In the Netflix series Eat the Rich: The Gamestop Saga (2022) novice retail investors explained how Robinhood’s app played a key role in encouraging them to trade for the first time. Built to “democratise” finance, Robinhood’s app was beautifully designed. First, it had a “clean”, “fresh” look. It was minimalist, uncomplicated and jargon free. You didn’t need to be Ray Dalio or Warren Buffett to understand its features. Second, setting up an account and depositing funds was easy. No need to wait around whilst others were trading away, taking advantage of the opportunities presented by COVID-19 induced volatility. Third, and perhaps most enticing of all, Robinhood’s app made trading fun. Just placed a trade? Cue the confetti to celebrate. Want to stay ahead of the latest trends? Easy. The app provided a summary of biggest movers and shakers.
There’s no denying the genius of Robinhood’s design. However, the fallout from the Gamestop Saga prompted regulators to carefully scrutinise the behavioural science that underpinned many retail trading apps. They were not impressed with what they found. The Massachusetts Securities Division stated that Robinhood had employed “strategies such as gamification to encourage and entice continuous and repetitive use of its trading application”. The UK Financial Conduct Authority (“FCA”) followed suit, commissioning research into self-directed trading in high-risk investments. Published in early 2021, the resulting report found that new trading apps had “…significantly reduced the barriers to entry and made self-directed investing (including in high-risk, high-return types like CFDs, cryptocurrency and investment-based crowdfunding) more accessible to consumers through low or no fee models and easy-to-use smartphone apps.” Combined with overconfidence, low levels of financial resilience and emotions such as a fear-of-missing-out (“FOMO”), attractive and frictionless trading apps can pose significant risks to retail investors, asserted the report. The level of concern was such that, in Finalised Guidance 21/1 on the fair treatment of vulnerable customers, the FCA stated an:
“…example of poor design that could result in harm to vulnerable consumers is contracts for difference (CFDs) offered to retail consumers. This can include financial spread bets. These complex, leveraged products are offered through online trading platforms. Before we imposed restrictions on how CFDs were sold to retail consumers, their projected returns made these high-risk, speculative products seem attractive. However, many consumers were unable to understand the complexities of the products or the impact of the leverage on the likelihood of the products making a profit. This put consumers, particularly those with low financial resilience, at risk of significant financial losses that they would be unable to absorb.”
Roll forward to Autumn 2022, the FCA clearly does not believe that the retail brokerage sector has paid enough attention to the work it undertook in 2021. Set against the backdrop of a cost of living crisis that, by May 2022, had plunged an additional 2.2 million UK based adults into a situation of low financial resilience (up to a total of 12.9 million from 10.7 million in February 2020), on 21st November 2022 the FCA released details of research that it had recently conducted into the gamification of trading apps. The findings of this research provided examples of features that give the FCA “cause for concern”, including:
- the provision of positive reinforcement after a user has placed a trade;
- celebratory messages;
- falling confetti;
- “leader boards”;
- the delivery of push notifications, ostensibly to provide users with market updates
- lists of real time price changes;
- those changes lit up in red or green; and
- suggestions about how much a user should invest, often defaulted to high amounts.
The FCA believes such features tend to “manipulate” customers to make decisions that are not in their best interests. In particular, the FCA considers that they risk equating high risk investing to gambling, something which poses substantial risk to customers who are vulnerable because of low levels of financial literacy and/or resilience. Customers who suffer from addiction could be enticed to trade at levels that are beyond their risk appetite. Accordingly, the FCA stated that it expects retail brokerages to review their products “now” to prepare for the implementation of the Consumer Duty.
It can be implied from the FCA’s statement that it expects the aforementioned features to be removed from trading apps, at least for retail clients. It would be a mistake, though, to assume this is the limit of the FCA’s expectations. A careful examination of Finalised Guidance 22/5 reveals several other features that firms offering retail trading apps would be wise to consider. Selected examples include:
- introducing “positive friction” in the account opening process. Instead of racing to onboard prospective customers as quickly as possible, firms should provide additional information to help them make informed investment decisions. This could involve requiring that prospective customers watch an educational video to help them better understand the risks associated with trading complex products;
- placing customers who exhibit low financial resilience and/or signs of addiction within a negative target market for complex products such as CFDs;
- re-examining where payment for order flow (“PFOF”) may exist in distribution chains for products manufactured by firms based in third countries but which are sold to customers in the UK;
- considering whether financial promotions help customers arrive at effective, timely and properly informed decisions, taking into account the work the FCA has recently undertaken concerning high risk investments;
- ensuring that customer support for a digital only service is sufficiently flexible to respond to the needs of customers facing unusual situations, for example when an account has been frozen; and
- if inactivity fees are levied, considering whether these unfairly take advantage of customers’ inertia.
Flashy IT systems may assist retail brokerage firms in meeting the challenges posed by the Consumer Duty. Nevertheless, there is no substitute for getting the basics right: careful planning, well oiled project management, comprehensive training and fully documented decision making. Effective implementation is unlikely to be as visually alluring as one of Robinhood’s trading apps. Then again, that’s precisely the point.
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Originally published by Thomson Reuters © Thomson Reuters
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