Australia: Guiding financial advice providers through the digital age – a development in the regulation of digital advice

Last Updated: 26 September 2016
Article by Adeline Hiew (formerly with Holding Redlich) and Timothy Whiting (formerly with Holding Redlich)

Most Read Contributor in Australia, September 2018

While the days of being provided with financial product advice at a face-to-face meeting appear to be far from over, the provision of financial product advice using digital means is becoming more prevalent.

Digital advice,1 otherwise known as 'robo' or 'automated' advice, involves:

"...the provision of automated financial product advice using algorithms and technology and without the direct involvement of a human adviser."2

Since 2014, ASIC has observed a rapid growth in the provision of digital advice amongst new and existing Australian financial services (AFS) licensees with a number of them developing digital advice models.3 In light of these developments, and following on from ASIC's discussion with a number of industry participants, ASIC has released guidance in the form of Regulatory Guide 255: Providing digital financial product advice to retail clients, to assist digital advice providers (i.e. AFS licensees and their authorised representatives) in complying with their legislative and regulatory obligations.

Background

On 21 March this year the Australian Securities and Investments Commission (ASIC) released Consultation Paper 254: Regulating digital financial product advice (Consultation Paper), which sought industry feedback on ASIC's proposals concerning:

  • the organisational competence obligation and its application to AFS licensees who provide digital advice; and
  • the monitoring and testing of algorithms (that are used to provide digital advice) by AFS licensees.4

As part of this Consultation Paper, ASIC attached a draft regulatory guide which contained (amongst other things) draft guidance on the above issues.

Regulatory guide

Following the receipt of several submissions in relation to the Consultation Paper, and ASIC's collective response to these submissions in Report 490: Response to submissions on CP 254 Regulating digital financial product advice last month, ASIC issued Regulatory Guide 255: Providing digital financial product advice to retail clients (Regulatory Guide) on 30 August 2016.

Whilst the Regulatory Guide is aimed at digital advice providers, ASIC has indicated that those who provide "combined (or hybrid) financial product advice models" (an advice model that incorporates digital and non-digital advice), or associated services (including technology or compliance services), should also consider the guidance in the Regulatory Guide.5

Some of the key takeaway points from the Regulatory Guide include:

  • organisational competence – when digital advice is provided, a natural person isn't directly involved in the provision of the advice as it is generated by an algorithm.6 For this reason, the minimum training and competence standards that would ordinarily apply to a financial adviser, do not apply in the digital advice context.7 However, in order to satisfy the organisational competence obligation in ASIC Regulatory Guide 105 - Licensing: Organisational competence, the Regulatory Guide requires an AFS licensee who provides digital advice to have at least one responsible manager who satisfies the minimum training and competence standards for financial advisers (contained in ASIC Regulatory Guide 146 – Licensing: Training of financial product advisers).8 Existing AFS licensees who provide digital advice have six months from 30 August 2016 (being the date of the Regulatory Guide) to comply with this requirement;9
  • monitoring and testing of algorithms – the Regulatory Guide contains a series of expectations that ASIC has with respect to the monitoring and testing of the algorithms used by AFS licensees to provide their clients with digital advice. As part of these expectations, AFS licensees who provide digital advice are expected to:
    • be able to control, monitor and keep records that describe changes made to the algorithms over the past seven years;10
    • have adequate measures in place that will suspend the provision of advice where an error with an algorithm is found, and is likely to result in loss for a client and/or breach the Corporations Act 2001 (Cth) (Corporations Act);11
    • have adequate human and technological resources in place that understand the technology and algorithms used,12 and can monitor and supervise the performance of the algorithms;13 and
    • employ robust compliance arrangements that regularly monitor and test the quality of the digital advice provided.14 One example of such an arrangement would involve an AFS licensee having a suitably qualified individual to regularly review samples of digital advice provided to clients, to ensure that the digital advice complies with the relevant laws;
  • cyber risks and information security – ASIC is of the view that "digital advice providers may be more likely to be targeted by hackers" and, consequently, ASIC expects digital advice providers to assess their cyber security against recognised frameworks, assess their information security arrangements against recognised security standards, and employ adequate security compliance measures where 'cloud' technology is used;15
  • compensation arrangements – as is the case with traditional financial product advice providers, digital advice providers must, unless an exemption applies, ensure that they have adequate compensation arrangements in place to compensate retail clients for any loss they may suffer as a result of the advice provider's breach of its obligations under Chapter 7 of the Corporations Act.16 The Regulatory Guide lists a number of points that digital advice providers should consider when assessing the adequacy of their compensation arrangements, such as the potential loss that may be experienced by clients if there is an issue with an algorithm, and how the digital advice provider's professional indemnity policy would treat a series of claims concerning a faulty algorithm (i.e. would the insurer treat all such claims as a single claim and, in effect, apply a lower limit to each claim under the policy?);17
  • best interests duty and the provision of scaled advice – while digital advice providers are still expected to adhere to (amongst other things) the best interests duty in the Corporations Act when providing their clients with personal advice, it can be difficult for digital advice providers to limit the scope of the personal advice provided (i.e. give scaled advice). This is largely due to digital advice not being directly given by a natural person who can discuss the limitations of the scaled advice with the client.18 To assist digital advice providers in avoiding such an issue, ASIC has included a number of "minimum expectations" in the Regulatory Guide that it expects digital advice providers to adhere to when providing digital advice. Some of these expectations include:
    • explaining the scope of the digital advice from the outset;19
    • requiring a client to acknowledge that the advice the client is after is within the scope of the digital advice being offered.20 For example, the digital advice system may include a statement at the beginning of the process which identifies the scope of the digital advice (i.e. what it does and doesn't include), and requires the client to read the statement and click on an acceptance button before being able to proceed; and
    • filtering out clients from the digital advice process if it is found that the digital advice is inappropriate for them, or when the client requests advice that the digital advice system is incapable of providing 21. For example, if a digital advice system asks if the client would like advice on how to make the most of their superannuation and any applicable Centrelink benefits in retirement, and the client answers 'yes' to this question, the digital advice provider would be expected to 'filter' this client out of the digital advice system if the system isn't capable of providing this advice to the client. However, in such circumstances, the digital advice system may ask the client if they wish to be contacted by the digital advice provider about receiving such advice from a financial adviser.

What next?

Due to the increasing prevalence of digital advice in the financial services industry, and the speed at which digital advice technology is evolving, we expect that the regulation of digital advice will be an interesting space to watch. However, for the meantime, we strongly recommend that digital advice providers familiarise themselves with the Regulatory Guide, and ensure that they can satisfy the relevant ASIC expectations, and requirements (including the minimum training and competence standards for digital advice providers) contained in the Regulatory Guide.

Footnotes

1 For the purposes of this article, the term 'digital advice' is to be interpreted as the provision of digital financial product advice to retail clients.

2 Australian Securities and Investments Commission, Regulatory Guide 255: Providing digital financial product advice to retail clients, 30 August 2016, para 255.1.

3 Australian Securities and Investments Commission, Consultation Paper 254: Regulating digital financial product advice, 21 March 2016, para 2.

4 Ibid page 1.

5 Australian Securities and Investments Commission, Regulatory Guide 255: Providing digital financial product advice to retail clients, 30 August 2016, paras 255.8 and 255.9.

6 Ibid para 255.52.

7 Ibid.

8 Ibid paras 255.51 and 255.53.

9 Ibid para 255.55.

10 Ibid para 255.74.

11 Ibid.

12 Ibid para 255.61.

13 Ibid para 255.74.

14 Ibid para 255.75.

15 Ibid paras 255.77-255.80.

16 Ibid paras 255.81-255.82.

17 Ibid para 255.86.

18 Ibid para 255.96.

19 Ibid para 255.99.

20 Ibid.

21 Ibid.

This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.

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