[Newsletter n. 6]

IT-related and web-based automation is transforming the provision of financial services and FinTech is rapidly and intensely developing worldwide.

In particular, a growing number of financial institutions, often referred to as “robo-advisors”, now provide advice or recommendations to consumers through automated tools, “which can potentially change the way consumers and financial institutions interact when buying or selling financial products”.  Therefore, automation, specifically in the provision of advice, is now effectively in the radar-screen of the European authorities.

Indeed, on 16 December 2016, the Joint Committee of the three European Supervisory Authority (the “ESAs”) published a report on the automation in financial advice (the “Report”), which is described as the provision of advice to consumers without, or with very little, human intervention and relying on computer-based algorithms and/or decision trees.

The Report contains the conclusions drawn by ESAs on the basis of the feedback received by market players to the Discussion Paper published in December 2015 (the “Discussion Paper”) with the purpose of assessing the need, if any, of a regulatory action in response to this technological evolution, spreading over the banking, finance and insurance sectors (see our Newsflash n. 2).

In their analysis, ESAs highlighted the main risks and potential benefits, both to financial institution and consumers, connected to the so-called robo-advisors and gathered 68 responses from various stakeholders (see our response in conjunction with MoneyFarm, the leading Italian robo-advisor operating in Italy and UK).

On the basis of such responses, ESAs have come to seven preliminary conclusions:

1. Benefits are accurately identified but sometimes overstated  

The benefits identified in the Discussion Paper (such as reduced costs, easy access and improved quality of the services) are deemed accurate but might, in some cases, be overstated and might need time before being fully realized, considering that the phenomenon is still at an early stage;

2. Risks are properly analysed but the likelihood and impact of materialization is variable  

The identification of risks is also considered accurate and they include, inter alia, limited access to information for consumers, operational risk due to the possibility of flaws in the functioning of the tool caused by errors or manipulation of the algorithms, legal disputes arising due to unclear allocation of liability, pro-cyclicality or herding risk in many consumers taking the same actions in relation to the same products/services.

The likelihood and impact of their materialization might vary depending on several factors, such as: (i) level of financial literacy of consumers, (ii) the way information is presented, (iii) the mitigating effect of human intervention (risk less likely to materialise if some form of human interaction is available), (iv) the current prevalence of hybrid models (which reduces the risks relating to flaws in automated tools), (v) the circumstance that automation in advice is not widespread yet (which reduces the herding risk), (vi) the outcome of technical and regulatory actions taken at private and institutional level (see below Bank of Italy’s task force);

3. Application of existing EU laws may mitigate risks 

Several EU laws and regulations (such as MiFID and MiFID II for the securities sector, the Insurance Distribution Directive for the insurance sector and the Mortgage Credit Directive and the Payment Services Directive for the banking sector) already apply to automated advice and can mitigate the relevant risks;

4. Robo-advice is more present in the securities sector 

The scale and intensity of the automation of advice is prevalent in the securities sector than in the insurance and banking ones and are not equally widespread across the EU;

5. On-going monitoring by ESAs on the evolution of the phenomenon 

Considering the growing impact on the market, the ESAs will continue to follow the development of the automation in financial advice, identifying compliance issues, assessing the consequences of its cross-border characteristics to national supervisory frameworks and initiatives;

6. Focus on full automated and hybrid tools 

The ESAs’ focus is on full-automation (“those cases where human intervention is completely replaced by an automated process – i.e. an algorithm or decision tree – that the consumer accesses directly”), however, given the common expectation that human advisors will co-exist and/or complement automated tools, the authorities extended their focus also on “hybrid” advice tools (in which the use of the automated tool is combined, to a certain extent, with human intervention);

7. ESAs monitor barriers to the development of robo-advisory 

Certain barriers to the development and widespread usage of automated financial advice tools in the three sectors have been identified (costs, legal obstacles, regulatory barriers, uneven definition of advice across different sectors, lack of consumer awareness, un-level playing field).

In conclusion, it should be noted that, while they will continue to closely monitor the robo-advice phenomenon, the European authorities have not developed, at this stage, any additional joint cross-sectoral requirements specific to this particular innovation.

 

The Discussion Paper and the Report remain a survey and a useful tool to read the actual scenario of automation in financial advice, but no change of the existing framework of applicable European and national legislation is envisaged as a result of this initiative to date. This implies that, in the meantime, “financial institutions should carefully assess the applicability of the above mentioned existing laws and regulations to the innovation they are developing”.

 

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Bank of Italy on Cybersecurity

Within the same context but at a Italian domestic level, it is worth noting the recent coordinated action of Bank of Italy and ABI (the Italian Banking Association) which on 20 December 2016 launched a task force to tackle threats linked to the growing digitalization in the banking and financial sectors (see our post) (Computer Emergency Response Team, “CERTFin”).

Cybersecurity is a key risk for consumers and also for financial institutions and the need to pursue the enhancement of tools aimed at preventing frauds and ensuring cybersecurity is one the priority at EU and national level.  CERTFin will enable banking and financial operators in Italy to exchange information effectively, offering them a series of tools and services to further strengthen security safeguards.

CERTFin will liaise with other institutional parties on initiatives under way at national and European level (such as the adoption of the Directive on security of network and information systems [the NIS Directive] by the European Parliament on 6 July 2016).

Participation in CERTFin will be open to all operators in the banking, financial, insurance sectors as well as IT and internet infrastructure providers.

 

We remain at your disposal should you need any clarification on these and other FinTech related matter.

 

Contacts:

Vito Vittore
Senior Partner

Marina Mirabella
Senior Partner

Elena Pagnoni
Of counsel

Luigi Bonifacio
Associate