Contributed by: Sumit Kochar, Shivam Gera and Jaydeep Saha
This article delves into the world of robo investment advisors in India, exploring their revolutionary impact on the financial sector. The technological advancements of Web 2.0 and 3.0 have led to the rise of algorithm-driven financial guidance, democratizing investing and making it accessible to a wider audience. The features, growth projections, and regulatory challenges of robo advisors are examined, emphasizing the importance of responsible data use and customer protection. This comprehensive analysis sheds light on the transformative potential of robo investment advisors, highlighting their role in shaping India’s fintech landscape and empowering investors for a prosperous future.
Introduction
Technological developments have significantly altered our way of living and affected every aspect of our daily existence. Web 2.0 has been a part of our lives since the year 2000. User-generated content, social networks, the cloud, and other aspects of Web 2.0 contributes to the enormous amount of data that is produced today. The daily production of data gave rise to the field of data analytics. Additionally, Web 2.0 includes several tech-driven mobile applications like Twitter, WhatsApp, and Instagram. Today, we speak of Web 3.0, which is anticipated to change society, business, and government as well as people. Due to its intrinsic characteristics of being open, decentralized, trustless, and embracing artificial intelligence and machine learning, this transformation is revolutionary and disruptive. Some cryptocurrencies fall under the Web 2.0 and 3.0 categories. Those developed during 2.0 have gained popularity recently and have included distinct features of Web 3.0. The financial industry has been profoundly impacted by technological development, which has spawned a brand-new age known as Fintech that is today seen as a separate industry. In India, this sector is where the majority of new businesses are emerging. Robo investment advising is one of the numerous specialized fields in banking and finance that provides a chance to these start-ups.
The emergence of robo investment advisory services has given the age-old profession of managing the money of other people, a new technological twist. This group of consultants offers financial guidance based on inputs from artificial intelligence or digital algorithms. It emerged as a part of the fintech evolution following the 2008 financial crisis as a result of the erosion of public confidence in conventional banks and financial institutions. Retail investors during that time felt the need for formal financial advice, which only wealthy and sophisticated investors could afford. So, the companies presented an algorithm-based answer to this investment dilemma by utilizing technological improvement. At the moment, robo investment advisors are part of the wealth management industry and work with minimal human interference. In recent years, this algorithm-driven financial solution has experienced enormous growth in popularity.
Who are Investment Advisors?
A person or organisation that offers ‘investment advice’ to another person in exchange for monetary value is known as an investment advisor. Financial planners, financial advisors, investment advisors, portfolio managers, and tax savings advisors are just a few of the functions that investment advisors do. According to the Securities and Exchange Board of India (Investment Advisors) Regulations, 2013 (‘SEBI Regulations’) an investment advisor must register with the Securities and Exchange Board of India (‘SEBI’) in order to conduct advising operations. According to SEBI Regulations, no person can represent themselves or function as an investment adviser unless they have a certificate of registration from the SEBI. No person is allowed to use the nomenclature ‘Independent Financial Advisor’ or ‘IFA’ or ‘Wealth Adviser’ in connection with the distribution of securities unless they are registered as a Registered Investment Advisors (‘RIA’) with the SEBI.
What are Robo Investment Advisors?
Robo investment advisors are digital advice platforms or automated investment advisors that offer automated, artificial intelligence and algorithm-driven financial guidance with little to no human interference. A typical robo investment advisor gathers information about an investor’s financial state and future aspirations via an online questionnaire and then uses the data to offer recommendations and automatically manage investors’ assets to generate superior returns based on the risk-return profile.
Evolution of Robo-Investment Advisory
In the United States, Wealthfront and Betterment, the world’s first robo advisors, began giving financial advice to public investors in the year 2010. Wealthfront started as a mutual fund company with human advisers. Wealthfront’s founders, Andy Rachleff and Dan Carroll set out to give financial counselling to the tech sector. When the founders of Wealthfront recognised the promise that computer software held for making financial advice more available to more individuals at a lower cost, they altered the company’s focus. As an outcome, there are now much more Robo Advisors in the world, and their Assets Under Management (‘AUM’) are expanding at a faster rate as well.
According to Statista data for the year 2023, the global AUM for Robo Advisory services is predicted to be $2.76 trillion, while the number for India is $ 33.49 billion[1]. By 2027, the global AUM for Robo advising is projected to be $4.66 trillion. AUM is expected to grow at a compound annual growth rate (‘CAGR’) of 14.00% globally and 14.01% in India between the years 2023 and 2027[2]. The USA has the dominant position Robo Advisory segment globally in terms of AUM.
India has a demographic dividend and many young investors, which creates a sizable market for robot advisors. These tech-savvy individuals prefer direct investing over using financial advisors or middlemen. Instead of using the services of a financial counsellor, many investors prefer the tech approach.[3] These young, tech-savvy investors will drive the demand for an ever-growing market for Robo Advisory services in India.
Features of Robo Investment Advisors
Robo investment advisors offer secure platforms that enable investors to maximise their return and lower their risk at a reasonable cost and with ease of use. While no financial advisor can be available around-the-clock, these robot advisors are available all time on a variety of platforms, including desktop, laptop, mobile, and tablet computers. The platform has the capacity to scale at very low costs will allow them to reach a wider audience. The Robo Advisors can also provide investors and clients with advice while monitoring their investing preferences without being subject to human prejudice. Some robot advisors can offer comprehensive services, such as tax, financial, and retirement planning. While a few smaller Robo Advisors still employ sample portfolios and constant portfolios, the majority create their investors’ portfolios using contemporary portfolio theory[4].
One disadvantage of robo investment advisors is that there is no human interaction. Investors frequently want the advice of a financial advisor because they prefer speaking with a real person rather than relying solely on a computer to make investment decisions. Robo advisors do not now support all financial assets. They only offer services related to limited assets, which is a restriction. Investors that utilize robo advisors must also be tech-savvy and use technology. However, given how much easier these tasks are now thanks to smartphones and mobile applications, this does not seem to be a severe limitation.
A typical robo advisor starts by gathering and selecting a few assets that represent the investment assets that an investor would be interested in investing in, taking into account risk and return. Following this, clients or investors complete the questionnaire, which aids the robo advisor in determining the risk profile of the investment. The questionnaire may include questions related to income, assets, loans, number of dependents, inheritance, previous savings, and future objectives.
These responses aid in determining the investor’s risk profile as a foundation for portfolio allocation. When choosing the portfolio, contemporary portfolio theory is used in the background. Once the threshold is crossed due to market movement, the majority of Robo Advisors have the ability to rebalance the portfolio. The investor’s risk profile is used to determine these thresholds. The final step is to monitor the portfolio in accordance with the investor’s preferred level of risk and make sure returns are produced for the investors.
Recent advancements pertaining to the regulation of Robo Investment Advisors in India
In India, Investment advisory services are governed by SEBI Regulations. For robo advisors that perform duties comparable to those performed by intermediaries regulated by the SEBI and the Reserve Bank of India (“RBI”) may pose regulatory and supervisory problems. The application of the existing legal framework to AI technologies may prevent robo advisors and other AI approaches from being adopted due to difficult compliance requirements.
In the year 2016, SEBI released a consultation paper titled ‘Consultation Paper on Amendments/Clarifications to the SEBI (Investment Advisors) Regulations, 2013’, wherein SEBI discussed the online investment advisory services and use of automated tools i.e., robo advisors to provide investment advice for the first time.
According to the consultation paper, there is no specific restriction under SEBI Regulation on registered investment advisors using automated guidance technologies to deliver Investment guidance. Investment Advisors (‘IAs’) that provide investment advice through robo advisors must follow the existing SEBI Regulations.
The investment advisors using robo advisors must also adhere to the additional compliances listed below since risk profiling of the investor is a requirement for the advisors before giving investment advice.
- Ensure automated tools are appropriate and applicable;
- Robust systems and controls must be in place to guarantee that any advice given using the tool is appropriate for and in the client’s best interest;
- The investment adviser is required to keep records relating to risk profiling, risk assessment of the client, and suitability assessment of the advice being given for a period of five years.
- The clients should be properly informed of the tool’s functionality and any restrictions on the results it can yield;
- A comprehensive audit system ought to be implemented;
- The investment advisor who utilized the tool is accountable for the recommendations;
- The automated tools of the advisors must also be open to audit and scrutiny.
But these proposals as mentioned in the consultation paper haven’t been implemented yet.
Currently, as per SEBI Regulations, registration is mandatory, and investment advisors are required to register the digital platforms with SEBI in accordance with Regulation 3. The SEBI stated in a circular dated 23rd September 2020 that an individual cannot provide both advisory and execution services at the same time. As a result, if an individual wishes to provide investment advice through the robo advisor platform, he or she must establish a separate entity, such as a corporation or a limited liability partnership (‘LLP’).
As per SEBI Regulations, an investment advisor intending to be registered requires a professional qualification requirement. However, in respect of robo investment advisors, the clarification for the same is not provided in the SEBI Regulations. Assuming the requirements are applicable to the person managing the digital platform, it defeats the main purpose of the robo investment advisors which is being more cost-effective than traditional investment advisors. Onboarding the professional in accordance with the SEBI Regulations will only increase the overall costs.
Further, in order to strengthen the conduct of IAs, SEBI issued a circular in December 2019 instructing investment advisors to provide investment advice only after completing the investor’s risk profile based on information provided by the investor and obtaining prior consent from the investor on the completed risk profile via registered email or physical document.
Intriguingly, the SEBI stated in a circular dated 23rd September 2020, that electronic consent obtained through the execution of a digital agreement and dissemination of that consent via the investor’s email cannot be regarded as consent. As a result, under Regulation 19(1)(d) of the SEBI Regulations, electronic consent will not satisfy the requirement of a mandatory agreement between investment advisors and clients, and investment advisors are now required to obtain consent through a physical document.
Following such standards are tough for AI-driven solutions to meet, and they may effectively limit the deployment of bots who are robo advisors capable of performing such functions within India, harming developers of such systems.
Other intermediaries, such as algorithmic trading bots, who are similar to stock brokers in certain ways, may encounter similar difficulties. Regulators in India’s financial sector may need to revisit legislation controlling intermediaries that are not technologically neutral or fit-for-purpose, in order to ensure that policies are outcome-focused.
Compliance of AI with the Regulations in the Financial Sector on Global Context.
- The price of complying with upcoming AI rules
Considering the use of AI as robo investment advisors in the financial sector is still in its infancy, any AI-focused regulation must be risk-based and proportional. Compliance costs for AI deployers may arise depending on the form of legislation that may become applicable to financial service providers. If the regulations include prescriptive processes and compliance requirements, AI deployers may be obliged to dramatically adapt their processes in order to comply. Such restrictions may also unintentionally stifle innovation by focusing on processes rather than outcomes.
- Significantly aligning AI with the Law
The RBI’s mandatory grievance redress systems for its regulated firms, notably the Reserve Bank of India’s Integrated Ombudsman Scheme, 2021[5], and specific regulations relevant to banks, do not dictate or limit the use of technology. However, financial service providers deploying such tools must consider whether the use of such tools jeopardizes their duties or adherence to the ‘spirit’ of the laws, as well as the level of human interaction required to supplement the deployment of such tools. According to the Basel Committee on Banking Supervision[6], banks are creating best practices to reduce risks related to the use of AI.
In contrast, on September 2021, the International Organization of Securities Commissions[7], which sets standards for the securities market, released a guidance report on the use of AI and machine learning by market intermediaries and asset managers. This report covered, among other things, the designation of senior management personnel who will be in charge of overseeing the development, testing, deployment, monitoring, and controls of AI and machine learning, and it required regulators to reevaluate their policies. The report also gave direction to robo advisory where investors must understand what criteria the robo adviser takes into account when delivering investing recommendations. For example, if an algorithm does not take into account the investor’s tax liability, the advising scope should specifically omit tax. subsequently, the IA utilising the automated technology will bear accountability for the advice provided by robo advisors. As a result, it is vital that those who build and/or deploy robo-investing algorithms are competent and sufficiently trained.
- Limiting the possibility of discriminating practices and prejudices
While fintech companies continue to use a variety of new data points to accurately underwrite loans and conduct creditworthiness assessments that go beyond conventional parameters, AI tools could also result in biased or discriminatory outcomes. To reduce such occurrences, financial service providers might need to conduct recurring audits and reviews of AI-driven processes. According to a 2017 paper by the Financial Stability Board[8], AI models may produce discriminatory results even where discriminatory characteristics are not input directly. As a result, the legality of such models has been challenged in several jurisdictions.
- Consumer protection for the most vulnerable
According to a discussion paper on AI and machine learning published by the Bank of England in October 2022[9], there may be special responsibilities for ‘vulnerable’ consumers, and in cases where AI technology does not adequately take into account the needs of such classes of customers, they may be more vulnerable to risk and harm. AI systems may also need to be trained to avoid targeting particular customer groups when marketing and acquiring new customers in order to sell financial products and services that have an unsuitable risk profile. In the context of India, where low rates of financial literacy persist, this is especially crucial.
Judicial Review on adopting AI on robo investment advisors.
The main question to ask when examining the legal and regulatory implications of AI adoption on robo investment services is whether the current legal framework is adequate to address potential legal problems or whether a new set of laws are required to govern these technologies. While some legal issues, such as those involving intellectual property rights and the use of data to develop artificial intelligence, may be covered by existing laws, others may call for new regulations that take into account artificial intelligence technology.
- Liability of AI
A robot or any AI technology cannot currently be held legally or accountable if a third person is harmed as a result of any action or inaction by the programme under the current legal system. Applying basic liability laws to artificial intelligence programs will become more difficult as they become more complex. When harm cannot be attributed to a human component or when an action or inaction by AI technology could have been prevented by human intervention, the issue of assigning responsibility will also come up. When AI enters into a contractual obligation after negotiating the terms and conditions of the contract and there is a subsequent breach of contract, the current legal system may once again be unable to assist.
In United States v Athlone Indus Inc[10] the Hon’ble Court that since robots and artificial intelligence programs are not natural or legal persons, they cannot be held liable even if any devastating damage may be caused. This traditional rule may need reconsideration with the adoption of highly intelligent technology.
Given that artificial intelligence entities are not viewed as being governed by the law, the pertinent legal question, in this case, is what kinds of rules, regulations, and laws will apply in these circumstances and who will make the decisions.[11]
- Privacy and Data Protection
The unrestricted flow of data is essential for the development of more advanced AI technology because it serves as their primary source of energy for the robo services. AI technology must therefore be created in a fashion that complies with all applicable privacy, confidentiality, anonymity, and data protection regulations. Regulations that guarantee there will be no misuse of personal information or security breach are necessary. Users should be able to halt the processing of their personal data and exercise their right to be forgotten through appropriate channels. However, it is unclear whether AI and other similar automated decision-making entities should be subject to the current security requirements in order to protect individuals’ right to privacy, which was recognized as a fundamental right by the Hon’ble Supreme Court in KS Puttaswamy & Anr. v. Union of India and Ors[12]. Additionally, this calls for the creation of a comprehensive data privacy policy that would apply to both the public and private sectors and regulate the protection of all data, including that which is used to create AI. Similar to the use of fingerprints or facial recognition through AI and machine learning, laws related to surveillance also need to be reviewed in these situations.
There are still a lot of loose ends to be tied at this time, such as the rights and obligations of the person in charge of the data used to develop artificial intelligence or the rights of the individuals whose data is being used to create these technologies. The tension between the development of artificial intelligence and the use of data for other, unrelated purposes needs to be carefully considered.
Conclusion
Robo investment advisory has emerged as a disruptive force in the Indian financial landscape, transforming the way individuals approach investing. The rise of these digital platforms has brought numerous benefits, such as accessibility, cost-effectiveness, personalization, transparency, and automation. Through the application of advanced algorithms and AI, robo investment advisors have successfully catered to a wider range of investors, making investing more affordable and user-friendly.
As the robo advisory industry continues to evolve, challenges remain, such as limited human interaction, data protection, stringent regulations of SEBI and potential vulnerabilities during periods of market volatility. However, with ongoing technological advancements, robo-advisors are expected to overcome these challenges and further enhance their offerings.
Robo investment advisory appears to have a bright future in India. Robo-advisors are projected to experience sustained expansion and adoption as investors look for effective and easy solutions to manage their funds and as financial literacy rises. These platforms will work in conjunction with traditional advisory services to provide a comprehensive investing ecosystem that meets the various requirements of investors. Robo investment advice, which democratises investment services and gives people the authority to control their financial destinies, represents an overall positive and transformational movement in India’s fintech industry. Investors, regulators, and industry stakeholders must work together and change as these platforms develop to ensure that robo investment advisors respect the greatest standards of accountability, transparency, and customer-centricity in the goal of financial prosperity for all.
[1] https://www.statista.com/outlook/dmo/fintech/digital-investment/robo-advisors/india?currency=usd
[2] https://www.statista.com/outlook/dmo/fintech/digital-investment/robo-advisors/worldwide?currency=usd
[3] https://www.businesstoday.in/magazine/markets/story/hello-robo-how-robo-advisory-firms-are-revolutionising-financial-services-in-india-308232-2021-10-08
[4] Beketov, Mikhail, Kevin Lehmann, and Manuel Wittke. Robo Advisors: quantitative methods inside the robots. Journal of Asset Management 19, no. 6 (2018): 363-370
[5]https://www.rbi.org.in/commonperson/English/Scripts/FAQs.aspx?Id=3407#:~:text=RB%2DIOS%2C%202021%20has%20simplified,are%20covered%20under%20RB%2DIOS.
[6] https://www.bis.org/publ/bcbs_nl27.htm
[7] https://www.iosco.org/library/pubdocs/pdf/IOSCOPD658.pdf
[8] https://www.fsb.org/wp-content/uploads/P011117.pdf
[9] https://www.bankofengland.co.uk/prudential-regulation/publication/2022/october/artificial-intelligence
[10] 746 F.2d 977, 979 (3d Cir. 1984)
[11] Gabriel Hallevy, The Criminal Liability of Artificial Intelligence Entities – From Science Fiction to Legal Social Control. https://ideaexchange.uakron.edu/cgi/viewcontent.cgi?article=1037&context=akronintellectualproperty
[12] Writ Petition (Civil) No 494 OF 2012.
