Directive II (MiFID II), however, FinSA’s conduct requirements are less stringent. It is thus difficult to see how Swiss-based RAs can achieve the higher MiFID II protection level without making their websites more informative by recourse to voluntary disclosures.
Drawing from the findings presented in this article, there is room for RAs to conceptualise more clearly their service-offering. Improvements can also be made in how RAs present risk information on their websites. A better balance of the risks and the benefits of investing will assist clients, as will more extensive disclosures on the use and governance of the algorithms relied upon by RAs. Best practices that Swiss-based RAs ought to embrace include making their policy on conflict of interests available online. It is also suggested that RAs communicate on their websites that they are obliged to conduct the suitability assessment, as set forth in FinSA, and that such assessment is meant to protect the client’s best interest. Importantly, RAs should ensure that in all cases they explain to their clients how the recommendations made to them are suitable.
Felix Mezzanotte is Assistant Professor at the School of Law, Trinity College Dublin.
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