ArticlePDF Available

Automated Investment Advice: Legal Challenges and Regulatory Questions

Authors:

Abstract

This paper examines the basics of the automated investment advice (Robo-Advisory), attempts a definition and a taxonomy, and lays the necessary groundwork for analysing this phenomenon. The aim is to offer a broad framework to allow a better understanding of the current legal situation of Robo-Advisory. For this purpose, it delves into some key aspects that lawmakers should consider in order to create and implement efficient regulation of this emerging digital technology. In this sense, the goal is to clarify some aspects to understand Robo-Advisory from the legal point of view, considering the determinant uses of this kind of software to the financial and investment services, with a brief and focus on the current European Financial Market Regulation. Keywords Robo-advisors, Fintech, financial services, automated investment advice, financial advice, MIFID II
1
Automated Investment Advice: Legal Challenges
and Regulatory Questions
By Pablo Sanz Bayón and Luis Garvía Vega
Research Members of Everis-Comillas Fintech Observatory, at Comillas Pontifical
University (Madrid, Spain) http://comillas.edu
This paper has been published in: Banking & Financial Services Policy Report, Volume
37, Number 3, March 2018, pp. 1-11. ISSN: 1530-499X
2
Abstract
This paper examines the basics of the automated investment advice (Robo-Advisory),
attempts a definition and a taxonomy, and lays the necessary groundwork for analysing
this phenomenon. The aim is to offer a broad framework to allow a better understanding
of the current legal situation of Robo-Advisory. For this purpose, it delves into some
key aspects that lawmakers should consider in order to create and implement efficient
regulation of this emerging digital technology. In this sense, the goal is to clarify some
aspects to understand Robo-Advisory from the legal point of view, considering the de-
terminant uses of this kind of software to the financial and investment services, with a
brief and focus on the current European Financial Market Regulation.
Keywords
Robo-advisors, Fintech, financial services, automated investment advice, financial ad-
vice, MIFID II
3
1. Introduction
Much has been said, written, and theorized about the so called “Internet of Value” ver-
sus the more common and extended “Internet of Information”. This leap of technology
and creativity on its application in the financial system has only been possible thanks to
the development of the “Fintech Industry” [Haddad and
Hornuf 2016]. Fintech or fi-
nancial technology” implies a new sector that has emerged to support the introduction
and implementation of digital technologies in the financial system, by adding value to
its normal operations [Kakavand
et al.
2016].
Embedded in the Fourth Industrial Revolution [
Schwab
2017] characterized by the ap-
plication of digital technologies that affect all aspects of human life, the development of
Robotics, Artificial Intelligence (AI), and Blockchain [UK Government Chief Scientific
Adviser 2016] are being considered “the next big thing” due to the many possibilities
that they entail for the future of the economy and its many sectors, and in particular
those regarding investment and financing [
The Economist
2015;
Garvía and Sanz
2017].
One of the many disruptors through these innovative approaches to the economy, and
applying modern technologies in doing so, are start-ups related to automated financial
advising and asset management called robo-advisors [
The Economist
2015]. These inno-
vative players, albeit more modest in size and resources than their traditional competi-
tors (banks and other financial institutions and human professionals such as investment
firms and financial advisors) are profiting from the aftermath of the 2008 financial crisis
and are thriving spectacularly in the financial sector [
Blackrock
2016]. Robo-advisors
have leveraged the mistrust of many consumers in the great banking corporations, and
are thus offering simpler ways to invest, mostly via smartphone or through their Web
sites, providing their customers with services accessible 24/7 at a minimal operational
cost [
Mercadante
2016].
4
This new kind of financial start-ups using Robotics and AI, labelled with the term
Fintech, is growing by the second, in all regions of the world, developing new financial
products and tools. And in doing so, they are shaping the present and the future of fi-
nance, and ultimately, of the global economy [
Meola
2016].
The development of robo-advisors started in the United States and has been increasing
exponentially over the years. This country has been pioneering the launch of robo-
advisors, which explains why most of them are located there.
1
In fact, the American
Robo-Advisory industry is currently expecting to grow exponentially, as reflected in
different reports which predict that by 2020 they will manage 2.2 billion dollars in the
United States.
2
Automated investment advisors increased their presence after the financial crisis of
2008. The incredibly high number of robo-advisors indicates a tendency toward a major
consolidation soon. Moreover, there is a clear and disproportionate market dominance
by a few companies such as Betterment and Wealthfront that have around 7.3 billion
USD and 5.1 billion USD of asset under management (AUM), respectively. This,
“combined with profitability challenges upon market entry, suggests that smaller play-
ers will be absorbed by larger companies, unless they collapse first”.
3
The number of robo-advisors have, however, been growing exponentially and are ex-
pected to continue like that, which predict a significant increase in other countries
4
The
situation in Europe is similar but on a much smaller scale. Although in the United States
there are more than 200 robo-advisors, in Europe they barely exceed 70.
5
That is why
we consider that while in the United States, the robo-advisors are widely used instru-
ments, as data reflect, in Europe they largely remain as an unknown tool with immense
potential.
5
Considering this market situation and current trends, the following part of this paper
studies the basics of robo-advisors in order to clarify the main points that regulators
have to take into account to provide an optimal legal framework that allow to promote
and control the future developments in the Robo-Advisory industry and its relationship
with other financial market players. For this reason, this paper focuses on the legal im-
plications as well as the shortcomings of the features and types of robo-advisors, and the
different ways to be regulated, as the new players of the Fintech industry.
One step further from these new prospects in financing is the application of digital tech-
nologies for legal compliance purposes. One of the major advantages that FinTech start-
ups have against the financial institutions is the relative lack of regulation, as opposed to
the major monitoring that banks suffer, especially since the 2008 crisis [
Arner et al.
2016
]. In this sense, the so-called “Regulatory Technologies”, or “Regtech”, are meant
to enable better and more efficient compliance processes, solving legal requirements in
a more cost efficient and secure way, and banks and other investment players have their
sights set of these innovative digital technologies [
Institute of International Finance 2017].
In this paper, we will analyze Robo-Advisory from this legal perspective, as one of the
defining uses of Robotics, AI, and Digital Technologies in the financial sector. The aim
of this work is to delve into some legal challenges that the application of robo-advisors
entails and the different regulatory approaches that we can find for the improvement of
the current legal framework of automated investment advice in the financial sector. Le-
gal implications as well as the shortcomings of these concepts and relations are dis-
cussed.
6
2. An Approach to a Basic Concept of Robo-Advisors through Its Current
Features and Legal Implications
Robo-advisor is a relatively new player in the financial markets. Although there is no
single definition of the term, most authors will agree that a robo-advisor can be roughly
defined as an algorithm, software, or computer program that will help investors some-
how (ENFINTECH 2017,
6
STATISTA 2016,
7
or VASILEVA 2017
8
).
Regarding how robo-advisors perform their task, there is a wide range of opinions. Alt-
hough some authors just talk about automatized processes, others go far beyond this and
talk about AI. This fascinating debate is not new and has various ramifications that will
probably become as controversial for finance as the debate regarding the rationality and
behavior of the investors (G
ARVÍA
/S
ANZ
2017). How smart could machines be, as well
as the comparison between human and AI is one of the main characteristics that will
help us to classify the various categories of robo-advisors.
For our purposes, one of the main features of a robo-advisor is being an algorithm that
has previously required of a programmer to be created. In our interconnected and glob-
alized world, the role of the programmer is probably the harder concept to define and
specify. This figure may range from a person or team that has just downloaded and pa-
rameterized an open-source code, to an entire group of engineers that have developed
software over months or years. In addition, we cannot rule out the possibility of having
a robot being programmed by another robot.
The algorithm will also belong to somebody, who will be the owner of the robo-advisor.
For its owner, the robo-advisor is an intangible asset whose book value derives from the
research’s investment costs. The owner and the programmer could be the same person
or not. In case there are different people, there should be a contract between them which
will define the relationship.
9
7
Once this point is reached, the question to be raised is “Could all investment services
based on algorithms be considered robo-advisors?” The answer is no, but the limit is not
clearly defined. As a reference, the Financial Industry Regulatory Authority (FINRA,
2016) considers client-facing tools used by financial professionals as robo-advisors
when they incorporate at least the following activities: customer profiling, asset alloca-
tion, portfolio selection, trade execution, portfolio rebalancing, and tax-loss
harvesting.
10
The second relevant feature of a robo-advisor is the service provided to the investor.
This service is provided by the user of the robo-advisor. Most of the times, this service
is an internet-based service.
11
Regarding the type of service given by the robo-advisor, it
is important to distinguish between a robo-advisor that just performs advising services,
and a robo-advisor that gives a more complete investment service, including for exam-
ple, the purchase and sale of financial assets.
If the robo-advisor just performs automated advising services, the user could directly be
the investor, while typically, in the second situation, the user will be an Investment
Firm, a banking institution, or an equivalent agent. One more time, the user and the
owner of the robo-advisor could be the same person or not. Also, it is important to con-
sider that in the case where the user is an Investment Firm or an equivalent figure, all
cautions and warnings that should be considered between an investor and the Invest-
ment Firm are a starting point to define also those between investors and robo-advisors.
The benefits of Robo-Advisory considering the relationship between the user and the
investor are several: They can provide better premium and personalized services: main-
ly, personalized customer service is done to high-capital portfolios to provide an inte-
gral service to the client.
12
The principle governing robo-advisors is that the customer
could be anyone who is interested in investing with a minimum of capital, usually af-
8
fordable for anyone, so it is not intended for a unique customer profile.
13
Regarding the
source of income for robo-advisors, it is mainly charged for advice and creation of the
client's portfolio as a commission. In this aspect, there is no global consensus. Each ro-
bo-advisor applies the rates it deems more appropriate by offering exemptions for capi-
tal, first month of testing, maintenance free, without commissions up to €10,000, etc.
14
In this respect, the implementation at European level of MIFID II
15
will make it possible
for clients to know the commissions that are passed on to them, making the investment
through robo-advisor more attractive for their low commissions.
16
Considering all previous features, we can define a robo-advisor as an algorithm that can
provide investment services to an investor. As said above, a robo-advisor will involve
taking on the following roles that could be played by the same or different actors: the
programmer, the owner, the user, and the investor.
3. Toward a Taxonomy of Robo-Advisors Regarding Its Role in the Financial
Market
Once the concept of the robo-advisor is clear, and its main characteristics are defined,
we will continue with a deeper analysis comparing different classifications done by dif-
ferent authors with the principal roles just described and the current situation.
If we consider the relation between the user and the investor, and accordingly with In-
vestment Firms legal requirements, the service must consider investors’ profile. There-
fore, the automated advice given by the robo-advisor must be different depending on the
final client profile.
This notion leads to a first taxonomy of robo-advisors depending on the level of evolu-
tion in terms of features and services between the user and the investor. Each new type
9
or step adds characteristics and services to the previous one, robo-advisor 1.0 being the
most basic one and robo-advisor 4.0 the most complete and sophisticated (Deloitte,
2016).
Robo-Advisor 1.0: There is no difference between the user and the investor. It
offers the most suitable single product or portfolio allocation to the client chosen
from a list after answering a test. The portfolio has to be managed by the inves-
tor himself as there is no bank or investment firm behind, also using their own
accounts and managing future adjustments.
Robo-Advisor 2.0: The robo-advisor is used to know investor's profile through a
test that is used to define the risk of the client and match it with the assigned
predefined portfolio for such risk. The investment firm is operated by profes-
sional human managers, and they are the ones that design predefined portfolios.
Robo-Advisor 3.0: The user is also managed by the robo-advisor, but under the
supervision of human managers. The adjustments and rebalancing are automati-
cally done by algorithms according to preestablished investment strategies. Pro-
fessional fund managers oversee the final control, in some occasions allowing
the client to slightly modify their portfolios to individualize them.
17
Robo-Advisor 4.0: The user is full-time operated by the robo-advisor, which
could offer a sophisticated risk profiling of the client that leads to direct invest-
ments via self-learning AI investment algorithms. Robo-advisors could shift be-
tween different asset classes based on changing market conditions and individu-
al investment needs such as profit, risk appetite, and liquidity aspects, monitor
and adjust single-client portfolios in real time to keep on track with their select-
ed investment strategy.
10
In addition to the different types of robo-advisors depending on the relation between the
user and the investor, we can find other classification depending on the rest of roles. For
example, attending to the degree of independence between the owner and the user, we
can separate them into three groups (Independent robo-advisor, Segregated robo-
advisor, and Integrated robo-advisor) and a fourth in which robo-advisor will be used
only as a tool for other users:
Stand-alone robo-advisor: The robo-advisor plays the role of an independent ad-
visor. A deposit is made at a bank or investment firm chosen by the client or by
the advisor, who will be the custodian of the client's assets. This robo-advisor
will oversee the elaboration of customer profiles, the construction of the portfo-
lios, and the monitoring of the investments. This is the only type of robo-advisor
that can provide independent automated investment advice according to MIFID
II.
Segregated robo-advisor (in a banking group but not integrated): It differs from
the previous one in the level of independence. Here, we can distinguish two sce-
narios, with or without incentives on the part of the asset distributors, but in ei-
ther case it is not integrated in the bank structure.
Integrated robo-advisor (as a part of a wider range of services): It is not an inde-
pendent advisor unless the bank takes this option and is fully integrated into the
bank's business model.
Robo for advice (digital advice for human advisors): It is only used as a tool.
The robo-advisor chooses between different portfolios that finally can be accept-
ed or not by the user. This type of robo-advisor does not have to be connected to
the services of a bank or Investments Services Companies (ISCs) being the
owner of the robo-advisor the one who charges the fees.
11
With the implementation of MIFID II at European level, advice and asset management
must be separated. In this sense, Independent robo-advisor has a great opportunity for
expansion.
18
This leads to a huge increase in the competition in the investment services
market. The coming years are going to be important in the robo-advisory field when
these emerging competitors enter the game and gain market share.
4. Some Reasons beyond the Emergence of Robo-Advisors and Horizons for a
Robo-Advisory's Legal Framework
Robo-advisors are a response to a more complex and wide-ranging set of services and
instruments offered in the financial markets. On the one hand, because of the new com-
plexity, new legal requirements have emerged in the financial sector (i.e., MIFID II),
and its very technical requirements can be easily accomplished by nonhuman advisors.
On the other hand, robo-advisors represent an absolute competitive advantage for their
users and financial institutions, considering big data analysis regarding their clients and
products information.
For both reasons, we can state that Robo-advisory is a response to the complexity that is
already allowing two functions for its users: Firstly, because it allows them to comply
with legal rules (legal compliance) and to manage a greater number of clients in an in-
creasingly complex environment. Other market players, without robotic support and its
applications in algorithmic trading, will not be able to comply with the new legal rules
at this level since the current and future financial regulation is based on knowing one’s
own customer and also the products advised or managed (information duties, transpar-
ency, suitability and convenience test, customer profiling, etc). Secondly, the other ad-
vantage of robo-advisors is to take advantage of economies of scale since they can man-
12
age data from thousands of customers and thousands of products, assets, and portfolios,
and additionally because thanks to the algorithmic trading they can turn the investment
services into a low-cost model with a more accurate level of legal compliance.
Even though automated investment services solve many current problems and improve
market efficiency, they introduce new risks and legal challenges that are not being ade-
quately addressed. Consequently, it is necessary to think about an optimal legal frame-
work for robo-advisors based on two aspects: The adoption of legal entities for them
(according to their real operations) and an effective control of data and risk manage-
ment, since otherwise we could attend a scenario of new systemic risks through the al-
gorithmic trading performed by these digital technologies.
One of the main competitive advantages of robo-advisors is their ability to manage mas-
sive amounts of data. Investment firms must therefore understand the features of their
financial instruments and establish and review effective policies and arrangements to
identify the category of clients to whom products and services are to be provided. Robo-
advisors are a perfect tool to comply with this requirement. Not only do robo-advisors
allow their users to know in a more exhaustive way their clients and financial assets but
also they enable their users to manage a huge amount of complex and dynamic data
which is very difficult and costly to handle for traditional investment firms. This is one
of the major reasons of the quick expansion of robo-advisors, although they are also
triggering the emergence of new systematic and operational risks.
19
Unlike traditional advisors (human beings), robo-advisors can go beyond the basic pro-
tection of clients' personal information and have a solid control and monitor of their
platforms to protect the algorithms from possible cyberattacks. European regulators
shall require providing a stronger data privacy policy where the question about how
13
personal data of clients are managed by robo-advisors should be answered in a proper
and direct way.
In view of the technological developments, recent financial markets regulation is trying
to provide for a degree of harmonization to offer investors a higher level of protection.
This is one of the main objectives of the legislative reform movement of the financial
markets as a result of the international economic crisis of 2008 and that 10 years later
has been lead to the implementation of MIFID II and Basel III.
20
In this sense, financial
institutions, banks, and investment firms must understand the features of the financial
instruments offered or recommended by them and their networks and establish and re-
view effective policies and arrangements to identify the category of clients to whom
products and services are to be provided.
21
As a result of these new regulations, traditional financial services can be performed eas-
ier by robo-advisors. So, in our view, far from requiring new and specific regulation,
robo-advisors could help in fostering compliance with newly developed financial regu-
lation. For this reason, we advocate not to expand the amount of financial regulation but
to clarify the current legal rules to allow a proper framework based on legal certainty for
the introduction and effectiveness of robo-advisors. As previously argued, robo-advisors
are giving to their users a competitive advantage that will lead them to manage a bigger
number of clients, benefiting from economies of scale with a relatively low-cost busi-
ness model. Things are not as simple, however. A complete regulatory framework for
the Fintech industry is still pending, as these technological innovations are growing fast,
and regulators cannot keep up their rhythm and changes [
Garvía and Sanz
2017]. The
case of robo-advisors is not different. In fact, the European Securities and Market Au-
thorities (ESMA) recognized this lack of regulation and the need to establish a tailored
regulation for Robo-Advisory [ESMA 2015].
14
Although the need for clear and effective regulation is beyond question, the scope and
depth of regulation of robo-advisors is unclear and should be discussed. For example,
VANGUARD (2016) mentions in their article the following issues: Governance and
supervision of digital advice tools and methodologies; Investors' profiles and assessing
investor risk tolerance; Suitability; Customer understanding of digital advice tool meth-
odologies and key assumptions; Cybersecurity risks; and Systemic risks.
22
Considering
these matters, we can develop a position to contribute to the legal regulation of Robo-
Advisory by identifying potential conflict areas that should be considered. We need an
innovative legal framework to accommodate Robo-Advisory as one of the main expo-
nents of the Fintech industry, together with digital currencies, blockchain, smart con-
tracts are other innovations [
EY
2016]. That is why it is more necessary than ever to
configure a world Regtech Agenda to meet the challenges of Fintech [
Deloitte
2016].
The next section is going to focus on the discussion about the most suitable forms of
legal entity for robo-advisors and the main legal requirements that robo-advisors need to
comply with.
5. Some Ideas about the Legal Forms for Robo-Advisors and Main Regulatory
Questions
Although at present there is not an explicit regulation for robotics under the European
Union Law, robo-advisors could be easily regulated under a different type of entities
called “Investments Services Companies” (ISC), depending on the financial services
they can provide to the users and clients. For this reason, as we stated before, we must
distinguish the task of providing advice, from the task of being able to invest in the
name of clients or manage portfolios in an automatically way (algorithmic trading
23
).
Accordingly, the requirements will be different depending on how robo-advisors are
15
constituted and its role and features. That will be crucial to understand and develop an
optimal and efficient liability regime.
The first aspect to consider is to distinguish between the legal entities that are only able
to advise clients and those which can go further in the offer of financial services (man-
age portfolios and invest on behalf of their clients). Financial advisors and advising
firms can provide advice to clients and investors only. It seems pointless, however, to
regulate robo-advisors using only one of these legal forms because these entities are not
legally entitled to invest money on behalf of third parties, which is the crucial task that
they can offer now thanks to advanced AI technologies. Advising and managing portfo-
lios while investing on behalf of third parties should conform to ISC requirements. In
this sense, the most suitable legal form would be the regulation of robo-advisors as a
specific type of ISC.
24
Regarding MIFID II (which came into force in January 2018), the key issues in this
kind of services are those related to compliance with Suitability and Appropriateness
Rules, as well as Privacy Rules [
PWC
2016]. The implementation of a suitable legal
form for the robo-advisors would, however, make their compliance with these require-
ments faster and easier. So, for instance, European robo-advisors must comply with
MIFID II regarding transparency rules in the prices of the services provided, investors’
interest protection and clarity in the portfolio creation process.
As any ISC, robo-advisors should comply with the main regulatory requirements for
financial advice and asset management. It requires transparency prenegotiation and
postnegotiation regarding the volume, price, and existence of secondary markets, and
some standards of conduct in terms of the type of client being advised—with higher
protection for those that do not have financial knowledge—the obligation to make a
suitability and convenience test, the obligation to inform the client at all times in an un-
16
derstandable way about the services and product provided, and the obligation of best
execution to provide the client with the best result possible.
In fact, the use of trading technology has evolved significantly in the past decade and is
now extensively used by many market players. Many of them make use of algorithmic
trading, where a computer algorithm automatically determines aspects of an order with
minimal or no human intervention. So, because of these risks arising from algorithmic
trading, robo-advisors should be regulated better and faster. For this reason, as MIFID II
recognizes, investment firms that engage in algorithmic trading pursuing a market mak-
ing strategy should have an appropriate system and internal controls in place.
25
More control and supervision of Robo-Advisory sector would be desirable to strengthen
the resilience of markets in the light of technological developments. In particular, one
field to explore is to set specific measures and technical guidelines, issued by ESMA,
on systems and controls in an automated trading environment for trading platforms,
ISCs, and competent authorities. In this sense, an European Authority (Agency) in the
field of Financial RoboLaw would be a very desirable project in order to centralize and
specialize the supervision of robo-advisors at the European level. It seems crucial and
very necessary to ensure that all firms using algorithmic trading (whether they are fi-
nancial institutions or investment firms, as users and owners of robo-advisors) are au-
thorized, and report about operations, clients, and products of their robo-advisors or
similar AI software for automated investment advice or asset management. Such author-
ization should ensure those firms are subject to organizational requirements under MI-
FID II and that they are properly registered and supervised.
In that respect, we endorse the MIFID II statement that ESMA should play an important
coordinating role by defining appropriate tick sizes to ensure orderly markets at Europe-
17
an Union level and ensure that market integrity is maintained in the light of technologi-
cal developments in financial markets.
6. Final Remarks on Legal Policy
After analyzing several aspects about the legal framework for robo-advisors, we
consider that the existing market conditions are an outstanding opportunity for
the introduction of robo-advisors in the financial sector. These opportunities and
future developments, however, require new and clear legal rules, better than the
existing ones. For this reason, lawmakers are called to enact laws on robotics
(robolaw) with more precision and technique, in order to solve current and po-
tential legal conflicts, as for example, we can observe in terms of interpretation
and implementation of MIFID II.
Regarding Robo-Advisory, we propose a change in its conceptual understanding,
to consider robo-advisors as a true “robo-managers” or “robo-brokers”, since the
regular operations of these computer programs or smart software—using ad-
vanced AI (deep learning)—can provide real decision-taking process of portfoli-
os and financial asset management on behalf of human beings. Until recently,
the human ability to control technology was unquestioned, now the trend
suggests a declining power differential and the possibility of an inverse power
relationship soon. AI is poised to exert increasing influence over human
opportunities and activities, such that human beings are increasingly under "the
loop". In this way, Liu and Zawieska (2017) have explored the impact that the
inversion of power between human beings and their technologies has on the
protection of human rights.
18
Automated investment advice will necessarily involve a mix of various roles that
can be played by the same or different actors: the programmer, the owner, the
user, and the investor or client. Considering the relation between each player, we
can obtain information that will be valuable when analyzing the legal framework
as well as the contractual relationship between the parties [
Finra
2017]. If we
consider the relation between the user and the investor, we can classify robo-
advisors depending on the step of evolution in terms of features and services.
Robo-advisors may range from what is called Robo-Advisor 1.0 (that only offers
advising services) to Robo-Advisor 4.0 that offers a full-integrated investment
service, including customer profiling, asset allocation, portfolio selection, trade
execution, portfolio rebalancing, and tax-loss harvesting [
Deloitte
2016]. In this
sense, it is also relevant to consider the relationship between the robo-advisor
and the information that they process. Here, it is necessary to distinguish be-
tween the information related to the client profile and information related to the
investment products. These are distinct levels of development which may not
necessarily coincide. Whereas some robo-advisors may work in the field of
product management, others could just have all their computer strength focused
on their client's risk profiles.
Considering this emerging digital technology, it should be necessary to clarify
the current legal framework applicable to “robo-advisors” (“robo-managers” or
“robo-brokers” in a true and practical sense) because we can distinguish many
types of them, and they present multiple features based on their functionality and
the provision of financial services to clients. With the implementation of MIFID
II, advising and asset management must be separated. For this reason, we sug-
gest that independent robo-advisors (and also “robo-managers”, i.e., AI comput-
19
erized management) have now a significant opportunity for market expansion,
so that regulators should focus on them as a matter of priority. Currently, we
face a lack of specific legal framework for the Robo-advisory sector. For this
reason, regulators are called to satisfy this demand of legal certainty for financial
market players, as it was acknowledged by ESMA.
Meanwhile, waiting for a specific regulation, robo-advisors are under the legal
system of each country, according to the rules governing their existing legal en-
tities and supervisory institutions. This is the case of liability issues for robo-
advisors. Obviously, for the time being, in case of faulty advice (or reckless as-
set management) made by robo-advisors against its clients (damages), it consti-
tutes a breach of legal or contractual duties, so it leads to a range of possible lia-
bilities. The liability should be transferred to real users of the software or its
owners (financial institutions and investment firms). If it is shown that the reck-
less operations made by the robo-advisors are due to the programming (software
design), the liability should be transferred to its programmer. In any case, the
management body of the firms involved should be responsible and accountable
for the overall strategy and supervision of their robo-advisors, taking into ac-
count the firm’s business and risk profile. Appropriate and detailed liability rules
regarding Robo-advisory need to be written into regulatory technical standards
at an international level. This should ensure that the legal framework for robo-
advisors is clear and certain.
Finally, the task of creating an innovative and specific legal framework for robo-
advisors ought to be accomplished carefully since, as we stated above, there are
many mixed features in robo-advisors that could generate new challenges for the
existing legal rules, principles, institutions, and entities, in case they only advise,
20
or manage portfolios, or also make investments on behalf of their clients. For all
these reasons, after analyzing the alternatives and prospective for European ro-
bo-advisors, we think that the option that best fits our criteria and that it is also
safer and more feasible is to work under the legal form of ISC, since nowadays
it seems pointless to operate automated investment advice systems with legal
forms that are not legally entitled to invest money on behalf of third parties.
Works Cited
Arner, D. W., Barberis, J. N. and Buckley, R. P. “FinTech, RegTech and the Reconcep-
tualization of Financial Regulation.” University of Hong Kong Faculty of Law Research
Paper No. 2016/035, 51. Available at:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2847806
Becker, M. “The Pros and Cons of Investing with Robo Advisors.” 2017. Available at:
http://www.thesimpledollar.com/the-pros-and-cons-of-robo-advisors
BI Intelligence. “The US still has the robo-advisor lead.” 2017. Available at:
http://www.businessinsider.com/the-us-still-has-the-robo-advisor-lead-2017-4
BlackRock. “Digital Investment Advice: Robo Advisors Come of Age.” EU:
BlackRock Investment Management (UK), Bloomberg, 2016.
Broughton, K. “How Banks Are Co-Opting the Robo-Advisory Revolution.” 2016.
Available at: https://www.americanbanker.com/news/how-banks-are-co-opting-the-
roboadvisory-revolution
Colaert, V. “RegTech as a response to regulatory expansion in the financial market.”
KU Leuven; Faculty of Law, Research Unit of Economic Law, 2017. Available at:
https://www.academia.edu/31897087/RegTech_as_a_response_to_regulatory_expansio
n_in_the_financial_sector
21
Deloitte. “RegTech is the new FinTech. How agile regulatory technology is helping
firms better understand and manage their risks.” 2016. Available at:
https://www2.deloitte.com/content/dam/Deloitte/ie/Documents/FinancialServices/IE_20
16_FS_RegTech_is_the_new_FinTech.pdf
ESMA. “Report on automation in financial advice.” 2015. Available at: https://esas-
jointcommittee.europa.eu/Publications/Reports/EBA%20BS%202016%20422%20(JC%
20SC%20CPFI%20Final%20Report%20on%20automated%20advice%20tools).pdf
EY. Innovating with RegTech Turning regulatory compliance into a competitive ad-
vantage, EY Publications.” 2016. Available at:
http://www.ey.com/Publication/vwLUAssets/EY-Innovating-with-RegTech/$FILE/EY-
Innovating-with-RegTech.pdf
Financial Industry Regulatory Authority (FINRA). “Report on Digital Investment Ad-
vice”. Washington, DC, 2016.
Garcia, L. and Sanz, P. “Legal challenges of Finance in the Fourth Industrial Revolu-
tion: Regtech vs Fintech?” Working Paper, 2018 (forthcoming)
Haddad, C. and Hornuf, L. “The Emergence of the Global Fintech Market: Economic
and Technological Determinants.” CESifo Working Paper Series No. 6131, 37. 2016.
Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2830124
Hazard, J. and Haapio, H. “Wise Contracts: Smart Contracts That Work for People and
Machines.” Jusletter IT, 2017.
Liu, H. and Zawieska, K. “A New Human Rights Regime to Address Robotics and Arti-
ficial Intelligence.” Jusletter IT, 2017
Institute of International Finance. 2016. Available at:
https://www.iif.com/system/files/regtech_in_financial_services_-
_solutions_for_compliance_and_reporting.pdf, last accessed September 2017
22
Kakavand, H., Kost de Sevres, N. and Chilton, B. “The Blockchain Revolution: An
Analysis of Regulation and Technology Related to Distributed Ledger Technologies.”
2016. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2849251, last
accessed June 2017.
Meola, A. “These are the top financial services providers and Fintech startups, Business
Insider.” 2016. Available at: http://www.businessinsider.com/top-financial-services-
providers-and-fintech-startups-2016-12, last accessed September 2017.
Meola, A. ”Robo Investing Reviews; Performance & Fees Comparison.” 2017. Availa-
ble at: http://www.businessinsider.com/bis-robo-investing-reviews-performance-and-
feescomparison-2017-1
Mercadante, K. “Robo Advisors: 5 Advantages to Automates Investing.” 2016. Availa-
ble at: https://cashmoneylife.com/investing-with-robo-advisors
MyPrivateBanking. “Robo Advisors vs. Human Financial Advisors: Why Not Both?”
2016. Available at: http://www.businessinsider.com/hybrid-robo-advisors-will-manage-
10-of-allinvestable-assets-by-2025-2016-8
PriceWaterhouseCoopers (PWC). “Robo Advisory moves forward in Italy”, , 2016.
Schwab, K. The Fourth Industrial Revolution, Crown Business, New York, 2017.
STATISTA. “Robo-Advisors.” 2016. Available at:
https://www.statista.com/outlook/337/100/robo-advisors/worldwide#
The Economist. “The next big thing.” 2015. Available at:
https://www.economist.com/news/special-report/21650295-or-it-next-big-thing, last
accessed October 2017.
The Economist. “The Fintech revolution. A wave of startups is changing finance for the
better.” 2015. Available at: https://www.economist.com/news/leaders/21650546-wave-
startups-changing-financefor-better-fintech-revolution, last accessed September 2017.
23
UK Government Chief Scientific Adviser. “Distributed Ledger Technology: beyond
blockchain.” Report, UK Government Office for Science, 2016. Available at
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/492972/g
s-16-1-distributed-ledger-technology.pdf
VANGUARD. “Overview of the U.S. Robo-Advice Landscape.” 2016. Available at:
https://advisors.vanguard.com/VGApp/iip/site/advisor/home
Notes
1. Burnmark through BI Intelligence (2017)
2. A.T. Kearney estimates that robo-advisors will manage 2.2 billion dollars in the United
States by 2020 (EnFintech, 2017). Although nowadays robo-advisors represent a small
portion of the US market, they are expected to growth till they reach a 15% of all US re-
tail asset under management with 7 trillion USD. This will happen mainly due to the
adoption of robo-advisors by banks, including Bank of America and Wells Fargo. This
movement will not happen just in the United States, but also among banks such as UBS
and BBVA, and large investment firms. Even with the impressive growth of the robo-
advisors in the United States, they are relatively tiny (Broughton, 2016). Vanguard
leads the market with 41 billion USD followed not so close by Schwab Intelligence
Portfolios, Betterment, Wealthfront, and Personal Capital.
3. BI Intelligence (2017)
4. The United States is leading the Robo-Advisory field with more than 200 robo-
advisors, followed quite a distance from Germany with 31 robo-advisors, being the sec-
ond largest country by number of robo-advisors. The third place is occupied by China
and United Kingdom with 20, followed by India with 19 and France with 17. Vanguard,
with 30.000 million dollars in assets and investment funds, leads the North American
market. In the Spanish market, they first appeared 3 years ago when FeelCapital was
24
created, with 4 robo-advisors in this market nowadays. Nevertheless, besides the pre-
dicted increase in the number of robo-advisors, there is also expected an increasing
trend toward vertical integration, finding a clear example in India where a payment
company has entered the robo advice space (Techfluence, 2017).
5. There are 73 robo-advisors in Europe, 26 of them in Germany, 19 in the United
Kingdom followed by 6 in Switzerland (Techfluence, 2017). There is a trend toward
B2C, although most of newly entered in German-speaking areas are retail-oriented ro-
bo-advisors. “The map shows B2C and B2B oriented firms, who either manage assets
for clients (B2C) or support this business model (B2B)”. There is expected an important
increase in the number of robo-advisors in Europe, reaching around 500 in the next five
years. These entries will be in all financial services areas, but mostly on “banks, asset
managers, wealth managers, insurance providers as well as from the non-financial sec-
tor. Partially this will also be part of a beginning vertical integration in FinTech.”
(Techfluence, 2017).
6. According to EnFintech (2017): “Robo-advisors are computer programs that automate
investments by applying modern portfolio management theories, which play with varia-
bles related to volatility and expected returns, among many other variables. Robo-
advisors profile the client based on questionnaires about their knowledge, experience
and investment objectives, then offer a portfolio of assets adapted to the saver. The hu-
man factor is no longer relevant when making investment decisions in the short term,
but always a human adviser is a vital aid to the investor, both to receive global financial
advice (taxes, assets, insurance, inheritance, etc.), As well as to receive a long-term vi-
sion that will help the investor to take short decisions, such as using one type of theft
advisor or another”.
7. Definition of robo-advisors according to Statista (2016): “The Robo-Advisors segment
contains private asset management providers who offer automated online portfolios in
which private investors can choose investment volumes depending on their scope and
private appetite for risk. Providers such as Wealthfront, Schwab Intelligent Portfolios
25
and Betterment allow private and/or institutional investors to invest their money (start-
ing at very small amounts) in pre-existing portfolios which are automatically managed
by individually configured algorithms. The advantage of these services lies in the pas-
sive role of the investor, who may not want or cannot afford, ongoing, personal moni-
toring of their portfolio development. Such automated investment services also allow
for the possibility of reaching attractive returns with low starting capital and without
specific investment know-how, which contrasts with classic investments offered by tra-
ditional banks. In the robo-advisors segment, financial figures show the assets under
management of automated online portfolios. Online brokers without automated and rec-
ommendation-based advisory functions are not included in this segment”.
8. Vasileva (2017) defines robo-advisor as: “Robots that offer the client financial advice.
These are developed from artificial intelligence and integrate very complex algorithms
through which they get the ability to recommend investment decisions that fit the condi-
tions of the client.”
9. Modern economies are held together by innumerable contracts. Current contracts,
however, are neither machine-readable nor easily human-readable. Hazard and Haapio
(2007) work on design criteria for smart contracts that could help understanding
contractual relationship between the owner and the user.
10. FINRA, 2016.
11. “Web platforms of the different robots are like each other, it emphasizes its simplicity
and the willingness to explain to the client the key aspects of its working method. It can
be summarized in 3 blocks, the first one the main page, is used to introduce the custom-
er to the services of the company, explaining to the customer who they are, how it
works and introducing the customer to the test; the second would be the profiling part of
the client, at this point all are similar, dedicating on average 6 questions of investor pro-
file and 4 questions of risk profile. Finally, we can group in the last block the intended
part of the website in which the client is explained in more detail the various aspects of
the company's work and its policy, as well as historical returns of the portfolios, FAQ,
26
blog with articles of interest, contact, legal information. And some of them offer a chat
service, in which the customer can quickly resolve any questions that may arise”
(FINRA, 2016).
12. Premium services give access in some robo-advisor such as Feel capital or Betterment,
offer additional services such as comprehensive risk control, tracking of the portfolio,
historical returns of your investment, reduction in rates. For example, betterment pro-
vides a free human advisor for accounts over $500,000, Wealthsimple provides a free
human advisor for accounts over $100,000, Charles Schwab Intelligent Portfolio ena-
bles tax loss harvesting for accounts over $50,000.
13. Following the introduction of MIFID II, in Europe, low-capitalization portfolios will not
be able to cover the cost of advice, since it must be obtained separately, with the robo-
advisor they could have an investment opportunity with affordable advice. In addition, a
great growth is predicted by the introduction of this regulation to have to be separated
the advice of the distribution of financial assets.
14. At European level, commissions are higher, around 0.25% and 2% commissions, but we
must also note that there are robo-advisors that charge 10% and 20% of total profits. In
the other hand, in the United States, commissions are lower and in addition they only
charge for capital management. Advice, rebalancing, maintenance, and other associated
expenses are free in all robo-advisors. These management fees range from 0.25% to 1%.
In addition, there is the possibility in robo-advisor in Europe and the United States that
only a single monthly payment is paid, in Europe, Feel Capital establishes to its clients
the monthly fee of €15, in the United States, we find Blooom with a fee of $10 a month
for any type of account and MarketRiders with $14.95 per month managing your in-
vestments autonomously.
15. Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014
on markets in financial instruments and amending Directive 2002/92/EC and Directive
2011/61/EU.
27
16. BI Intelligence (2017) warns about the fact that some of this robo-advisors have addi-
tional fees. “AssetBuilder, FutureAdvisor, and Rebalance IRA all charge trade fees. As-
setBuilder's range from $20 to $50 per trade, FutureAdvisor's from $8 to $24, and Re-
balance IRA's from $50 to $70 for each portfolio rebalance. The company also charges
a $250 account opening fee. Both TradeKing Advisors have fees for add-on services
and a $50 IRA account closing fee, while WiseBanyan has add-on service fees.” (Meo-
la, 2017).
17. The statistics shows that 80% of robo-advisors have the 3.0 features and characterized
toward increasing the service offering, the automation—including the automation of
portfolio’s rebalancing—and the technology used (Deloitte, 2016).
18. According to the forecast, in less than a decade, digital-advisory services will be 50
times larger when compared with the small part of the wealth management market they
were in 2015. In 2015, there were 32 trillion USD assets under management, of which
less than 100 billion USD belonged to robo-advice. See Broughton, K., 2016. How
Banks Are Co-Opting the Robo-Advisory Revolution. [Online]
https://www.americanbanker.com/news/how-banks-are-co-opting-the-roboadvisory-
revolution.
19. Legal requirements concerning robo-advisors and their databases depend on the type of
information they are managing. If the information is related with their clients or
investors, personal data protection and investor protection requirements shall be
observed. If the information is related with the financial instruments under their control,
then transparency, risk, and valuation aspects should be considered.
20. https://www.bis.org/bcbs/basel3.htm.
21. See Introductory Paragraphs 70 and 71 of MIFID II.
22. We should add the key point of the liability in case of faulty advice, technical failures in
the robo-advisor´s operating. There are some theoretical and hypothetical models of
liability that might be applied to robots (analogies to minors or animals), but it would be
28
advisable to develop a specific liability rules for them and for any kind of similar IA
machines or smart financial software, in order to regulate them.
23. We take the meaning of algorithmic trading from Article 4 (Definition Number 39) of
MIFID II: “trading in financial instruments where a computer algorithm automatically
determines individual parameters of orders such as whether to initiate the order, the tim-
ing, price or quantity of the order or how to manage the order after its submission, with
limited or no human intervention, and does not include any system that is only used for
the purpose of routing orders to one or more trading venues or for the processing of or-
ders involving no determination of any trading parameters or for the confirmation of or-
ders or the post-trade processing of executed transactions”.
24. Moreover, all the existing legal entities shall accomplish MIFID 2 and MIFIR6
regulation, which in some cases are entirely applicable and in others just partially. In
any case, robo-advisors should report back to the Supervisors and Regulators about
their operations, instruments, and clients (disclosure and transparency rules).
25. See Article 17 MIFID 2.
... This debate includes a discussion of whether companies that provide algorithmic investment recommendations can meet the requirements for existing investment advice and what modifications are needed. Bayón and Vega (2018) explain that a complete regulatory framework for the fintech industry is still pending and thus the scope and depth of robo-manager regulation have not yet been finalized and should, therefore, be discussed. Baker and Dellaert (2018) similarly consider this issue and identify questions that regulators must answer in the context of fully comprehensive regulation. ...
Article
Full-text available
Robo-managers offer automated asset management; however, their overall performance is highly debated. We analyze 15 robo-managers from Germany, the United States (US), and the United Kingdom (UK) by conducting a comprehensive qualitative and quantitative study. The qualitative comparison shows considerable differences between the various robo-managers, not only across but also within countries. The quantitative evaluation utilizes different measures to evaluate the performance of the robo-manager sample. Our results indicate that each country has one particularly favorable robo-manager. Furthermore, we find that the costs and characteristics of rebalancing measures have only a small effect on performance. This article is protected by copyright. All rights reserved.
Chapter
This chapter shows that networks widely distribute both big data and fintech applications, allowing fintech firms to execute their activities all around the world. Furthermore, the unbundling of the intermediation process into chains of transactions is leading banking and financial activities outside the scope of supervision. Thus, this chapter investigates the reason fintech applications do not appear to be regulatory-neutral. It also investigates the ‘acts of fintech’ and the responsibility of individuals in developing network of operations and concludes by assessing the current need for transparency, with regard to both the circulation of financial information in the market and the mitigation of the bargaining power in bilateral transactions.
Chapter
Full-text available
Resumen Los denominados robo-advisors están recientemente en el punto de mira de los organismos reguladores y supervisores de los mercados financieros. Numerosas instituciones financieras y empresas de servicios de inversión han ido incorporando sistemas autónomos de asesoramiento que minimizan costes operativos. Sus principales ventajas se materializan básicamente en una mayor eficiencia en la prestación de dichos servicios. No obstante, algunos organismos supervisores comienzan a advertir posibles problemas jurídicos que pueden surgir con el empleo de este software avanzado y han alertado de los posibles errores que pueden contener sus programaciones o la insuficiente información sobre la que pueden ejecutar determinadas decisiones o prestar servicios financieros. El presente trabajo tiene por objeto examinar el fenómeno de los robo-advisors a fin de contribuir a una eficaz política legislativa global sobre ellos. Una política legislativa que garantice la efectividad de sus ventajas operativas al mismo tiempo que permita disminuir los potenciales riesgos que esta aplicación informática puede traer consigo. En particular, este trabajo pretende examinar si los robo-advisors prestan un asesoramiento financiero y personalizado cumpliendo con los deberes fiduciarios legalmente exigibles a todo gestor de intereses ajenos, o si por el contrario han de considerarse únicamente como una herramienta instrumental al servicio del asesor financiero humano, en cuyo ámbito de responsabilidad se ha de incluir el deber de vigilar el correcto funcionamiento de este tipo de software. Palabras clave: robo-advisor, Fintech, empresas de servicios de inversión, mercados financieros Abstract The so-called robo-advisors are recently in the spotlight of the regulatory and supervisory bodies of the financial markets. Numerous financial institutions and investment services companies have incorporated autonomous advisory systems that minimize operating costs. Its main advantages materialize basically in greater efficiency in the provision of such services. However, some supervisory bodies begin to warn of possible legal problems that may arise with the use of this advanced software and have warned of possible errors that may contain their schedules or insufficient information on which they can execute certain decisions or provide financial services. The purpose of this paper is to examine the phenomenon of robo-advisors in order to contribute to an effective global legislative policy on them. A legislative policy that guarantees the effectiveness of its operational advantages while reducing the potential risks that this computer application may entail. In particular, this work intends to examine whether the robo-advisors provide financial and personalized advice in compliance with the fiduciary duties legally enforceable to any manager of foreign interests, or if instead they should be considered only as an instrumental tool at the service of the financial advisor human, whose scope of responsibility must include the duty to monitor the proper functioning of this type of software. Keywords: robo-advisor, Fintech, Financial Law, financial markets, investment service companies
Chapter
Full-text available
Resumen El presente trabajo tiene como objeto contribuir a la reflexión y debate contemporáneo sobre el papel del derecho en el contexto de la Cuarta Revolución Industrial y más concretamente esbozar posibles premisas y principios para la consideración de una nueva política legislativa adaptada a la nueva realidad que trae consigo la digitalización y automatización de funciones y procesos económicos y mercantiles. El ecosistema económico global, informático y cibernético está haciendo surgir una nueva sociedad y un nuevo concepto de mercado que requieren replanteamientos institucionales y modos diferentes de abordar sectorialmente las cuestiones y soluciones de carácter jurídico. Palabras clave: revolución digital, Fintech, cadena de bloques, Regtech, Legaltech, Contratación inteligente, criptoeconomía, token Abstract The purpose of this work is to contribute to contemporary reflection and debate on the current role of Law in the context of the Fourth Industrial Revolution and, more specifically, to outline possible guidelines for the consideration of a new legislative policy adapted to the new reality that brings with it the digitization and automation of functions and economic and commercial processes. The global economic, cybernetic and computer ecosystem is bringing about a new society and a new market concept that require institutional rethinking and different ways of dealing with legal issues and solutions. Keywords: Digital Revolution, Fintech, BlockChain, Regtech, Legaltech, Smart Contracts, Crypto-economy, Token
Article
Full-text available
We investigate the economic and technological determinants inducing entrepreneurs to establish ventures with the purpose of reinventing financial technology (fintech). We find that countries witness more fintech startup formations when the economy is well-developed and venture capital is readily available. Furthermore, the number of secure Internet servers, mobile telephone subscriptions, and the available labor force has a positive impact on the development of this new market segment. Finally, the more difficult it is for companies to access loans, the higher is the number of fintech startups in a country. Overall, the evidence suggests that fintech startup formation need not be left to chance, but active policies can influence the emergence of this new sector.
Article
Full-text available
The relationship between human beings and AI appears to be on the cusp of foundational change: until recently the human ability to control technology was unquestioned, but now the trend suggests a declining power differential and the possibility of an inverse power relation-ship soon. AI is poised to exert increasing influence over human opportunities and activities,such that human beings are increasingly under ‘the loop’. This paper explores the impact that the inversion of power between human beings and their technologies has on the protection of fundamental human rights.
Conference Paper
Full-text available
Modern economies are held together by innumerable contracts. However, current contracts are neither machine-readable nor easily human-readable. The Ricardian Contract paradigm of parameters, prose and code posits a hybrid model of automation and conventional legal text. This paper connects recent work on design criteria for 'Smart Contract Templates' with prose objects and prototype inheritance demonstrated at CommonAccord. Templates authored and shared as prose objects can become the basis for automation, codification, commentary, big data analysis and graphic presentations. Full text available at: https://ssrn.com/abstract=2925871
The Pros and Cons of Investing with Robo Advisors
  • M Becker
Becker, M. "The Pros and Cons of Investing with Robo Advisors." 2017. Available at: http://www.thesimpledollar.com/the-pros-and-cons-of-robo-advisors BI Intelligence. "The US still has the robo-advisor lead." 2017. Available at: http://www.businessinsider.com/the-us-still-has-the-robo-advisor-lead-2017-4
Digital Investment Advice: Robo Advisors Come of Age
  • Blackrock
BlackRock. "Digital Investment Advice: Robo Advisors Come of Age." EU: BlackRock Investment Management (UK), Bloomberg, 2016.
How Banks Are Co-Opting the Robo-Advisory Revolution
  • K Broughton
Broughton, K. "How Banks Are Co-Opting the Robo-Advisory Revolution." 2016. Available at: https://www.americanbanker.com/news/how-banks-are-co-opting-theroboadvisory-revolution
RegTech as a response to regulatory expansion in the financial market
  • V Colaert
Colaert, V. "RegTech as a response to regulatory expansion in the financial market." KU Leuven; Faculty of Law, Research Unit of Economic Law, 2017. Available at: https://www.academia.edu/31897087/RegTech_as_a_response_to_regulatory_expansio n_in_the_financial_sector 21
These are the top financial services providers and Fintech startups, Business Insider
  • A Meola
Meola, A. "These are the top financial services providers and Fintech startups, Business Insider." 2016. Available at: http://www.businessinsider.com/top-financial-servicesproviders-and-fintech-startups-2016-12, last accessed September 2017.