Regulating Robo-Advisory

By Maume, Philipp | Texas International Law Journal, Fall 2019 | Go to article overview

Regulating Robo-Advisory


Maume, Philipp, Texas International Law Journal


Table of Contents

Introduction..............................................50

I. Robo-Advisory and Fintech.....................54

A. The Fintech Phenomenon............54

B. Fintech Regulation and Regulatory Sandboxes..................55

C. The Four Categories of Fintech Regulation................57

D. EU Financial Intermediaries Regulation as a Model...............59

II. Robo-Advisory in Theory and Practice.............60

A. History and Market Size..........................60

B. Definitions...................................61

C. Hybrid Robo-Advisors...............................66

D. The Pros and Cons of Robo-Advisory........................68

III. The Issues of Robo-Advisory Regulation.72

A. Regulators ' Approaches to Robo-Advisory.72

B. The Elements of Robo-Advisory Regulation.74

C. The Objectives of Financial market regulation.77

D. The Level Playing Field.79

E. The Applicable Standard for Robo-Advisors.84

Conclusion.87

Introduction

In 2017, a commercial aired on US television.' It depicted a young, sympathetic woman with a sign around her neck saying "65K"-a reference to her annual income. This woman, let's call her Anna, sits in the waiting room of fictitious "Brokerage LLC," waiting for a financial advisor to see her. In the background, we hear a light but slightly melancholic piano tune. As hours go by, several other customers wearing signs with significantly higher numbers are given priority by the advisor, while Anna still has to wait. The unsurprising (although arguably unrealistic) punchline of the commercial is that Anna finally finds an advisory firm that claims to provide financial advice for "every retirement investor," including investors with small and medium incomes.

This simple-but-effective 30-second commercial draws on well-known facts in the finance industry. First, in all Western societies, persons with small and medium incomes increasingly need to rely on private investment to ensure their financial wellbeing for retirement. With an annual income of $65,000, Anna represents a typical young professional with a college degree.2 However, in the US, only affluent people with significant savings are able to get professional advice, as their savings would be attractive for conventional financial advisors.3 Financial advisors are not interested in average people, as their account balances are too low. This leads to an obvious problem for Anna: she is effectively barred from receiving professional help for her retirement savings plans.

What appears to be an unspectacular story with a happy conclusion becomes a pressing issue if we look at it on a greater scale. There are millions of "Annas" (or "Steves") out there.4 The UK Financial Conduct Authority (FCA) estimates that in the UK alone 16 million people (out of a population of 67 million) could be trapped in this so-called "financial advice gap."5 If these people fail to make the most of their savings, they might not be able to keep up their lifestyles, or worse, become dependent on social welfare. This is not only a problem for Anna and the state that would need to provide financial support. There are also wider financial implications. Inefficient investment strategies are detrimental to financial market growth, as they hamper the transfer of money to the place where it is most needed-raising the costs of capital.6

New technologies in the financial markets seem to offer a way out of this dilemma. Socalled robo-advisors, online-based advisory services that use algorithms to create investment recommendations with no human input, promise to deliver financial advice at a fraction of the cost associated with traditional financial advisors. This would be a viable option for Anna and Steve. Starting humbly in 2010, assets under management by robo-advisors have since skyrocketed.7 As of late 2019, robo-advisors had worldwide assets worth $980 billion under management, with no end in sight. …

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