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Conor McMahon, Reporter at Fora talks to Peter Oakes, Founder of Fintech Ireland about how automated financial advice is expected to shake up the wealth management sector

SO-CALLED ‘ROBO-ADVISORS’ already manage billions of dollars in the US, but they have yet to make their way to these shores.

Traditional wealth management has been largely untouched by the march of digital on this side of the Atlantic, and the sector is still overwhelmingly burdened by paper and admin work.

But not for much longer. Automated financial advice is already making waves in the UK, and Ireland could see a surge of robo-advice firms setting up shop in a bid to access investors in Europe.

Fora spoke to fintech expert Peter Oakes, founder of Fintech Ireland and a former director at the Central Bank, to get the lowdown on what exactly robo-advisors do and how they might shake things up in 2017.

What are robo-advisors?

Robo-advisors are basically online money managers or “investment intermediaries”, Oakes says. They offer financial advice based on an algorithm.

Users supply them with financial and personal information that they use to make recommendations on where to invest. In a nutshell, they offer low-cost financial advice.

“We all know that the biggest expense of a portfolio is all the administration,” Oakes explains. ”The thinking behind a robo-advisor is that there must be a large portion of people out there that actually just need very simple advice.”

Independent financial advisors take a big bite out of returns on investments in fees. Robo-advisors basically do away with that money trail.

What kind of advice do they give?

The user fills out an online form and the robo-advisor firm feeds that data into their technology. The robot uses that information to create an automated series of investment recommendations based on the user’s appetite for risk.

For instance, somebody close to retirement would be categorised as having a low-risk appetite, Oakes explains.

Based on the details furnished to the robo-advisor, it would most likely recommend that a user invests in money markets and avoids property ”because you really want your funds to be liquid because you’re coming up close to retirement. The same should apply in the case of equities, as there is greater risk there – and that’s want you probably wish to avoid when you are about to get the golden watch.”

Will they do away with humans?

The answer is no, but they still pose a potential threat to traditional wealth management firms and financial advisors.

Much like any industry that robotics and automation have affected – car manufacturing, media, customer service to name but a few – the humans won’t be completely wiped out, but their functions change.

“There still will always be a need for a human intervention from time to time,” Oakes says.

“Because it’s a regulated service, you’ll still have human interaction, especially if you’re lodging a complaint – maybe (the robo-advisor) has moved your money into the wrong fund even though you have proof of confirmation.”

It’s worth noting that the some users might be nervous about a complete lack of face-to-face interaction. A wholly automated experience might spook them from putting their trust in an algorithm.

“It may just be that the robo-advisor actually just gives advice and then leaves it to the individual to execute how they get that investment exposure,” Oakes suggests.

The benefits

The pros of robo-advisors outweigh the cons – on paper at least.

“If you look at your investment portfolio and you have a pension fund for example, even when you’re returning 5% a year, after the financial advisor starts taking out charges at the current rate, you’re probably only getting a 1.5% return on your money,” Oakes says.

“This is an opportunity to increase that 1.5% to maybe 3%, so you’re doubling your return.”


Who will they appeal to?

Oakes thinks robo-advisors will be targeted at people who are already involved in passive investments, like exchange-traded funds (ETFs), as these kinds of investment porfolios are easier for individuals to invest in without the need for financial advisors.

A robo-advisor would suit those types of investments because an algorithm can easily identify trends.

“There are tracker funds out there and they’re doing very well,” Oakes says. “You could set up a robo-advisor that predominantly puts people into tracker funds or recommends tracker funds.”

Robo-advisors will also appeal to anyone who is used to doing their banking online.

When will they come to Ireland?

It’s hard to say for certain, but robo-advisors are tipped to enter the market in 2017.

One of the possible motivations for coming to Ireland is access to the European Union’s investment management licence, MiFID, short for the Markets in Financial Instruments Directive. It’s the regulatory licence that non-banks use for investment management services. 

A robo-advisor firm that wants access to EU member-state markets might look to set up shop here and avail of the MiFID directive.

“If you were an Irish investment adviser or wealth manager, there are threats and opportunities here – in equal amounts,” Oakes says.

What does it mean for the heavyweights?

A recent PwC report suggested that traditional wealth fund managers are asleep at the wheel when it comes to robo-advisors.

It described the global wealth management industry as “one of the least tech-literate sectors of the financial services industry” and warned that it was falling behind non-financial services industry.

“Client expectations is sharply at odds with what’s currently being provided,” it said.

According to the report, what is currently on offer in the wealth-management industry is sharply at odds with what their clients, high net worth individuals (HNWIs), expect.

In her commentary on the report, PwC’s Olwyn Alexander said that the “sector is now acutely vulnerable to digital innovation from fin-tech newcomers, including robo-advice services” – and that firms that didn’t respond wouldn’t survive in the medium- to long-term.

Yesterday (13 September), the Central Bank issued through its Policy & Risk Directorate, a Cross Industry Guidance in respect of Information Technology and Cybersecurity Risks.  

The Directorate falls under the leadership of Gerry Cross.  A short video about the Central Bank’s thinking on the topic was released in conjunction with the Guidance – see You Tube channel. While its great to see the Central Bank embrace the use of social media, it seems to have a long way to go to have this recognised - at the end of the day on 14 September there had been only 131 views of the video.  That is quite remarkable given that the Central Bank regulates about 10,000 financial service providers and funds in Ireland and protects directly and indirectly a population of 4.8million. 

The Central Bank’s concerns are being driven by the potential impact of inadequate cybersecurity controls on the firms themselves, their customers and the risks for financial stability.

Given that Information technology is now at the heart of the supply of financial services and that the incidence of cyber-attacks and business interruptions is on the increase, the Central Bank is saying that firms should assume that they will be successfully targeted. Its view is that the security and resilience of IT systems, their governance and management must improve to reflect this reality.


Summary of Central Bank inspection findings:

• Alignment between firms’ IT strategy and the overall business strategy is weak. IT capabilities are not matched to the business ambitions.
  
• Firms are not taking a holistic view of IT risks across the business, which results in poor identification, monitoring and mitigation of IT risks.
  
• Shortcomings in IT risk assessment and identification with many firms not maintaining comprehensive IT risk registers and risk identification being backward rather than forward looking.
  
• Older technology supporting key business operations and requiring significant resources and/or investment to manage associated risks.
  
• Non-existent or inadequate data classification frameworks and policies.
  
• Staff not sufficiently trained on cybersecurity risks.
  
• Ineffective firewall management/inadequate intrusion detection processes with weak IT security monitoring.
  
• Deficiencies in governance of IT related outsourcing including a lack of thorough due diligence on prospective service providers, poorly documented/constructed outsourcing agreements and inadequate monitoring of service delivery.
  
• Inadequate and untested disaster recovery and business continuity plans.
  

Expectations of the Regulator

The Central Bank expects that:

• Boards and Senior Management of regulated firms fully recognise their responsibilities for these issues and put them among their top priorities.
• Firms must robustly address key issues such as alignment of IT and business strategy, outsourcing risk, change management, cybersecurity, incident response, disaster recovery and business continuity. 
• Firms make sure that they understand these risks and that they are managed effectively. 
  

The Central Bank's supervisory engagement will reflect the new Guidance when it assess firms.

Director of Policy & Risk, Gerry Cross, said: “Developments in technology have fundamentally changed business processes and models in financial firms.  These advancements have resulted in benefits for firms and their customers.  However, they also bring significant risks as firms become increasingly interconnected and more reliant on complex IT systems, including outsourcing service providers.”  

“The Central Bank is demanding increased effectiveness in this area.  We are undertaking considerable work to require improved IT risk management and cyber resilience across regulated firms. This includes enhanced supervisory capabilities and increased focus on these risk areas."

So what’s in the Guidance? 

Here’s the table of contents:

• Executive Summary
  
• Purpose
  
• Background
  
• Supervisory Issues Identified To Date.
  
• Next Steps.
  

1. GOVERNANCE

• Board of Directors and Senior Management Oversight of IT and Cybersecurity Risks 
  
• IT Specific Governance.

2. RISK MANAGEMENT 

• IT Risk Management Framework 
  
• IT Disaster Recovery and Business Continuity Planning 
  
• IT Change Management
  

3. CYBERSECURITY

4. OUTSOURCING OF IT SYSTEMS AND SERVICES 

• Appendix 1: Glossary 
• Appendix 2: Key International Guidance for Firms
  

If you need to know more or wish to discuss, please contact Peter Oakes at [email protected] / +353872731434.  Peter Oakes is a board director of regulated firms which too must implement this Guidance, he is a former Director of Enforcement at the Central Bank and works across cross-industry in financial services in London and Dublin. 

Spoiler alert, if you were hoping for an announcement of an Irish ‘sandbox’ to join the UK FCA and the Aussie ASIC sandboxes in yesterday's (05 May 2016) fintech speech by the Central Bank, you’ll be disappointed.  

The word ‘sandbox’ is like the word ‘sex’; if you put it in the heading of a fintech article, you're sure to get attention.

There is no indication that the Irish Central Bank is thinking of a sandbox or an innovation hub from today’s speech by Bernard Sheridan (Central Bank Director of Consumer Protection).  However nothing in the speech reads to me that the Central Bank will not go down that path.  The tone of the speech is very open and cautious, leaving the Central Bank room to manoeuvre (or pivot as we say in industry) as it responds to the challenges of fintech and, in the case of this speech, consumer protection risk.  We might expect a prudential driven fintech speech in the future as the areas of financial stability and market conduct area the  focal point of other Directors at the Central Bank.  

At a speech given at the Financial Services Innovation Centre in the Cork yesterday, the senior central banker commenced by saying he ‘was struck by the growing and significant level of interest there is in fintech developments across a wide variety of sources including international regulatory bodies’ and it being ‘a clear sign of things to come’ for regulated and non-regulated fintech firms.  Reference was made to a number of Mr Sheridan’s international peers, including;

• Mark Carney, Chair of the Financial Stability Board: global regulators are evaluating potential stability implications that emerging financial technology poses to the global financial system including “systemic implications of financial technology innovations and the systemic risks that may arise from operational disruptions”.
• European Commission: “the retail financial services sector is experiencing significant change as it is affected by digitalisation. New business models are emerging: online-only providers and technology companies are entering the market, offering services (within Member States and sometimes cross-border) including electronic money transfers, intermediation in online payments, financial data aggregation, peer-to-peer funding and price comparison”.
• Steven Maijoor, Head of EIOPA: “financial innovation is important and, at its best, contributes to economic growth. However, this can only be achieved and sustained where consumers have confidence in such innovations. Our role as European Supervisory Authorities is to monitor new financial activities and to take action where appropriate.”
  

Returning to Ireland, the regulator noted that its strategic plan has identified the increased risks arising from technological developments and the increased reliance on information technology by regulated firms, their customers and suppliers. He also reminded that cyber risk is a key emerging threat and that the regulator’s Consumer Protection Outlook Report highlighted financial innovations as a key consumer risk - “[t]he consumer benefits of accessibility and convenience must be matched by service reliability, safety and security, and transparency of cost of services”.

While I agree that the issue of financial stability risk arising through innovative financial services is important, this isn’t something new.  Rather it seems to me that regulators, even if they considered this to be an issue previously, may not have had the confidence to express their concerns until recently.  It feels like regulators have been driven out of their comfort zone and forced to confront the rapid (re)evolution in industries which they traditionally pondered about for years, if not decades, before setting out their prudential, consumer and conduct risk concerns.  While it is a fair observation to note that “Fintech is transcending traditional boundaries and borders, not just physical but also regulatory as it blurs the lines between regulated and unregulated activities”, this is nothing new.  The same can be said of banking and investment house conglomerates which run empires of regulated and unregulated firms, to which the same tests are applicable as to whether they are regulated or not.  A significant problem in the world of fintech are the inconsistent interpretations across the EU.  For example, peer-to-peer lending is considered to fall under the Payment Services Directive in Germany and Italy, but the same activity in Ireland is not.  This has nothing to do with the fact that the activity is provided through fintech or not.

The regulator goes on to note that “As new technologies change the everyday provision and delivery of financial services for consumers and firms, it becomes more challenging for regulators to monitor what is going on as the regulatory rulebooks and supervisory tools struggle to keep pace with developments.” Quite frankly, I don’t understand why it becomes more challenging for regulators unless they remain static and continue with outdated and backward looking supervisory systems instead of real-time and data analytic supervisory systems.  The information which they need to keep abreast of is rapidly moving to digital format.  They have a number of options here: (1) insist on being provided access to this data direct, which is what fintech firm Uphold Inc voluntarily does, by providing real time transaction data to the regulators; (2) ramp up their own resources, i.e. technology, understanding of data analytics, AI, staff and education; and (3) try to stop the advancement so that it remains at a level at which regulators are capable of supervising - but good luck with regulating the internet!

Consumer protection and the Central Bank
As we know, the Central Bank has a statutory objective of effective regulation of financial service providers and markets, while ensuring that the best interests of consumers are protected. And it is fair for the regulator to let us know its thinking that the disruptive impact of financial innovation is impacting on its risk priorities and the way it does its work. The regulator noted that “[f]intech certainly has the potential to bring many benefits for firms and consumers and the framework should protect the consumer’s best interest and enable the management of additional and new risks by firms while not stifling innovation or damaging consumers’ trust and confidence in financial services”.  This sounds impressive until one asks exactly what are the precise ‘risks’ which are of concern to the local and overseas regulators? Saying general that there are risks to financial stability and consumer protection simply because change is afoot does not help inform the debate.

In the eyes of the Irish regulator a few of the areas where fintech and innovation are impacting on its consumer protection work include: (1) monitoring of consumer risks; (2) authorisation process for new firms; (3) new product development; and (4) how we are changing our approach to assessing consumer risks in firms. Noting that point 4 mitigates point 1, there are really only 3 areas here.

1. Monitoring of emerging risks
Under this heading the regulator noted that the findings from its consumer focus groups included people being “time poor”, people wanting more convenient and less time consuming complaints processes, including online channels for formal complaints. I get this point, but I am at a loss as to why this “presents a real challenge as to how innovation can be utilised better to marry the two consumer needs i.e. having a convenient and easy to use complaints process while at the same time enabling interaction with an experienced member of staff to resolve complaints in a fair, timely and transparent way”.  Surely the advent of online and ‘direct to supplier’ chat support forums on many of today’s websites is the starting point.  This is not an issue about the channels available to consumers, but rather the quality of the interaction and therefore the resolution of a complaint?  

I liked the next part of the speech.  I think it was meant to provide comfort, but will probably spook those who feel that we live in an Orwellian society – “The Central Bank also undertakes regular social media monitoring and gathers intelligence from platforms such as social media sites, public discussion fora and media sources in order to gain an insight into and keep abreast of current issues being raised by consumers”.  One suspects that monitoring might also focus on the behaviour of regulated firms in cyber space too.

We learn in the speech that the European Supervisory Authorities (“ESAs”) accept that increased automation of advice to consumers provides potential benefits, such as wider access, lower cost and more consistent consumer experience.  And we also learn that the ESAs are concerned about potential risks, e.g. consumers’ understanding of the nature of the service, limitations or errors in the tools and/or algorithms used. The ESAs are now considering what specific regulatory or supervisory actions should be taken to mitigate consumer risk in automated advice.

2. Authorisation Process
There is nothing new under this heading.  We covered this area when the changes were announced.  In fact, these changes we announced following our engagement with the regulator back in 2015.  See our April 2015 update here and our May update here. Suffice to say that the regulator repeated its adoption of the three key principles: accessibility; transparency; and timeliness.  The Central Bank reminded that its role is not to act as advisers to potential applicants but rather to provide clarity and certainty by responding to applicants in an open and facilitative way.

3. New Product Development
From 2017 new guidelines will be in place for banks and payment institutions, which will be followed by other sectors over time.  These guidelines will be a key part of the overall consumer protection framework. Product oversight and governance arrangements are to be an integral part of the firm’s governance, risk management and internal control framework requiring firms, amongst other things, to identify the target market, test products before launch, monitor how the product is performing and take remedial action where problems arise. Product testing will be required to enable the firm to “assess how the product would affect its consumers under a wide range of scenarios, including stressed scenarios”.  Product monitoring will be required on an on-going basis.

4. Assessing Consumer Protection Risks
Under the last heading the Central Bank announced that it is developing its Consumer Protection Risk Assessment supervisory model which will assess how firms are utilising technology to support their consumer risk management including:

• how systems are used to alert firms to emerging and existing consumer risks;
• how firms consider consumer risk management and reporting when developing new systems;
• the maturity of firms’ analytics techniques in terms of identifying and escalating emerging and crystallised consumer risks.

The regulator noted that technological innovation can enable firms to deliver an effective internal consumer protection risk model and management information and support the delivery of suitable products and services. Looks like regtech to me.

Future Challenges

In his concluding remarks Bernard Sheridan said that there was potential for:

(i) a greater level of engagement between innovators, innovation centres and regulators so that we can all be better informed and involved in helping avoid the crystalisation of consumer protection risks in new innovations;
(ii) at a firm level, there is an opportunity for fintech to play a bigger part in developing products and services that help support regulated firms in monitoring and managing consumer risks;
(iii) at the product level, fintech can bring forward innovative solutions for firms seeking to deliver suitable consumer-focused products and services and support firms meeting their regulatory requirements in product oversight and governance;
(iv) and finally, at the consumer level, fintech can help deal with the issue of product complexity and the increasing difficulties that consumers are having in understanding financial products and services.

His final words on fintech and consumer protection were, unsurprisingly, “We all can and must play our part in ensuring that innovation and consumer protection are closely aligned and, above all, that we are continuously focused on getting it right for the consumer”.

Joe Lavelle ([email protected]) writes on Fintech incubators and opportunities for Ireland for www.fintechireland.com.  A chartered account and payments sector regulatory consultant, Joe  specialises in successfully establishing FinTech entities in Ireland, the UK and Malta as authorised financial institutions .

The global FinTech sector has experienced rapid growth with the investment in FinTech start-ups resulting in the introduction of niche technologies producing unique service offerings tailored to specific consumer and business needs. Successful entities have benefited greatly from Government support while the existing large payment sector players are choosing to adapt and work alongside these start-up enterprises with a view to embracing their model and supporting their innovative approach by supporting “incubators” to nurture start-up entities through their early stage development. Such initiatives have in many instances also received the support of Financial Regulators such as the approach adopted by the UK Financial Conduct Authority “FCA” who have played a key role in ensuring a practical approach to complex financial regulatory compliance obligations which for these low risk classified start-up Companies can prove to be a major hurdle.

Incubators have to date provided startups with invaluable support through mentoring, support services, stakeholder connections and investment in research and development.  Developing, testing and researching is key to assessing any opportunity with new ideas taking an average of 100 days to pass through innovation funnels such as that at Visa. Dublin has long been renowned for its commitment to investment and ability to attract research and development opportunities while the Irish English speaking labour force has achieved global recognition for its high degree of skill and expertise in areas such as technology and finance and support services such as IT hosting. The rapid innovation in the FinTech sector presents the perfect opportunity for Ireland to become a significant hub for attracting the high potential FinTech Companies. Ireland has successfully attracted technology giants such as Facebook, Google and Airbnb however it has been noted to “lag behind” in its ability to attract and nurture FinTech Companies by failing to adopt a “joined up strategy” that would encompass private business, Government Agencies and the Regulatory Authorities.

In a recent interview David Page, Innovation Partner at Visa Europe Collab outlined his views on the important role of FinTech incubators and indicated where the emerging European capitals of FinTech were located. According to Page the established innovation hubs include London, Berlin, and Tel Aviv noting that London has being highly successful in becoming recognised as one of the global capitals for FinTech innovation supported by its practical approach to financial regulation,  strong startup community in Tech City, early-stage investors and government support allowing new FinTech businesses to thrive. Israel is widely considered to be the ‘startup nation’, with more startups per capita than any other region globally while Berlin which is seen as slightly different as “a creativity hotspot”. Stockholm is becoming the FinTech capital in the Nordics while there are some exciting startups coming out of Barcelona. This trend indicates the significant opportunity for Ireland, in particular Dublin, to join this innovation race and become one of the leading FinTech capitals in the world.

The strong FinTech incubator presence in London, Tel Aviv, Stockholm and Berlin demonstrates the significant opportunity for Dublin (as well as Cork, Limerick, Galway and our cousins in the north - Belfast) to attract high potential start-up FinTech businesses however, if this is to be achieved the approach taken by the government and regulatory authorities will be a major factor in determining if Ireland will indeed be successful in joining in the emergence of this truly innovative FinTech race which is transforming the way global citizens pay for goods and services by exploring technologies to innovate the payments sector.

www.fintechireland.com

This was first published June 29, 2015 by Adrian Marples of Alternatives Elect.  Our thanks to Adrian for allowing us to upload this informative piece on fintech.

After years of one-way traffic, the Irish Financial Services & Fintech outlook for 2015 is promising. Senior Irish financial executives, and bankers in particular, are returning to Dublin. They will face a changed landscape with recent employment headlines centred all too often around the proliferating FinTech sector, or larger firms using Ireland for a data or cyber security hub.

However, the tide across the more traditional financial services sector is turning. Credit Suisse is currently seeking regulatory approval in Dublin ahead of relocating its European prime services business from London. This is major news for Dublin. This is a significant, risk-taking business, a world away from the back office operations which have become the mainstay that populate the banks of the Liffey. Whilst Credit Suisse’s competitors will been watching this closely, many of them are already quietly moving other roles to Dublin, some of them much further up the value chain, under the radar on a piecemeal basis.

For well compensated Irish expats in particular, these developments present opportunities to return home.  There is an increase in senior financial services talent returning to Dublin for the first time since the crisis. Senior bankers can now return to Ireland without suffering the eye-watering pay cuts that were on offer a couple of years ago.

Earlier this year, the Irish government outlined an initiative to increase jobs in the IFSC by 10,000 within 5 years. Dublin has slipped drastically in rankings compiled for the Global Financial Centres Index, from 10th in 2009 to 70th in 2014. The flight of banks like Commerzbank and Goldman Sachs during the recession years didn’t help Ireland’s ability to lure marquee talent to the docklands.

Banks are now under intense pressure to cut costs in the face of increased regulation and lower profits from their investment banking arms. Many international banks already have a presence in Ireland, either for tax reasons or to house their fund administration businesses, so logistics are considered favourable.

Ireland presents a strong proposition for financial services firms. We occupy the same strategically important time zone as London and there is a much vaunted, well educated, English speaking work force. Critically, there are much lower real estate and labour costs than competitor banking hubs.

There are other pressures causing the return in demand for talent: a skills shortage exists, particular in the regulatory space, as firms adapt to the rigours of the Single Supervisory Mechanism. Both domestic and international banks will pay a premium for experience gained outside Ireland across risk, analytics, cyber security, audit and compliance.

Whilst it remains to be seen whether other international banks follow the bold steps of Credit Suisse, the prospects for the FinTech sector look altogether more assured. A combination of factors, such as legacy technology issues and regulatory headaches for mainstream financial services firms, are causing bountiful opportunities to firms operating in this sector right now. Looking to the future, there is also the widespread expectation that a new generation of customers will gradually turn away from one-stop shops and opt for single channel providers for their financial products.

From a talent perspective the challenge for these firms will be to mature from a strong technology proposition to a more wholly structured and institutionalized business. As businesses mature, there will be a requirement for fresh talent to populate new CEO / COO positions as firms adjust to the operational demands which come with scale, whilst a Commercial Director will be required to drive sales in new markets.

After several years where compliance and non-core businesses dominated the agenda we can hopefully look forward to a new era of growth across both the traditional financial services and Fin Tech industry. The shadow of the regulator will never be far away but current trends suggest significant cause for optimism.

www.fintechireland.com