Robo-advisors could pose a great risk to both wealth management firms and customers, according to a thematic report published by the European Banking Authority (EBA), entitled report on the prudential risks and opportunities arising for institutions from fintech.
Some of the key risks of robo-advisors are conduct related, which could lead to regulatory fines and customer redress. This fear is only increased by the intention for robo-advice to be provided on a large scale. As a result, if there are issues with the quality of the advice provided or its compliance with relevant regulations, they could have a prudential impact on the institutions’ operational risk profile, affecting the safety and soundness of institutions.
One conduct risks is the possibility that algorithms will recommend unsuitable products and could also facilitate inadvertent or deliberate market manipulation. This is in addition to the possible fines or redress costs given the potential scale of the service. As the quality of advice could be less controlled, there is also the possibility that it could harm long-established firms’ reputations, particularly technology companies. There is also the risk that that existing firms may struggle to adapt and persuade their existing clients, some of which may be unable to use digital platforms, to put their trust in a robo-advisors.
Some customers could take issue with the lengthy questionnaire required to receive the advice. The main risk here is that some firms could reduce their survey in a bid to please their clients, which could result in the firm not having enough information to make investments suitable for customers.
There are also substantial ICT risks associated with robo-advice. It would be reliant on effective ICT controls to mitigate ICT risks, including change risk, availability and continuity risk, and security risk, which arises from the online nature of the service, perhaps increasing vulnerability to cyber-threats. Highly automated ICT systems could present difficulties in determining the reliability of advice generated, because they may lack transparency or auditability, which would be exacerbated if the systems utilise AI-based technologies such as unsupervised learning. This could also pose a challenge for regulators and supervisors.
According to a report by the European Supervisory Authority (ESA) robo-advice is currently not widespread across all EU member states. However, this could change rapidly, leading to another risk which is that robo-advice services could be provided across jurisdictional boundaries. Compliance with the regulatory and legal requirements of multiple jurisdictions could be another challenging area for institutions, which could affect legal and compliance risks.
However, of course the research showed that there are also opportunities associated with robo-advisors, most of which are associated with lowering costs. In theory, the use of robo-advisors will mean less personnel are required, and so firms’ overheads will be lower, which should result in lower fees for clients. This could in turn open up financial planning and wealth management to those who previously could not afford it.
There is the possibility that robo-advisors could enhance transparency as investments would be more visible to customers.It is also seen as an opportunity for new market entrants, as they will not be hampered by the same problems existing firms will be, such as legacy IT system costs and inefficiencies.
EBA is an independent EU authority which works to ensure effective and consistent prudential regulation and supervision across the European banking sector.