New fintech developments and online advice trends are a constant in the investment industry, forcing regulators to adapt.
Many studies show investors are taking their time adopting digital tools thanks, in part, to fears of buying investments online. Yet a KPMG report says global fintech investment surpassed US$31 billion in 2017, led by the U.S., and that it’s grown to US$122 billion over the last three years.
This means regulators have to remain vigilant, and that’s exactly what’s happening, says Sean Sadler, partner at McCarthy Tétrault LLP in Toronto.
Since speaking to Advisor’s Edge in fall 2017, he’s seen “more take-up from securities regulators in collecting data, and better understanding [of] the way online advisors offer services.” While industry watchdogs are “actively involved in granting registrations to these businesses,” they’re also “placing terms and conditions” to protect investors, he says (see “What Canada’s robos have to say,” below left).
Sadler lists five areas of online advice that regulators could focus on:
- KYC and suitability, and how conflicts of interest are managed;
- overall cost and fee transparency;
- how trades are executed;
- data security; and
- how algorithms work and are designed.
Regulators and SROs know the first four well, but determining how to supervise algorithmic data collection could be a challenge, he says. Their work could include questions around “how and whether an algorithm has been designed to produce objective investment outcomes or narrow the outcomes to benefit a business.” That could be in relation to the sale of proprietary products and disclosure, for example.
IIROC’s latest steps
IIROC noted in its 2017/2018 compliance priorities report that the number and types of online-advice offerings continue to grow. The SRO has developed a “flexible” testing module for such businesses to address online advisors’ “development of proprietary technology, white labeling, and strategic alliances […] with other dealers.”
From online advice businesses, the SRO is looking for clear disclosure around products and conflicts of interest where proprietary recommendations are made, and for “an appropriate account-opening process, including adequate online [KYC] and risk-tolerance assessments,” the report said. It’s also seeking “sufficient” oversight within firms and of affiliated advisors.
On April 9, IIROC announced a study it’s spearheading alongside Accenture, which will use industry consultations to look at the evolution of advice and the effects of innovation, technology and changing client demands. One goal is to figure out “how regulation may need to change to accommodate innovation,” the SRO said in a release.
For now, the SRO’s expectations for online advice firms and traditional firms remain similar. But IIROC’s new testing model, in particular, is designed to look at how an online business is structured and the services it provides. It also checks whether firms are doing what they “told us they would do at the time they were proposing their business model(s),” says Sandra Blake, vice-president of business conduct compliance at IIROC.
The SRO is paying attention to initial and ongoing communication processes, and if the firms are routinely reaching out to investors who come forward with questions or concerns, she says.
As with traditional firms, online advice businesses will be tested every one to four years, depending on where the firm lands in the SRO’s risk model, says Wendy Rudd, senior vice-president of member regulation and strategic initiatives.
She adds that regulators don’t define firms as online versus human-driven. “We look at the dealers that we regulate and the services they offer on a spectrum, going from order-execution-only, which is the discount brokerage platforms or DIY investing, to various flavours of online services.” As such, “testing really does vary,” she says.
What should be consistent is how strict regulators are around the use of technology and the algorithms behind it. As Sadler says, regulators could ask whether the people designing and supervising the use of such tools have both investment and technical expertise, to ensure that “an investment advisory professional understands how they work.”
What should be clear to investors, he adds, is who’s responsible when online advice processes break down. One model to consider is how advice from non-resident broker-dealers, advisors or fund managers is regulated, says Sadler. Currently, when one of these non-resident entities gives advice, a Canadian firm or advisor must agree to be responsible for any associated losses.
IIROC spokespeople confirmed that, to date, there have been no public cases or complaints related specifically to online advice. Still, IIROC says it will keep refining its testing procedures.
Says Rudd: “In our traditional advisory world, a registered representative, or advisor, has a relationship with every client.” If there were an online advisory problem that a client didn’t cause himself, “we would look to the firm, given that it created the algorithm. The client would not be without recourse.”
What Canada’s robos have to say
When asked about the fairness of regulators’ approaches, some of Canada’s major robo firms held similar views.
Wealthbar CIO Neville Joanes and Invisor CEO Pramod Udiaver both said online advisors should be held to the same rules as traditional firms. Wealthbar and Invisor are registered as portfolio managers under provincial legislation. Udiaver says that the online advice model must ensure the advisor is held accountable to a fiduciary standard where clients’ needs are concerned, along with maintaining focus on suitability.
Wealthsimple CCO Michael Holder, who agrees, said there’s a “spirit of partnership” between firms and watchdogs. He cited OSC’s LaunchPad, created in 2016, and CSA’s Regulatory Sandbox, which debuted in 2016 and will run until at least 2019. Both initiatives are designed to more efficiently help fintech businesses navigate rules and requirements, and come to market faster.
Justwealth co-founder and CIO James Gauthier said regulators have “been reasonably fair” by offering many consultations, but that the space is growing faster than rules have adapted.