Recognising the increasing popularity of digital advisory services (also known as robo-advisory services) globally and its potential to improve consumers' access to low-cost investment advice, the Monetary Authority of Singapore ("MAS") had on 7 June 2017 issued a Consultation Paper on Provision of Digital Advisory Services ("Consultation Paper"). The Consultation Paper sets out, among others, the proposed amendments to existing legislation to facilitate the provision of digital advisory services in Singapore as well as proposals to mitigate the risks posed by the provision of such robo-advisory services to clients, in especial to those by “client-facing tools” (i.e. digital advisory tools that clients can use directly and which has no human adviser intervention in the advisory process). The MAS consultation closed on 7 July 2017.
A summary of the proposals put forward by MAS in the Consultation Paper is set out below.
1. Expansion of licensing exemptions
Digital advisers provide advice on investment products using automated, algorithm-based tools with limited or no human interaction. Generally, digital advisers will have to be licensed for fund management or dealing in securities under the Securities and Futures Act (Cap. 289) ("SFA") and/or providing financial advice on investment products under the Financial Advisers Act (Cap. 110) ("FAA").
Subject to certain safeguards, MAS has proposed for certain digital advisers to operate as licensed or exempt financial advisers under the FAA without the need for additional licensing under the SFA as set out below.
(a) Expansion of licensing exemption for dealings in securities other than CIS
Digital advisers typically assist clients in the execution of recommended investments by passing the clients' trade orders to an intermediary (such as a brokerage firm) for execution. Such activities are ordinarily caught as dealings in securities under the SFA and any person carrying out such activities is required to hold a capital markets services ("CMS") licence unless otherwise exempted. Licensed and exempt financial advisers are currently exempted from the requirement to hold a CMS licence for dealing in securities when assisting clients to subscribe for or redeem units in unlisted collective investment schemes ("CIS"). In June 2015, MAS proposed to expand the licensing exemption for licensed and exempt financial advisers to help clients transact in both listed and unlisted CIS, provided that such dealings are incidental to their advisory activities. This proposal will take effect in the next round of amendments to the Securities and Futures (Licensing and Conduct of Business) Regulations. As outlined in the Consultation Paper, MAS further proposed to extend the licensing exemption to any securities defined under the SFA and will allow licensed and exempt financial advisers to apply for exemptions on a case-by-case basis before the proposed legislative amendments take effect.
In order to ensure that there are adequate safeguards in connection therewith, MAS proposed (i) to expand financial advisers' obligations to assess clients' knowledge and experience for transacting in specified investment products ("SIPs") to include listed SIPs and (ii) to require licensed and exempt financial advisers to furnish a risk warning statement to clients at the point of account opening when advising them on overseas-listed investment products.
(b) Expansion of licensing exemption for provision of fund management services incidental to advisory activities
Currently, licensed financial advisers are exempted from the requirement to hold a CMS licence for fund management where it conducts fund management activities that are deemed incidental to its advisory activities in respect of unlisted CIS. MAS proposes (i) to expand the scope of the current licensing exemption to include listed CIS and (ii) to extend the current licensing exemption to exempt financial advisers.
2. Dispensation with prior client approval for each and every rebalancing transaction
Digital advisers typically offer rebalancing of clients' portfolios to align the portfolios back to their original recommended asset allocation. With the proposed expanded exemption for both licensed and exempt financial advisers conducting fund management activities in respect of both listed and unlisted CIS, digital advisers which are licensed or exempt financial advisers will similarly be exempted from the requirement to hold a CMS licence in fund management to engage in portfolio rebalancing activities for portfolios that comprise solely of CIS. MAS further proposed to dispense with the requirement for digital advisers to obtain prior approval of the client in respect of each and every transaction, subject to certain safeguards. Digital advisers relying on this dispensation will be required (i) to disclose and obtain their clients' one-time prior acknowledgement in writing of the fees and terms of their discretionary portfolio rebalancing services and (ii) to notify clients prior to each and every rebalancing transaction so that clients are given an opportunity to object to the rebalancing transaction, if they wish to do so.
3. Case-by-case exemption from collecting full information on the financial circumstances of clients
Prior to making a recommendation that takes into account a client's investment objectives, unique financial circumstances and particular needs, a financial adviser is required to take reasonable steps to collect and document information from the client as prescribed under paragraph 11 of the Notice on Recommendations on Investment Products ("FAA-N16"). Such information includes, among others, the financial objectives of the client and the risk tolerance of the client as prescribed under paragraphs 11(a) and (b) of FAA-N16 respectively. MAS noted that digital advisers typically provide advice on exchange traded funds ("ETFs") with limited use of derivatives ("traditional ETFs") as opposed to a full suite of investment products. As MAS is of the view that the risk of a client purchasing an ETF beyond his financial means is relatively contained, MAS proposed to grant case-by-case exemptions to operators of fully-automated “client-facing tools” from the need to collect full information on the financial circumstances of a client as prescribed under paragraphs 11(c) to (i) of FAA-N16 when advising on traditional ETFs. This will allow MAS to engage applicants on the specific safeguards that they intend to put in place to ensure the suitability of their recommendations in spite of incomplete information on the financial circumstances of their clients. Digital advisers seeking to apply for this exemption will be (i) required to demonstrate that the threshold questions posed to potential clients can effectively filter out unsuitable clients; (ii) required to provide a risk disclosure statement to their clients and (iii) expected to have controls in place to identify inconsistent responses provided by their clients.
4. Relaxation of criteria for CMS licences in fund management for digital advisers
Some digital advisers who intend to obtain CMS licences in fund management to service retail investors may not meet the five-year corporate track record requirement of managing funds for retail investors in a jurisdiction which has a regulatory framework that is comparable to Singapore or the requirement of having at least S$1 billion of total assets under management ("AUM"). MAS is prepared to admit any digital adviser who does not meet the aforesaid requirements, subject to (i) its key individuals having relevant collective experience in fund management and technology; (ii) the recommended portfolios comprising at least 80% of traditional ETFs, with a cap of 20% invested in listed shares, listed investment grade bonds and foreign exchange contracts for hedging purposes and (iii) the digital adviser undergoing a post-authorisation audit conducted by an independent third party at the end of its first year of operations on key risk areas.
5. Development, monitoring and testing of client-facing tools
Digital advisers have to ensure that the methodology of the algorithm behind their “client-facing tool” is sufficiently robust and that sufficient back-testing and gap analysis are conducted to ensure reliability of output and sufficient mitigation of gaps. Digital advisers are also expected to ensure that they are adequately staffed with persons who have the relevant competency and expertise to develop and review the methodology of the algorithms.
Any digital adviser which chooses to outsource the development of its “client-facing tool” to a third party will have to subject such third party service provider to appropriate due diligence processes to assess the risks associated with the outsourcing arrangement.
Digital advisers are also expected to have policies, procedures and controls to monitor and test their algorithms. Minimally, digital advisers should have access controls to manage changes to the algorithms, controls to suspend the provision of advice if an error or bias within the algorithm is detected and compliance checks on the quality of advice provided by the client-facing tool.
6. Provision of information on algorithms and conflicts of interest
MAS noted that potential conflicts of interest may arise in situations where the algorithm of the “client-facing tool” is designed to favour or limit its recommendations to selected investment products for which the digital adviser or its affiliate would receive higher commissions. In such situations, digital advisers are required to disclose to their clients in writing of any actual or potential conflict of interest arising from any connection to or association with any product provider, including any material information or facts that may compromise their objectivity or independence. MAS further expects digital advisers to disclose to clients the reason for their selecting the investment products and the limitations of the recommendations provided, if any.
7. Responsibility of the board and senior management
The board and senior management of the digital adviser shall be responsible to maintain effective oversight and governance of its “client-facing tools”, including putting in place systems and processes to ensure a sound risk management culture and environment, as well as ensuring compliance with the relevant rules and regulations. Specifically, MAS expects the board and senior management to be responsible for approving the design and methodology development of the client-facing tool and ensuring its proper maintenance, approving the policies and procedures that apply to the systems and processes of the client-facing tool, maintaining oversight over the management of all client-facing tools and ensuring that the requirements set out in the Notice and Guidelines on Technology Risk Management are adhered to.
Bird & Bird: Reaction
MAS’ proposals to promote better access to digital advisory services must be seen as a positive one that is keeping in tandem with global developments. To the extent that the requisite safeguards are built into our regulatory infrastructure, there is no reason why such an initiative should not be seen as a progressive step in the right direction.
We expect to see more developments in this space and we look forward to see how Singapore’s approach towards digital advisory services will evolve.
The above discussion is intended only to be a summary of the proposals put forward by MAS in the Consultation Paper. Please refer to the Consultation Paper, a copy of which can be found on MAS' website, for full details on the proposals put forward by MAS.This article is produced by our Singapore office, Bird & Bird ATMD LLP, and does not constitute legal advice. It is intended to provide general information only. Please contact our lawyers if you have any specific queries.