New con­sul­ta­tion pa­per con­tem­plates the in­evitabil­ity of in­creas­ing au­to­ma­tion in the fi­nan­cial ad­vi­sory busi­ness

Investment Executive - - FRONT PAGE - BY JAMES L ANGTON

The BCSC ex­am­ines the rise of AI in fi­nan­cial ser­vices.

over­see­ing the growth of fin­tech with­out aban­don­ing in­vestor pro­tec­tion or sti­fling in­no­va­tion is fast be­com­ing one of the big­gest chal­lenges fac­ing reg­u­la­tors. Now, reg­u­la­tors must look ahead to a fu­ture that prom­ises ar­ti­fi­cial in­tel­li­gence (AI) re­plac­ing hu­mans and the dawn of fully au­to­mated robo-ad­vice.

A new con­sul­ta­tion pa­per from the B.C. Se­cu­ri­ties Com­mis­sion (BCSC) ex­am­ines the cur­rent and pos­si­ble fu­ture state of fin­tech reg­u­la­tion.

Dur­ing the past few years, reg­u­la­tors have found them­selves faced in­creas­ingly with new busi­ness mod­els, novel se­cu­ri­ties and in­no­va­tive fi­nanc­ing tech­niques. For the most part, reg­u­la­tors have tried to ac­com­mo­date these de­vel­op­ments within the ex­ist­ing reg­u­la­tory frame­work.

For ex­am­ple, the Cana­dian Se­cu­ri­ties Ad­min­is­tra­tors (CSA) treats reg­is­tra­tion rules as be­ing “tech­nol­ogy-neu­tral”: the same re­quire­ments that ap­ply to tra­di­tional in­vest­ment firms for col­lect­ing “know your client” (KYC) in­for­ma­tion or as­sess­ing suit­abil­ity also ap­ply to on­line ser­vices.

Now, though, reg­u­la­tors are be­gin­ning to grap­ple with the prospect of tech­no­log­i­cal de­vel­op­ments that may make this ap­proach out­dated.

The BCSC’s con­sul­ta­tion pa­per, which is out for com­ment un­til April 3, con­tem­plates the in­evitabil­ity of in­creas­ing au­to­ma­tion in the fi­nan­cial ad­vi­sory busi­ness. The pa­per re­ports that on­line ad­vi­sory firms an­tic­i­pate a fu­ture in which they will be able to au­to­mate many tasks — in­clud­ing KYC col­lec­tion, deter­min­ing suit­abil­ity and mak­ing in­vest­ment rec­om­men­da­tions — that peo­ple cur­rently per­form. For this to hap­pen, reg­u­la­tions are go­ing to have to change.

Un­der the CSA’s cur­rent ap­proach, hu­man in­ter­ven­tion is re­quired to con­firm whether a rec­om­men­da­tion that an al­go­rithm gen­er­ated is suit­able. Ac­cord­ing to the BCSC’s pa­per, this re­flects reg­u­la­tors’ be­lief that the ad­vi­sory process re­quires hu­man over­sight and that reg­u­la­tors “can un­der­stand the de­ci­sion-mak­ing path” of a per­son bet­ter than that of an al­go­rithm. But this is chang­ing.

The BCSC re­ports that AIen­abled apps are get­ting bet­ter at col­lect­ing, pro­cess­ing and an­a­lyz­ing data: “De­vel­op­ments in ma­chine learn­ing are im­prov­ing the qual­ity of de­ci­sion-mak­ing by AI, and al­go­rithms are be­ing re­fined to help hu­mans bet­ter com­pre­hend the de­ci­sion­mak­ing path AI takes.”

Once firms au­to­mate the ba­sic in­vest­ing process (KYC, suit­abil­ity and in­vest­ment rec­om­men­da­tions) com­pletely, hu­man over­sight of these ac­tiv­i­ties “may pro­vide lit­tle added value and only add to in­ef­fi­cien­cies,” the BCSC’s pa­per states.

In an­tic­i­pa­tion of this sit­u­a­tion, the BCSC is look­ing at how reg­u­la­tion should evolve. The reg­u­la­tor is seek­ing feed­back on how over­sight should be car­ried out in a world in which ad­vanced AI is do­ing much of the work of the tra­di­tional re­tail in­vest­ment process. And the BCSC’s pa­per calls for ideas for al­ter­na­tive in­vestor pro­tec­tion mech­a­nisms that can be re­lied upon within a fully au­to­mated ad­vi­sory process, apart from sim­ply re­strict­ing the in­vest­ment prod­ucts firms can of­fer.

In ad­di­tion, the BCSC’s pa­per in­di­cates that robo-ad­vi­sors also want more guid­ance about out­sourc­ing and re­fer­ral ar­range­ments be­tween their busi­nesses and tra­di­tional port­fo­lio man­agers. The pa­per states that reg­u­la­tors need to con­sider whether to al­low firms to uti­lize “regtech” so­lu­tions when out­sourc­ing cer­tain as­pects of the KYC and suit­abil­ity pro­cesses that cur­rently must be con­ducted in-house.

Fur­ther­more, the BCSC’s pa­per con­tem­plates whether reg­u­la­tory ac­tion is needed to deal with ob­sta­cles that are im­ped­ing the process of in­vestors trans­fer­ring as­sets and switch­ing firms — in­clud­ing both reg­u­la­tory re­quire­ments that may be slow­ing down the process and the in­dus­try’s ad­min­is­tra­tive prac­tices.

The BCSC’s pa­per also looks at the chal­lenges fac­ing the reg­u­la­tion of cryp­tocur­ren­cies, ini­tial coin of­fer­ings (ICOs) and in­vest­ment funds that in­vest in these emerg­ing as­set classes.

The CSA is­sued a no­tice last year that sets out that reg­u­la­tor’s views on the sta­tus of ICOs and cryp­tocur­rency-based in­vest­ment funds. To date, the CSA has taken the po­si­tion that ICOs must be as­sessed on a case-by-case ba­sis to de­ter­mine whether they con­sti­tute se­cu­ri­ties. This trig­gers reg­is­tra­tion and other re­quire­ments for of­fer­ings that in­volve se­cu­ri­ties.

The BCSC’s pa­per in­di­cates that firms are look­ing for more guid­ance on whether a par­tic­u­lar ICO will be con­sid­ered a se­cu­rity. The pa­per so­lic­its feed­back on the cri­te­ria that reg­u­la­tors should use in mak­ing these judg­ments, and also con­tem­plates dif­fer­ent ICO mod­els that could be uti­lized to avoid be­ing clas­si­fied as in­volv­ing a dis­tri­bu­tion of se­cu­ri­ties.

As firms de­velop meth­ods to in­vest i n ICOs and cryp­tocur­ren­cies, the BCSC pa­per also con­sid­ers whether tra­di­tional pro­fi­ciency re­quire­ments for fund man­agers — such as re­quir­ing knowl­edge of se­cu­ri­ties and con­ven­tional port­fo­lio-man­age­ment tech­niques — are rel­e­vant to port­fo­lio man­agers who fo­cus on dig­i­tal as­sets. The pa­per sug­gests this tra­di­tional knowl­edge may not be as im­por­tant as the un­der­stand­ing of “cryp­toe­co­nomics.”

Al­though the BCSC pub­lished the pa­per on its own, reg­u­la­tory sources in­di­cate that many of the same top­ics are be­ing dis­cussed at the CSA as part of its “reg­u­la­tory sand­box.” The CSA is ex­pected to pub­lish ad­di­tional guid­ance soon that will ex­pand on its ini­tial views on cryp­tocur­ren­cies, ICOs and cryp­tocur­rency-fo­cused in­vest­ment funds.

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