This post aims to provide a a general overview on the licensing requirements introduced by the Securities Commission of Malaysia (“SC”) for potential applicants seeking to be licensed as a robo-advisory firms under the the revised Licensing Handbook (“Handbook”) published on 9 May 2017.
What is a robo advisory firm?
Essentially, a robo advisor is a platform that allows investors to invest online using technology and monitor their investment portfolio.
At the moment, retail investors in Malaysia have limited to low-cost financial advice and investment tools. The entry barriers to invest are relatively high, especially for fresh graduates and those in the lower-income group. A typical unit trust fund may charge an investor a sales fee of up to 5% and an annual management fee of 1% to 1.5%. In other words, an investor would have already lost up to 6.5% of his money before it is even invested in the market.
A robo advisor on the other hand aims to avoid overcharging investors by imposing a single flat fee against the investment sum. To illustrate, a robo advisor may typically charge annual management fee anywhere between 0.3% to 1.0% which is inclusive of management, custodian and transaction fees. Generally, the minimum investment amount on a robo advisory platform can be as low as RM50. The management fee would also decrease significantly depending on the total investment sum.
On 5 March 2018, The Edge, a local business daily, in an article titled “The robo-advisors are coming” covered 3 applicants seeking to be applied as licensed robo advisory firms, namely Main Street Capital Sdn Bhd, Smartly Pte Ltd and Valuefy Solutions. With exception to Main Street Capital Sdn Bhd, both Smartly Pte Ltd and Valuefy Solutions are foreign applicants, originating from Singapore and India respectively. Smartly Pte Ltd is reported in the article to be licensed in Singapore by the Monetary Authority of Singapore and now seeking to be licensed in Malaysia as well. Similarly, Valuefy Solutions is also seeking to expand its operation from India across South East Asia. It is not mentioned in the article whether any of these firms 3 has actually applied to the SC to be registered as a DIM.
Robo advisory as a regulated activity
Digital investment management
The phrase “robo advisory” is not the terminology being used in the Handbook as the Handbook / SC defines such robo advisory firms as Digital Investment Management (“DIM”). The Handbook defines a DIM as “fund management business which incorporates innovative technologies into automating its discretionary portfolio management services for its clients”.
In this article, the phrases robo advisor and DIM are used interchangeably.
Fund management as 1 of the 6 regulated activities
Fund management is one of the six regulated activities governed by the SC under the Capital Markets and Services Act 2007 (“CMSA”). To offer “robo advisory” services, the applicant must be a Malaysian company licensed as a Capital Market Services Licence (“CMSL”) holder as fund management in relation to portfolio management. There is no shareholding / equity requirement on the CMSL applicant and all that SC requires is that the shareholder fulfills the ‘fit and proper’ (see below). In other words, the applicant may be wholly owned by a foreign party. There needs to be two (2) holders of Capital Markets Services Representative Licence (“CMSRL”) (ie the individuals) attached to the CMSL holder.
Certain exemptions have been made for DIM applicants as well namely the requirements to have at least one (1) Bumiputera director and maintaining at least 30% Bumiputera staff composition are waived.
On a side note, it may be worth mentioning that a robo advisory firm may also be registered in Labuan, an offshore jurisdiction in Malaysia. Algebra, which is operated by Singapore-based Farringdon Asset Management is a shariah compliant robo advisory platform. According to Algebra’s website, it is regulated by the Labuan Financial Service Authority.
General requirements (Highlights)
The following section sets out the general requirements to be a licensed robo advisory firm in Malaysia.
1. ‘Fit and proper’ person
To apply as a DIM, the applicant must be ‘fit and proper’ set out in sections 64 and 65 of the CMSA. In essence, a ‘fit and proper’ person is someone who is not involved in any securities/capital market offence, good financial standing and track records. The ‘fit and proper’ test is imposed against all the applicant’s directors, chief executive officer, managers and substantial shareholders. The SC may impose additional conditions to satisfy this requirement.
2. Ensure technology capabilities and support to undertake the DIM business
The applicant must demonstrate:
(a) that it has a clear organisational structure with clear lines of responsibility and authority; and
(b) that it has the necessary IT systems and adequate internal control systems to operate a DIM business.
In addition to the above, the Handbook also imposes the following additional requirements on the applicant to qualify as a DIM.
(a) Have sufficient knowledge understanding of the algorithm used in the digital investment management business.
(b) Ensure at all times the outcomes produced by the algorithm are:
(i) consistent with the applicant’s investment strategies;
(ii) corresponds to the risk profile of the investor; and
(iii) compliant with securities laws and relevant guidelines.
(c) Have a robust support system which includes a secure environment pursuant to the Guidelines on Management of Cyber Risk and other relevant guidelines.
3. Comply with the SC’s “digital value proposition”
As this licence relates to digital and technology, the SC sets out the following conditions that form the pillar of the digital value propositions that the applicant must comply with:
(a) Digital business model.
The business model must have a clear value proposition that demonstrates how digital innovations can deliver positive outcomes to its target investors and any other target beneficiaries.
(b) User-centric delivery
Delivery of services to target investors and any other target beneficiaries must include user-centric interface and experience, integrated investor education on the services offered to create greater confidence, trust and engagement, and transparent fee structure.
(c) Automated investment proposition
Automated proposition must involve core components of portfolio management services including risk profiling, suitability assessment, asset allocation and rebalancing. Applicants may not be eligible if only limited parts or only non-core parts of the investment service are automated
In summary, the applicant has to demonstrate that its digital business model has a clear proposition in terms of its target investors and other potential users. The applicant must also fulfil the rudimentary aspects of a robo-advisory platform such as automated investment allocation and user-centric elements such as categories of investors, awareness on the services offered and transparent fee structure. Similarly, the platform must contain core components of portfolio management services such as risk profiling, suitability assessment, asset allocation and rebalancing.
4. At least 2 licensed representatives (ie CMSRL holders)
To qualify as a DIM applicant, the applicant must have at least 2 licensed representatives.
Each candidate must satisfy the following minimum requirements:
(a) at least 2 years of relevant experience in fund management in relation to portfolio management activity; or
(b) at least 5 years of relevant experience in fund management in relation to portfolio management activity.
The minimum number of 2 CMSRL holders is to be maintained at all times.
A person may qualify as CMSRL holder if the person passes the SC Licensing Examination namely Modules 9 and 10. A CFA charter holders is exempt from Module 10.
Alternatively, the person may seek an exemption. The SC may allow an exemption if the person is able to demonstrate he or she has at least 20 years working experience and at least 10 years relevant experience in the portfolio management industry and held a senior management position in a regulated entity.
5. At least 1 licensed director
The applicant is required to have at least 1 licensed director. Such director must have at least 5 years relevant experience in fund management and holds a CMSRL for portfolio management.
It may be possible for a licensed CMSRL holder to act as a licensed director as well provided that such holder fulfils the minimum requisite experience.
Any material change in respect of the directorship or shareholding must be notified to the SC. For a licensed director, such proposed change must be first approved by the SC.
6. Adequate financial resources
Another requirement imposed by the SC is to have at least RM2 million paid up capital. Additionally, the applicant is required maintain a shareholders funds of RM2 million at all times.
In our view, such financial requirement may be rather high for many young fintech startups to comply. Therefore, it may be expected that many potential DIM applicants may come from established firms or foreign mature startups with the requisite financial backings.
Addressing key challenges
In the course of our regulatory and compliance services, we have identified 3 main challenges which an applicant may face on its application namely compliance, talent sourcing, and technology integration.
The first issue is compliance. As far as the SC is concerned, investor protection is paramount. Therefore, the applicant must be able to demonstrate that it has taken all the steps and measures so that the requirements have been complied. The applicant’s business model will be scrutinized and the applicant must also show that it is able to fulfil the conditions imposed by the SC.
For instance, one of the conditions imposed under the digital value proposition by the Handbook is to have a clear digital business model. Unless the applicant is an established player, it may be difficult for the applicant to provide or show proof that its digital business model is indeed workable. Similarly, the Handbook requires the applicant to demonstrate that the rationale, risks and rules behind the algorithm for the DIM business is well understood.
In addition, as DIM falls as a subset of a portfolio management firm (akin to an asset management firm), the applicant is also required to satisfy the conditions imposed under the Guidelines on Compliance Function for Fund Management Companies (“Guidelines”). To illustrate, some of the key conditions imposed under the Guidelines are for the applicant to provide sufficient internal policies on managing conflicts of interests, safeguarding clients’ interests and management of trusts account, and dealing with other external stakeholders such as custodians and brokerage houses.
For a seasoned applicant that may have been licensed and operating in other jurisdictions, it may not be difficult to fulfil these conditions under the Guidelines. However, most of the existing policies or documents may have to be reviewed and localised to conform to Malaysian laws. For a young startup, satisfying these conditions would indeed be a daunting task.
2. Talent sourcing
Another challenge is talent sourcing. As the applicant is required to have at least 2 licensed representatives, sourcing these talents may be difficult as they are very limited in the first place. Based on the SC’s Annual Report 2017, there were only 817 CMSRL holders involved in fund management. In contrast, there were 6,431 CMSRL holders involved in dealing in securities.
It may be difficult to persuade the potential candidates to leave their employments as many may be employed in established traditional asset management firms. Furthermore, since there is no guarantee that the SC may ultimately issue a DIM license to the applicant, many potential candidates may be reluctant to join such new venture firm especially if the applicant is a young startup. For foreign entrants, it may be more difficult to source these elusive talents without resorting to engaging a recruitment agency. One way to avoid this issue may be through a conditional offer. In this case, the candidate may enter into an undertaking to leave his or her present employment to join the applicant when the approval by the SC has been obtained.
3. Technology integration
Finally, on the technology side, we predict that the applicant may have to apply certain level of customisations in respect of their existing technologies so that it conforms with the local circumstances and dynamics. For example, the applicant must also abide by the SC’s Guidelines on Management of Cyber Risk, which sets out the governance measures imposed on the applicant’s directors in dealing with cyber threats including having a business continuity plan in place in the event of any cyber attacks.
Also, the applicant is expected to work along existing traditional service providers such as brokerage houses and custodians in performing trading instructions and management of trust accounts for the DIM clients. There may be some level of ‘handholding’ involved to get the service providers up to speed to appreciate the applicant’s online business. Having a clear and well understood process flow would help each and every ecosystem players understand their respective roles so that the DIM platform works smoothly.
As at the date of this article, we have yet to hear any announcement by the SC on any successful DIM applicant. It is interesting to point out that on 15 March 2018, during a press conference, Tan Sri Ranjit Ajit Singh, the chairman of SC made a remark that the SC is expected to introduce the first licensed robo-advisory firm “very soon”.
Therefore, it would be interesting for Malaysia to have its first licensed robo advisory platform as it will certainly increase the interest among young people to invest given the financial savings and other benefits that will be derived from using such online platform. On a national level, a robo advisory platform will indirectly increase the diversity of capital market participants in Malaysia by having more retail investors to be involved rather than the usual pension funds and mutual funds.
This article is written by Izwan Zakaria, our Senior Associate at Zurinalaw. For more information about the regulatory framework on robo advisory in Malaysia, please contact Siti Zurina Sabarudin at +03-76245215, or e-mail at firstname.lastname@example.org.