This article was originally published in French in Bilan.ch, Swiss economic magazine.
Clients and Staff are often both distrusted.
Robots do not advise. They sell products by achieving the best possible match.
If clients’ best interests guide decisions, we will get Compliance for free.
Forcing the Private Banking industry to adapt to new regulatory framework in US, Europe and Switzerland is costly and takes time. It prevents managers to think about anything else, such as sustainable business development and client satisfaction. This is already worrying but there is worse.
The worse fate is reserved for clients, due to the complexity that is created for them, and their relationship managers. Clients and Staff are equally distrusted.
Let’s be clear, I am strongly in favor of risk management. This is necessary in any industry and especially in finance. Managing risk is probably a bank’s first responsibility. But we should talk about the risks of financial investments. However, today it seems that risk management is primarily focused on legal risk: risk of being sued by clients or by the regulator, and risk that an employee will not respect the new rules of the industry.
This is probably the result of a past based on trust, when a handshake was enough to establish a contract. In the regulatory race that has begun, I wonder whether we are creating a counterculture that could hamper long-term development, and depress clients as well as employees.
The way banks adapt to regulation (MiFID II in Europe and soon LSFin in Switzerland) works against what should be a wealth manager’s DNA: trusted advice.
With the good intention to protect clients, regulators do not trust the banks advice and want to avoid the misselling of unsuitable products; they want to be sure that investment advice is delivered in the client’s best interests.
To this end, they have created the “suitability” concept. They do not detail implementation but merely talk about “appropriate measures”. They also call for continuous training and I guess they will soon ask for certification as in England.
Banks have 3 types of clients: those who delegate the management of their wealth, those who make their own choices, and those in between who are waiting for advice.
Banks know it is through advice that they can differentiate themselves.
In their concern to provide advice for a large volume of clients while mitigating the underlying legal risk and keeping costs manageable, banks have for the most part adopted a solution:
i) assign clients a risk profile (Conservative, Balanced, Growth),
ii) create Portfolio models with products that match these profiles,
iii) automatically alert client relationship managers if there is a deviation between risk profile and actual clients investments.
The advantage is that this meets regulators’ expectations and, from this point of view, protects the banks from their regulatory obligations as well as the risk of client complaint.
But does this meet clients’ expectations?
The clients have to sign numerous documents and update them in the event of a change in their risk profile. They will also have to justify their choices, or at least acknowledge that their relationship managers have warned them about the risks, which relationship managers will confirm by leaving a note in the client journal.
Not only this is highly complex paper work, but also the clients do not necessarily want to fit in a box.They expect personalized advice rather than automated, as this is why they did not delegate management in the first place.
By the way, how are products matched to risk profiles? thanks to the risk data provided by the financial information providers (Reuters, Bloomberg and consort).
Wait a second, the same data providers that provide their services to all market players? Yes, indeed.
But once a box has been assigned, what will then differentiate two banks, or even two clients? Aren’t clients going to be offered the same products? Based on the risk assessment of the product and the profile, this is exactly what should eventually happen.
With this approach, we are simply leveling down the value propositions.
Who will benefit? Robo advisors. Because they basically do nothing more than match a risk profile with appropriate products based on common data from finance information providers.
Take a process that can be repeated identically and sooner or later it will be digitized.
The value of this process will drop, and with it its price, so will margins. Only the race towards new assets (at all cost) will maintain revenues. This is exactly what is being observed at the moment (by taking over banks or hiring relationship managers in the hopes of attracting their clients). As volume of clients and assets increase, this will in turn strengthen the need for a compliance-based culture…
It is a negative infernal spiral for wealth managers.
In that digital game, Fintech start-up are great: streamlined, agile and digital native. Above all, they instinctively understand how to use digital for the benefit of their clients. And for their own benefit as well, by exploiting the masses of data collected on clients. They do not transfer old practices to the Web. They reinvent the usage by putting themselves in clients shoes. They make every effort to offer a great client experience based on the client’s habits, at the best possible price.
Can wealth management players avoid this scenario? Yes.
Wealth management players could address a client segment that is complicated for robots: either in terms of service (advice on the whole wealth as opposed to the distribution of financial products) or in terms of clients segments (HNWI or even UHNWI). Additionally, as soon as the client is considered a qualified investor the regulator reduces the duty checks.
They could also avoid this scenario by adopting the Fintech working habits (based on client experience and agility) and tools (client oriented IT).
Finally they could exploit robots’ weaknesses. Robots are good at math, but they still lack two critical skills to mimic human advisors (so far): empathy and convictions.
Empathy makes it possible to continuously adapt to the profile and needs of a client. With a robot, a client can define their own risk profile (“I am Growth oriented”), but who will check that a psychological bias has not deceived him? Who will adapt the risk profile if the needs and circumstances change throughout the client life cycle?
Convictions relate to the preferred investments by the manager and the bank, the diversification and the timing expertise. If these are well explained, put into perspective and supported by financial as well as emotional arguments, they will convince a client to trust one banker over another.
Robots do not advise. They sell products by achieving the best possible match.
Then, give risks their right place.
Compliance and Risk Management is a barrier to entry in this industry, but it is not a differentiating factor as such, except in the way it is implemented. Do we want to create more complexity for clients and employees, or do we create a client-oriented organization that is friction-free for clients as well as for employees? Are we trying to protect the bank or the client? Do we want to satisfy the clients or the regulator?
If clients’ best interests guide decisions, then we will get Compliance for free.
As bank will uphold both the spirit and the letter of what regulators expect.
By following this route, banks will gain on two levels: client and employee satisfaction, and long term differentiation.