An Overview of the SEC Rule on Robo-Advisory Services in Nigeria by Akorede Folarin

Though a relatively new concept – only a few years old, Robo-Investing and Robo-Advisory services are taking the financial industry by storm globally. Motivated by the demands of a digitally-oriented/tech-savvy new generation of young investors and asset managers, Robo-Advisors have become irresistible as they offer not only automated investment services but also fees that are well below what is obtainable with traditional investment managers. To put things in perspective, as of 2021, Robo-Advisors (also spelt “Robo-Advisers) manage around $500 billion in investment and it is presently estimated that Robo-Advisory services will become a $1.2 trillion industry by 2024.

In line with the three-pronged approach to regulating innovation in the financial services industry in Nigeria recently adopted by the Nigerian Securities and Exchange Commission (“SEC”/”Commission”), the Commission released the Rule on Robo-Advisory Services in Nigeria on 30^th August 2021 to regulate the adoption and deployment of Robo-Advisory services in the Nigerian capital market. This newsletter examines the proposed rules and their significance in the Nigerian capital market.

Scope of the Rules

The Rules will apply to all capital market operators and persons (Individual & Corporate) offering or seeking to offer Digital (Robo) Advisory Services in the Nigerian Capital Market. Such individuals or corporate bodies will be required to register with the SEC to operate as such.

Framework for Digital Robo Advisory Services

Under the Rules, digital advisory services mean the provision of investment advice using automated, algorithm-based tools which are client-facing, with little or no human adviser interaction in the advisory process. A “Robo Adviser” is also defined to mean persons who provide digital advisory services while “Fully Automated Robo Advisers” mean Robo Advisers with no human adviser intervention in the entire advisory process).

A Robo Advisory service occurs where:

1. a client answers a series of questions on his risk tolerance, investment objectives, investment time horizon, inputs an investment amount; and
2. the input of the client is analyzed using algorithms, and an investment portfolio is recommended to the client.

Advising on Investment

Robo-Advisers are required to carry out due diligence assessments on their clients to determine that they possess the relevant knowledge and experience to invest in complex instruments through Customer Knowledge Assessment (“CKA”) or Customer Account Review (“CAR”).

All advice on investment products must be appropriate for the client’s circumstances and must take into consideration relevant information collected regarding the client’s financial objectives, risk tolerance, employment status, financial situation (including assets, liabilities, cash flow and income), financial commitments, current investment portfolio, the portion of the client’s assets that is to be invested, etc.

The Robo Adviser must make sufficient information available to the client to enable him/her to make an informed investment decision. The Rules, however, permit the Robo Adviser to exempt a client from providing full information where (i) the advice is fully automated with very limited human interaction; (ii) there are in-built “knock-out” or threshold questions to effectively identify and eliminate unsuitable clients (e.g. clients who cannot afford to lose their principal investment sums); (iii) there are controls in place to identify and follow up on inconsistent responses provided by clients; (iv) a risk disclosure statement is provided to clients to alert them that the recommendation given to them does not take into consideration their financial circumstances; and (v) the advice is limited to instruments within the regulatory purview of the Commission.

However, even when relying on this exemption, Robo Advisers must still take reasonable steps to collect information on the client’s financial objectives and risk tolerance to satisfy themselves that the investment recommendation is suitable.

Effecting Clients’ Instructions

Where a client accepts the portfolio recommended, the Robo Adviser must relay the client’s orders directly to the relevant capital market operator (CMO) for execution; except the Robo Adviser is licensed to execute transactions on behalf of their clients i.e. to provide portfolio/fund management services.

Where a client seeks to rebalance (i.e. revise) his/her portfolio after having originally rejected or amended the recommended portfolio and the Robo Adviser is also responsible for executing the transactions on behalf of the client, the Robo Adviser must obtain the express consent of the client, to accept the client’s revised portfolio.

Robo Advisers that also provide portfolio/fund management services must, where the client decides on an alternative investment decision contrary to the recommendation of the Robo Adviser, rely on the client’s order and obtain a written decision/mandate from the client, highlighting in writing that the client is aware of their responsibility for the investment outcome and suitability of his/her investment decision.

Developing and Monitoring the Client-Facing Tool (CFT) and Algorithm

Robo Advisers must develop their client-facing tools/CFT (i.e. the interface through which the Robo-Advisory services are carried out) in compliance with best practices, and must monitor the interface and algorithm to phase out errors and bias.  The CFT must be developed with Knock-out questions to identify and eliminate unsuitable investors.

The CFT and algorithm must be regularly monitored by the board and the senior management of the Robo-Advisor to ensure optimum performance, although they may delegate the day-to-day operational oversight to other personnel. Compliance checks on the quality of advice provided by the client-facing tool are to be carried out regularly and also when changes are made to the algorithm. The frequency of such compliance checks must be commensurate with the size and complexity of the Robo-Adviser’s operations.

Where a Robo-Advisor outsources the maintenance of their CFT to a third party, that third party is not required to register with SEC. The Robo Adviser must, however, carry out due diligence to ascertain the suitability of those third parties.

Trading in Foreign Securities 

Robo-Advisors may advise Nigerian clients about foreign securities but must warn their clients at the point of opening an account and when advising them on foreign-listed securities.

When advising on foreign-listed securities, Robo Advisers must assess the merits of those securities in line with the client’s investment objectives, financial situation and particular needs, and must ensure that they are not violating any applicable laws and regulations.

Disclosure of Material Information

Robo-Advisors are mandated to provide in clear and simple language sufficient information to their clients to enable them to make informed investment decisions. They must at the very least provide written information about the assumptions, limitations and risks of the algorithms, the circumstances under which the Robo-Advisors may override the algorithms or temporarily halt the Robo-Advisory service, and any subsequent material adjustments to the algorithms

Other Compliance Requirements

1. Robo Advisers are required to comply, on an ongoing basis, with all the applicable business conduct requirements set out in the Investment and Securities Act (ISA) and the Rules and Regulations, Notices and Guidelines issued pursuant to the ISA.
2. Robo-Advisors must ensure that portfolios offered to clients are within the regulatory purview of the Commission and that their principal officers have experience with fund management and technology.
3. Robo-Advisers must undergo a post-authorization technology audit conducted by an independent third party at the end of each operational year and file a report with the Commission within three (3) months of the date of the close of the audit.
4. Robo Advisers are required to set up internal policies and procedures to address technology risks. They must also comply with the SEC’s Technology Risk Management (TRM) Guidelines and file a quarterly report to the CBN on such compliance.
5. Robo-Advisors that intend to add portfolio/fund management to the services they offer to their users must apply to the SEC to be registered as a Fund/Portfolio Manager and must comply with the applicable Rules and Regulations governing Fund/Portfolio Management.
6. Robo Advisers are also required to comply with the Commission’s Regulations on Anti-Money Laundering and Combating the Financing of Terrorism Act, 2013 and exercise a closer level of diligence for ‘Non-face-to-face transactions’ (NFTFs) to mitigate the risks of impersonation.

Conclusion.

As the digitalization of the global financial industry progresses at its current rapid pace, the demand for democratized, integrated, and digitally accessible investment advisory services is projected to also rise contemporaneously. Robo-advisers are expected to experience even wider adoption over the next few years, as the financial industry capitalizes on the greater efficiency that this technology offers.

With just about 2% of Nigeria’s population investing in the stock market due to lack of awareness, lack of requisite investment acumen/sophistication, high fees charged by traditional investment advisors, etc., the SEC Rules on Robo-Advisory services is a step in the right direction. It will help to bring clarity to the space, spur wider consumer adoption and financial inclusion and reaffirm Nigeria’s pace-setter role in the African financial industry.

***Akorede Folarin is a corporate/commercial lawyer with Olajide Oyewole LLP (A Member of DLA Piper Africa). He has a keen interest and developing expertise in Fintech, Capital Markets, Private Equity and Mergers & Acquisitions. He can be reached at akinakoredef@gmail.com