United States: Artificial Intelligence In Financial Services: Tips For Risk Management

Technology is rapidly changing the way investment advisers deliver services to their clients. Funds are now using a range of technology solutions, from advanced trading algorithms to artificial intelligence and machine learning, in order to provide better services to their clients. However, regardless of these advances in technology, funds must take into account their obligations to comply with the securities laws and related rules and regulations. Regulators are stepping up their enforcement actions in this area, as shown by the SEC's recent proceedings against two robo-advisers for violations of the antifraud, advertising, and compliance provisions of the Investment Advisers Act in connection with their automated investment management services.

The term "artificial intelligence" is sometimes used loosely to designate a collection of solutions that require different inputs. Here are some key differences that funds should understand, because each technology comes with its own risks:

View the full Artificial Intelligence in Financial Services: Tips for Risk Management infographic here.

The power of AI and advanced data analytics lies in its ability to augment human decision-making. Although computers are increasingly able to perform tasks that have been traditionally associated with human intelligence, there is no truly "autonomous" technology and firms using AI strategies must implement policies and procedures to appropriately test them for efficacy before and after deployment, and continue monitoring to help ensure compliance. Here, the term "AI" is used at a high level and interchangeably with machine learning and deep learning, in regard to technology that uses data, regardless of form and quantity, to improve performance. Summarized below are some key considerations for building a responsible AI framework.

1 – Accountability
The more complex the program, the more difficult it might be to trace a direct line from the program to the result. However, for compliance purposes, funds must be able to maintain and demonstrate sufficient control over AI decisions. This is important under U.S. securities laws and regulations, to show the fund is properly executing client instructions. Additionally, under the General Data Protection Regulation (GDPR) in the EU, funds must be able to explain to customers what data is being collected and exactly how their data is used, and this requires explaining how any automated solutions work. Finally, funds should be able to trace AI decisions to ensure these decisions align with the fund's own objectives. This includes documenting all stages of AI solutions, including testing and approvals, training, monitoring and maintenance.

2 – Bias
We are all familiar with the concept of "garbage in, garbage out." Feeding algorithms with incomplete or incorrect data is the primary cause of erroneous AI outputs. Risk managers across all industries are therefore increasingly concerned about the unintended bias of AI, such as when data sources are incomplete or contain unintentionally biased information. Rigorous testing processes and controls in the data, model and human use of AI can help ensure data integrity and reduce the risk of unintended biases and errors.

3 – Transparency
AI is sometimes referred to as a "black box" because the connection between inputs and outputs is not always clear and the inner workings are difficult to understand. This poses the risk of discrepancy between the program's code and the resulting transactions. The "black box" problem may also create the perception of a lack of transparency for asset managers and customers alike – e.g., if they don't know how AI comes up with its decisions, they may not trust it. And managers may not be able to explain to regulators how decisions are being made in complex AI transactions that contain hidden decision-making layers. Adding transparency and explainability to the modelling process is key to any responsible AI framework.

4 – Data Integrity
As mentioned, AI solutions are programmed to process data differently, by refining the way decisions are made over time. The corollary of this process is that AI decisions are only as good as the inputs. The first results are likely of lesser quality than subsequent ones. Second, if data continues to be limited or inaccessible after the first decisions are made, the results might not improve at the expected rate. Simply put, AI's effectiveness depends on the availability of sufficient, high-quality data.

5 – Governance
The fast pace at which technology evolves requires corporate governance to stay knowledgeable and abreast of the technology. It is important to design effective AI operating models and processes to improve accountability, transparency and quality. Regulators will expect funds to have in place robust and effective governance and controls, including a risk management framework (RMF) to identify, assess, control and monitor risks associated with each AI application. In this regard, AI may also accelerate the RMF lifecycle and impact risk appetite statements.

6 – Errors
With the speed at which AI evolves comes the potential for magnification of errors. Since AI is designed to "learn" from inputs, any error that occurs early in the program's execution might quickly turn into a large scale problem. Updates should be executed as smoothly as possible, while minimizing any risks to upcoming, pending or completed transactions. Still, glitches or "bugs" might occur when AI is upgraded, and there might also be issues with the accessibility or use of legacy data. Funds should have processes and procedures in place to document and identify faulty logic or reasoning, as well as remediation protocols.

7 – Security
Increased dependency on AI may introduce additional security vulnerabilities. Funds should have in place appropriate procedures for rigorous validation, continuous monitoring, verification and "adversarial" testing. Limiting access to AI systems to appropriate personnel may help prevent manipulation and exploitation of data.

8 – Cost
Although AI solutions were adopted by funds in order to drive cost efficiencies, they might not always be the most cost-efficient solution once other risks have been assessed. This depends on the degree of personalization that is required by the fund, and the cost at which it is offered. AI solutions also require skilled technical staff to design, maintain and run the systems. Additionally, what works in one sector might be very different in another sector. For example, a recent survey conducted by the European Financial Management Association in partnership with Deloitte shows that the banking and insurance sectors assess the impact of AI differently. Although AI is an attractive customer service option for banks, it is less appealing for insurance companies, perhaps due to the different level of engagement required for certain transactions. Conversely, AI might provide a better solution for back office/operations in the insurance sector than in the banking sector.

9 – Insurance
Funds and other organizations increasingly manage the risks posed by their AI solutions with appropriate insurance coverage. Although new products are being created to meet increasing demand, insurers occasionally perceive AI as a risk multiplier. In addition to creating risks of its own, AI changes how insurers and funds alike analyze risks they have already identified.

AI must be used responsibly. Although funds are increasingly considering AI solutions, they should look carefully at how AI impacts existing risks and creates new potential legal and compliance risks for their organization. We expect regulators to closely monitor AI applications and continue to be aggressive in bringing enforcement actions against firms for the misuse of AI. Building a responsible AI framework will help funds maintain compliance with legal and regulatory requirements, while continuing to provide high levels of customer service in a cost-efficient manner.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Sign Up
Gain free access to lawyers expertise from more than 250 countries.
 
Email Address
Company Name
Password
Confirm Password
Country
Position
Industry
Mondaq Newsalert
Select Topics
Select Regions
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions