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New global survey reveals tensions between optimism and unease

  • Majority believe AI and other fintech will make financial markets more competitive by 2018
  • But more than three-quarters say regulators are unable to keep pace with changing technology
  • Sixty percent say more regulation of AI and machine learning is needed to offset risks
  • Almost half think their own companies don't understand the material risks inherent in AI

Ghosts in the machine: Artificial intelligence, risks and regulation in financial markets shows an industry rapidly seeing the potential benefits of AI, while being increasingly concerned about risk and the ability of regulators to keep pace.

The survey asked 424 senior executives from financial institutions and fintech companies around the world as well as leading experts in the field for their view on how AI will affect the financial sector, what risks and benefits AI will bring to the sector, what the associated regulatory and legal challenges will be and many more questions. Surprisingly similar views emerged from across the globe, with only a few notable variations, such as AI investment seen as lagging slightly in Asia Pacific compared to other regions and Latin American participants seeing AI as a regulatory tool to combat money laundering first rather than market misconduct, the top choice elsewhere.

Key findings

The results provide some insights into the likely future of the financial sector. The most dramatic changes brought about by AI and machine learning within three years are expected to be in the areas of provision of credit, asset management, trading and hedge funds.

On the positive side, AI is expected to improve financial institutions' risk management, through more in-depth assessment of risk in portfolios and more incisive, comprehensive and informed credit-risk assessment. Machine learning is also predicted to make financial markets more competitive by as soon as 2018.

On the flipside, the use of AI in the financial sector brings about significant uncertainties and risks, such as the risk of malfunctioning algorithms, humans' misuse of technology and concerns surrounding the security, privacy and quality of data.

Regulatory inadequacy and the rise of the machines

Survey respondents expressed great unease about the future regulatory response to AI. Over three-quarters are not confident that regulators have the adequate knowledge and skills to stay abreast of new financial technologies and understand the potential implications of AI for financial markets.

Arun Srivastava, head of Financial Services Regulation at Baker & McKenzie says, “Financial institutions have been fined billions of dollars because of illegality and compliances breaches by traders. A logical response by banks is to automate as much decision-making as possible, hence the number of banks enthusiastically embracing AI and automation. But while conduct risk may be reduced, the unknown risks inherent in aspects of AI have not been eliminated."

Survey participants suspect that regulators are only just beginning to understand the potential implications of AI for financial markets and companies. For now, much of their attention is still focused on fighting the last war, identifying compliance breaches by humans directly abusing technology. Their attention is only now beginning to turn to the integrity of algorithms, and any rule-writing on machine learning in the next few years will focus here.

The most popular solution revealed by the survey is more collaboration between fintech companies and regulators, with the second most popular choice coordinated, cross-border cooperation between regulators.

Financial sector calls for yet more regulation

Experts interviewed acknowledge the degree of risk surrounding the use of AI. The survey backs up these concerns, with the risk of malfunctioning algorithms and concerns surrounding the security, privacy and quality of data leading 60 percent of respondents to call for new laws and regulations.

Remarkably, only 16 percent believe financial institutions are already overregulated. A surprising finding perhaps for an industry that has seen relentless waves of new laws and regulation since the global financial crisis.

Almost half of those surveyed are doubtful that that even their own organisations fully understand the legal risks associated with new financial technologies. Such risks include, for example, corporate liability as well as data protection and privacy risk.

Adrian Lawrence, Partner at Baker & McKenzie expects access to data to play a central role in the scope and impact of AI systems, noting that "Data, and the various rules and processes which both enable and regulate access to and use of that data, stand at the heart of disruptive fintech businesses. Even the most advanced and intelligent algorithms and models are useless without efficient, secure and legal access to detailed, accurate and up-to-date data sets."

Human error versus machine error

Just like humans - programmes, computers and machines have the capacity to be stupid. The danger is that they can act at a far greater scale and speed. The importance of maintaining human oversight, comprehension and control of emerging AI systems exposes the contradiction at the core of the technology. When confronted with inherently risky tasks – such as making investment decisions and bets on unknown future events – over-reliance on AI can magnify systemic risks. Yet the same technology can improve the depth and quality of financial institutions’ due diligence of companies. Through their powerful data-crunching capabilities, such applications can also help identify fraud, money-laundering, bribery and other corrupt practices that more conventional methods would struggle to uncover.

With these examples in mind, the survey respondents appear hopeful that machine learning will help them to minimise risks, in some cases. Nearly six in ten (58%) believe it will “greatly enhance” their risk-assessment processes. Machine learning techniques can, for example, be used to alert fund managers about emerging weaknesses in invested companies . Astrid Raetze, Partner at Baker & McKenzie also expects consumer credit risk assessment to be enhanced through more thorough risk profiling of customers suggesting that, “AI should also reduce risk in some areas if deployed properly. Market misconduct and anti-money laundering (AML)/Know Your Customer (KYC) processes are areas where regulators could harness AI to improve regulatory oversight and scrutiny.”

With great power comes….?

Jeremy Pitts, Global Head of Baker & McKenzie's Financial Institutions Group, concludes:

"Many survey respondents are cautiously optimistic about AI’s future role in financial markets. This optimism derives from the recognition that it will transform entire market segments, product lines and greatly increase aspects of risk assessment capability. Concerns on the other hand highlight the potential dark side of AI and the need for banks and other financial institutions to feel they can rely on the rule of law and effective regulation to protect them and their customers by creating a safe environment for innovation to flourish. Applying the truism that business hates uncertainty, the survey results show there is much work to be done."

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