The Financial Services Regulatory Authority of Abu Dhabi Global Market released a regulatory framework for Digital Investment Managers (Robo-advisors). They recently issued a new Supplementary Guidance: Autorisation of Digital Investment Management (“Robo-advisory”) Activities. The organization believes that these regulations will promote oversight, fairness, accountability, and transparency in the digital financial sector.
“Robo-advice leveraging AI and data analytics is an area of FinTech that has enormous potential to improve investment decision making in the Middle East and Africa region,” said Richard Teng, the Financial Services Regulatory CEO of ADGM. “With this guidance, we aim to make it easier for digital investment businesses to operate in ADGM and in turn provide investors with greater access to professional investment tools to help achieve their financial goals.”
The ADGM issued the guidance under Section 15(2) of the Financial Services and Markets Regulations 2015 (FSMR). According to the organization, the regulation is relevant to those who apply for Financial Services Permissions to conduct Regulated Activities, as defined in the FSMR (Section 19), where applicants undertake Digital Investment Management.
The ADGM defines “Digital Investment Management” as financial services that use algorithm-based technology. These tools require limited human interaction between clients and Robo-advisory providers. Their affluent customers are comfortable receiving financial services through digital channels. It also influences how they select service providers.
Digital Investment Management business models fall under two different categories within the GCC region. The first one is the fully digital model which requires little human interaction with clients, other than technical support services. The second is the hybrid model, where clients can interact with a financial adviser to discuss automated digital investment strategies produced by algorithm-based technology.
Digitized platforms allow financial managers to offer customized, cost-effective investment management services to their clients. Unfortunately, this technology has inherent risks that differ from traditional business investment models. The guidance explains how the FSRA applies regulatory safeguards to Digital Investment Managers. Additionally, the document discusses how managers can mitigate risks this technology poses to clients and the ADGM’s goals.
“As an international financial center, ADGM actively enhances its framework and platform to support innovation and the varying financial needs of businesses, investors, and consumers,” Teng said. “We look forward to welcoming more Robo-advisors to establish their presence in Abu Dhabi in ADGM and support investors with their innovative solutions.”
The guidance addresses two critical areas. The first involves regulatory permissions that the ADGM requires operators need to provide digital investment services. The second addresses how the FSRA will apply authorization criteria to areas such as governing technology and algorithms, and suitability and disclosure. The ADGM has established the following guidelines for Robo-advisors in their new supplementary guidance.
Permission Required for Digital Investment Management – As part of their business plan, Digital Investment Managers must have Financial Services Permissions to undertake Regulated Activities. They include credit advising, investment arrangements, and managing assets. Additionally, the manager may hold the assets of clients. They can also establish direct, asset-holding relationships with customers and regulated Custodians. In the latter case, the administrator needs an FSP to conduct “Regulated Activity of Managing Assets,” unless they meet exclusion criteria (Schedule 1, Paragraph 47.) FSP-accredited managers don’t need separate permissions to advise on investments, credit issues, or financial deals if these Regulated Activities are an incidental part of their business. For details, read Sections 3.1 – 3.4.
Prudential capital requirements – The ADGM requires Digital Investment Managers (who manage assets under 3C Category) to have a base capital of $250,000. Businesses that advise on investments or credit arranging deals must meet the $10,000 base capital requirement. The regulators require a higher prudential capital requirement for Digital Investment Managers because of the inherent risks involved with the investment process. These administrators can make investment decisions without first obtaining a client’s approval. Additionally, there is an increased operational complexity to hold client assets as part of the discretionary asset management process. For details, read Section 3.5.
Algorithm governance – Digital Investment Managers offer algorithms as their primary service. These professionals oversee critical components of the investment management process including portfolio allocation, risk profiling, and rebalancing. The FSRA requires Digital Investment Managers to create internal governance structures and hire a competent Board and top administrators. They must regulate and control the deployment, performance, design, and security of all algorithms. Qualified staff should ensure algorithm models functions, and provide documentation to explain its logical structure or decision tree. Additionally, businesses must establish safeguards to provide security and access controls for their model’s integrity. Companies should conduct ongoing monitoring and testing to assess whether the models achieve their outcomes and objectives. For details, read Sections 4.4 – 4.5.
Technology governance – Digital Investment Managers must ensure that its systems and controls are commensurate for the scale and complexity of its business operations. These controls include information transmission and storage, investor safeguards and protections, outsourcing, technical operations, and contingency arrangements. Additionally, managers must assess and mitigate risks for their clientele. For details, read Sections 4.6 – 4.7.
Suitability requirements – Digital Investment Managers should follow suitability rules outlined in the FSRA’s Conduct of Business Rulebook (COBS). The ADGM requires Digital Investment Managers to offer reasons for Specified Investments they recommend to clients. Companies should design a Risk Profile Questionnaire. They must ensure the information used to assess suitability can handle the risk and complexity of Specified Investment transactions on their platform. For details, read Sections 4.8 – 4.10.
Disclosure – The FSRA expects Digital Investment Managers to comply with the disclosure requirements in COBS. The professionals must provide sufficient details about the services they provide to Retail and Professional Clients. Digital Investment Managers should provide clear, fair communications to their customers that are not misleading. They should provide details about the nature and scope of services, products, and if they’re suitable to meet the client’s objectives. The companies should tell customers about any conflicts of interest. For details read Sections 4.11 – 4.14.
For a full list of requirements read the Supplementary Guidance: Autorisation of Digital Investment Management (“Robo-advisory”) Activities.
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