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23 June, 2017
The Monetary Authority of Singapore (the "MAS") has issued a consultation paper on 7 June 2017 (the "Consultation Paper"), inviting comments on proposals to vary certain aspects of the Securities and Futures Act (Chapter 289) (the "SFA") and the Financial Advisers Act (Chapter 110) (the "FAA") in order to facilitate the provision of digital advisory services, which are services that clients can use directly with limited or no human adviser interaction (commonly referred as robo-advisers).
This client update details key aspects of the MAS proposal, covering:
- risk management requirements; and
- proposed exemptions under the SFA and FAA and the regulatory safeguards associated with them.
Risk Management: Governance and Supervision of Algorithms
In assessing the unique characteristics of, and risks posed by, digital advisers, the MAS has in the Consultation Paper set out several specific expectations which it has stated that the board and senior management of the digital adviser must address, focusing particularly on the governance structure within the organisation and the oversight of the algorithm that is used.
Developing the Client-Facing Tool
In the development of the client-facing tool, MAS has emphasised that it would expect the digital adviser to ensure that the methodology of the algorithm is robust – it must collect all the necessary information and be able to sufficiently analyse the information to make suitable recommendations. Sufficient pre-launch back-testing should be performed on the client-facing tool in order to ensure that it can reliably produce an output that is consistent with the intended investment recommendations. A gap analysis should be performed against the requirements stated in the MAS Notice on Technology Risk Management [CMG-N02] (last revised on 6 March 2014) and in the Technology Risk Management Guidelines (published in June 2013) to ensure that all identified gaps are adequately mitigated before the client-facing tool goes live.
Back-testing and gap analysis should also be performed whenever any changes are made to the client-facing tool.
Staff who are responsible for developing and reviewing the methodology of the algorithms must also have the competency and expertise to perform their roles.
Monitoring and Testing of Algorithms
In the Consultation Paper, MAS has highlighted the following processes that it expects to be in place to monitor
and test the algorithms to ensure that they perform as intended:
- access controls to manage changes to the algorithms whenever necessary;
- 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 (to be conducted regularly and whenever there are changes to the algorithms), and which must include post-transaction sample testing that is reviewed by a qualified human adviser.
Disclosure of Information on Algorithms and Conflicts of Interest
In the Consultation Paper, MAS has also invited comments as to the extent to which a digital adviser must disclose information on its algorithm to clients.
It is proposed that, apart from complying with existing disclosure obligations under MAS Notice on Information to Clients and Product Information Disclosure [FAA-N03] (last revised on 20 February 2013), digital advisers should disclose the reasons for the selectivity and limitations of the recommendations given. For example, given that a client may not have the opportunity to seek clarifications on the specific products being recommended to him (owing to the lack of face-to-face interactions with a human adviser), MAS is proposing that a digital adviser should reveal other investments which have not been considered but which may have characteristics similar to, or superior to, those that have been considered.
Exemptions from Licensing and Regulatory Requirements
In the Consultation Paper, MAS has confirmed that a separate licensing regime will not be established for digital advisers. Instead, certain concessions from the existing regulatory frameworks will be provided for, and before the legislative amendments are implemented, MAS will entertain exemption applications on a case-by-case basis.
Suitability of Recommendations
In the Consultation Paper, MAS has announced that it will, on a case-by-case basis, consider exempting digital advisers who employ fully-automated client-facing tools (i.e. where there are no human adviser intervention at all within the advisory process) from the need to collect full information on the financial circumstances of a client when advising on traditional exchange-traded funds ("ETFs"). This is currently a requirement under the MAS Notice on Recommendations on Investment Products [FAA-N16] (last updated on 1 April 2017) ("Notice FAA- N16"). MAS has said it will consider granting an exemption from this requirement if the digital adviser is able to demonstrate to MAS that it has specific safeguards to ensure that the recommendations generated from the client-facing tool remain suitable, notwithstanding that there could be incomplete information on the clients. This is in recognition of industry feedback to the effect that the requirement under Notice FAA-N16 is less relevant in a digital advisory environment since the clients retain full discretion on the amount they wish to invest and cannot be subject to any form of influence or active solicitation on the investment amount during the investment process.
MAS has also given examples of what would be appropriate safeguards. Firstly, a digital adviser's online processes or algorithms should not be able to exert any influence over the amount that a client chooses to invest, and the client-facing tool should include threshold questions, the responses to which would effectively filter out those clients for whom the digital advisory service is unsuitable. Secondly, digital advisers seeking an exemption from Notice FAA-N16 would also need to provide a risk disclosure statement to clients to alert them to the fact that the recommendations do not take into consideration their financial circumstances, existing investment portfolios or the affordability of the investment. Thirdly, digital advisers must have controls to identify inconsistent responses given by the client with a view to alerting these to the client, or a backend data analysis process to automatically flag out inconsistent responses given by the client for subsequent follow-up.
Portfolio Management Incidental to Advice
MAS would extend the scope of the exemption in paragraph 5(1)(g) of the Second Schedule to the Securities and Futures (Licensing and Conduct of Business) Regulations (Reg. 10) ("SFLCBR"). This provision currently exempts a licensed financial adviser from having to hold a capital markets services licence for fund management when it manages a portfolio of units in unlisted collective investment schemes for a client, provided that such licensed financial adviser obtains the client’s prior approval for each transaction it undertakes for the client. The scope of the exemption will be extended by the inclusion of exempt financial advisers and the inclusion of portfolios where there are both listed and unlisted collective investment schemes. The requirement for the financial adviser to have to obtain the client’s prior approval for each and every transaction will also be abolished. It was felt that the risks arising from rebalancing a portfolio can be addressed without the need for client approval on a per- transaction basis.
Waiver of Corporate Track Record Requirements
Currently, a fund manager who seeks a capital markets services licence to provide fund management services to retail clients is required to have (i) a five-year corporate track record; and (ii) total assets under management of at least S$1 billion. In the Consultation Paper, MAS has indicated that it will consider waiving these requirements, in relation to a digital adviser who seeks to offer a similar service, provided that certain safeguards are met, namely:
(a) the key individuals (this being presumably a reference to the directors and key professional staff) must collectively have the relevant experience in fund management and in technology;
(b) the recommended portfolios must comprise primarily of traditional ETFs (at least 80%), with a cap of 20% on listed shares, listed investment-grade bonds and foreign exchange contracts for hedging purposes; and
(c) the digital adviser must undergo a post-licensing audit conducted by an independent third party at the end of its first year of operations on key risk areas, including anti-money laundering and countering the financing of terrorism, handling of client moneys and assets, technology risks and suitability of advice.
Execution of Investment Transactions
MAS has also proposed to broaden the scope of the exemption in paragraph 2(j) of the Second Schedule to the SFLCBR. This provision currently exempts licensed and exempt financial advisers that are authorised to market collective investment schemes, from having to hold a capital markets services licence for dealing in securities when the financial adviser markets or redeems units in unlisted collective investment schemes. Acknowledging industry feedback that the existing exemption is worded far too narrowly, MAS is proposing that financial advisers will be exempt for all dealings which are incidental to their advisory activity. With this amendment, financial advisers who assist clients in passing along trade orders to brokers for execution will not be required to be licensed to deal in securities.
In light of the proposed changes, consequential changes will also be made to Notice FAA-N16 so that the requirement imposed on financial advisers to assess their clients' knowledge and experience for transacting in specified investment products will be extended to include listed specified investment products. Similar to what is already required of brokers under the MAS Notice on the Sale of Investment Products [SFA 04-N12] (last updated on 29 April 2015), financial advisers will also be required under Notice FAA-N16 to provide a risk warning statement to highlight to clients that the level of investor protection may differ when the client invests in an overseas-listed investment product not regulated by MAS.
Consultation Period
The consultation period closes on 7 July 2017.
A copy of the Consultation Paper can be assessed here.
