Transparency vital in digital advice
Digital advice providers must be transparent on the limits of their services, their dependence on client-provided information, as well as cost disclosure, while providing access to cheaper advice, according to BlackRock.
The fund manager's Viewpoint, titled ‘Digital Investment Advice: Robo Advisors Come of Age', outlined the global regulatory landscape on digital advice, and focused on best practices for digital advisers, including the need for algorithm design and oversight, disclosure standards and cost transparency, and best trading practices.
Even as BlackRock emphasised that digital advice providers would be subject to the same regulatory requirements as traditional financial advice providers by the Australian Securities and Investments Commission (ASIC), it said new innovation in financial services would necessitate consideration of the applicability of current regulations and appropriate supervisory approaches.
In terms of transparency, digital advisers must help clients understand the risks and costs linked to advisory service and risks of investing in general.
"For example, in cases where clients may have aggregated a subset of their assets for the digital advisor's management, the digital advisor may not be managing the entire asset base and, as such, will make limited recommendations," the paper said.
Digital advisers must also disclose the limits of their tax management capacity if their clients have not aggregated all accounts. Clients should be aware that while some advisers may offer a full discretionary service, which could include rebalancing, simpler advisory models may not offer an automatic rebalancing service.
Advisers must also inform clients of the costs they can expect, including upfront fees for advice, and whether fees would be levied on allocations to cash management channels.
In terms of algorithms, key questions to ask would include:
- Has the algorithm included transaction costs or termination fees, if any?
- Has the algorithm included tax implications, and if so, does it have the cost basis of each asset? and
- Does the algorithm include considerations on the level of risk that is suitable for the consumer, particularly if their financial knowledge and experience is limited?
Similar to the Australian Securities and Investments Commission's (ASIC's) regulatory guide on digital advice, BlackRock said digital advisers should understand the analytic approaches that would be used in algorithms, even if it was provided by a third party.
"Testing and control of the algorithm should be a separate function from compliance or internal audit teams, whose role is to challenge and advise those responsible for the design and operation of the algorithm on an ongoing basis," the BlackRock paper added.
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