While the smokescreens on the greenwashing battlefield have yet to lift, a new headache file has presented itself in financial markets: the impact of artificial intelligence on market participants and regulators. On that front, transparency is “zero”, European Markets Authority Esma has concluded in a new study on artificial intelligence in EU securities markets.
Fewer than 0.2 percent of all Ucits funds in the European Union have informed Esma that they use artificial intelligence, according to the researchers. The reputational risks it might involve can make professional investment firms very cautious about promoting AI.
So far, there is also little reason to be extensively bullish on AI. In practice, AI-related funds do not outperform traditional mutual funds, the research suggested. AI, like all other market players, is at the mercy of the “fundamental uncertainty of financial markets”. Therefore, like any human and product, AI should be subject to a process of regulation.
In fact, the experts argued, practice also shows that AI combined with human tuning and/or supervision yields the best results. Where AI does have an independent role to play is in classifying data pre- and/or post-trade. This is especially true for ESG analysis, but increasingly also for AI›s potential in automated trading.
Esma concluded that one of the biggest risk factors of using AI is its impact on performance models and risk management. Esma said concerns about the use of AI apply in a general sense to all quantitative models. More importantly, the knowledge gap between intermediaries and quantitative finance can widen as a result of AI.
Market concentration risks
When it comes to investments, the increased uptake of AI can create new risks in transparency, market concentration systemic risks, a bias towards algorithms, operational risks and model risks.
At a systemic level, the authors of the study warned in particular about concentration risks. The development of AI, entry into these markets may become increasingly difficult and may involve outsourcing to just a few asset managers who can deal with the required resources in terms of money, technology, infrastructure and data.
At the same time, such concentration is in turn also a risk for the financial sector as a whole, as the European supervisors and regulators identified in its 2022 Advice on Digital Finance.