MAS issues guidelines for providers of digital advisory services

Chris Hamblin

10 October 2018

The digital advisory process typically begins with the client typing in an amount that he wants to invest and answering a series of questions about his risk tolerance, investment objectives and investment time-horizon. The digital advisor then analyses his responses using algorithms and generates a recommended portfolio. If the client accepts that portfolio, the robot may relay his trade orders directly to a brokerage firm for execution. Over time, with changing market conditions, the client’s portfolio may deviate from its original recommended asset allocation. When this happens, the robo-advisor will adjust or 'rebalance' his investments to maintain the target asset allocation. Every robo-advisor that operates in Singapore ought to be licensed for fund management, dealing in capital market products and/or providing financial advisory services, depending on its operating model.

The importance of organising algorithms

The MAS has set out its 'expectations' concerning the way in which algorithms should work. A fault or bias in the algorithms could damage a large number or all of a digital advisors’ clients who rely on its recommendations. With this in mind, the mas states that it is the responsibility of the board and senior managers of the firm to oversee and 'govern' the client-facing software effectively. They should see to it that there are enough resources to allow them to keep an eye on the performance of algorithms. The firm should train everyone who uses the 'tool' and should employ people with the right expertise to develop and review the methodology behind the algorithms. The board and senior managers must also set up systems and processes to:

approve the design and 'methodology development' of the client-facing 'tool' and ensuring its proper maintenance;
approve the policies and procedures that apply to its systems and processes;
keep overseeing its management, appointing people to approve changes to the algorithms and doing something to prevent unauthorised access to them;
ensure that the firms adheres to the dictates of the MAS's Notice and Guidelines on Technology Risk Management; and
keep documents that describe the design and development of the algorithms.

When it develops client-facing software, every digital advisory firm ought to:

ensure that the methodology behind the algorithms is sound;
ensure that every 'tool,' as the MAS insists on calling it, collects all necessary information and analyses it properly, especially when it is spotting and resolving contradictory or inconsistent responses from clients;
put controls in place to weed out unsuitable investors, such as "knock-out questions" that eliminate people who are obsessed with capital preservation or who say that they cannot afford to lose their principal investment sums; and
test the 'tool' before it begins to serve customers and, when making changes to it, detect any error or bias in the algorithms.

The algorithms must classify clients according to their risk profiles correctly, basing this activity all the while on their own responses. The mas is especially keen on the robo-advisory firm in question "back-testing" things using hypothetical inputs in an effort to ensure that the risk profiles generated by the algorithms are in line with its own risk-profiling methodology. The testing should ensure that the algorithm scores and assigns risk profiles to clients correctly and consistently and should see to it that the algorithms produce the intended asset allocation and investment recommendation according to the digital advisor’s risk-profiling methodology.

Information about algorithms and other subjects

The MAS expects robo-advisors to 'minimally' disclose the following things in writing to their clients.

The assumptions, limitations and risks of the algorithms.
Circumstances under which the robo-advisors may override the algorithms or temporarily halt the digital advisory service.
Any significant adjustments to the algorithms.

The usual money-laundering rules and advertising regulations apply. Digital advisors operating as financial advisors must comply with the existing disclosure requirement for conflicts of interest. Robo-advisors are allowed to pass clients’ orders concerning specified products other than over-the-counter derivatives contracts such as overseas-listed exchange-traded funds or ETFs to brokerage firms for execution. As such, it is important for financial advisors to tell clients that the level of protection afforded to them may differ for such overseas-listed products because they operate under different regulators. Digital advisors should not advertise specific model portfolios that they may recommend or provide on their digital platforms, although they are free to advertise their services as much as they like.