Introduction
Technologies like Artificial Intelligence ("AI") are expected to be inevitable in all high rank sectors including the securities market. It is projected that AI has the potential to add 1 trillion dollars to the Indian economy by 2035.1 SEBI, being a market regulator, effectively oversees the market's operation and it has been adapting methods in response to rapidly evolving technology.
The operation of AI is expected to inevitably increase efficiency and enhance business activities. Indian companies are also gearing up for this transformation and have witnessed an increased integration of AI into production processes from 8% in 2023 to 25% in 2024.2
No doubt that AI tools facilitate the execution of their tasks, it is frequently argued that complete reliance on AI tools may not always be significant and that they may not fully comprehend or provide the precise results that are anticipated from them. One of the key factors can be attributed to be a lack of strict and effective legislative framework.
The Government of India has made an attempt to regulate AI use and encourage its responsible application. Recently, under the IndiaAI Mission "Safe and Trusted AI", various proposals were requested for projects including risk mitigation and deepfake identification by the Ministry of Electronics and Information Technology. Moreover, SEBI has also made remarkable initiatives in understanding the integration of AI in the securities market and it has been working towards regulating and inculcating the usage of AI in its framework.
This article highlights SEBI's initiatives to regulate the usage of AI by mandating disclosure requirements and holding Market Infrastructure Institutions ("MIIs"), Intermediaries and others accountable for its usage of such AI technologies.
Current SEBIs Framework
- Compliance Requirements for MIIs
SEBI has imposed reporting requirements on MIIs including all
registered Depositories, stock exchange and Clearing Corporation
vide Circular dated January 31, 20193. It mandates that if any
depository participant uses any application or system or offers any
service which uses AI/ML techniques, it shall report to SEBI on
yearly basis and the Depositories shall consolidate and compile
such report on yearly basis and submit it to SEBI The said Circular
also provides that all MIIs using or offering AI/ML techniques
shall also fill requisite form and submit to SEBI
on a quarterly basis.
Pursuant to SEBI Circular dated May 09, 20194, SEBI imposed reporting requirement on all registered Mutual Fund, Asset Management Companies ("AMCs") and AMFI, respectively. It provides that all the registered Mutual Funds which uses any application or system or offers any service which uses AI/ML techniques shall fill requisite form and make submission on quarterly basis and AMFI shall consolidate the information on AI/ML application or system on quarterly basis and submit to SEBI.
Such reporting shall contain details about the name of the tool/ technology that is categorized as AI/ML, type of area where AI/ML is used, whether it disseminates investor mentor trading advice or strategies, whether key controls and control points in AI/ML works in accordance with the mandatory cyber security control requirement, what are the safeguards in place to prevent abnormal behavior of the AI/ML application/ system and various other details.
Such elaborative disclosure mechanism helps investors and stakeholders to take informed decision which shall be best for their interest. Recently, SEBI published a consultation paper dated November 13, 20245 wherein it deliberated on assigning responsibility on regulated entities including MIIs, Intermediaries, AMCs, managers of pooled investment funds for the usage of advanced AI/ML technologies.
Usage of advanced AI technologies enhances investment and trading facilities, disseminates strategies and advices and also enhances the efficiency of other business activities.
All such regulated entities that use AI/ML technologies whether designed by it or produced by any other 3rd party shall be solely responsible for:
(a) The privacy, security and integrity of the investors
(b) Stakeholders' data including data maintained by it in a
fiduciary capacity throughout the process involved
(c) If the output arising from the usage of such tools and
techniques is relied upon or dealt with
(d) For the compliance with applicable laws in force.
By imposing such restriction and responsibility, SEBI is aiming to protect the paramount interest of all the investors and other stakeholders involved in the securities market. SEBI has approved this proposal in a board meeting dated December 18, 20246
- Responsibility on digital platforms
Pursuant to SEBI Intermediaries Regulation, Securities Contract
(Stock Exchanges and Clearing Corporation) Regulations and
Depositories and Participants Regulations, SEBI has mandated that
no regulated entities including MIIs, Intermediaries and others
shall have any direct or indirect association with another person
including digital platforms who provides advice or any
recommendation whether directly or indirectly, or makes any claim,
of return or performance, expressly or impliedly, in respect of
securities, who are not permitted by the board to do so.
However, such association shall be allowed if it is made through a
specified digital platform ("SDP").
SEBI has suggested that for getting recognition as a SDP, the digital platform shall inculcate certain preventive and curative measures.
One such preventive measure is deployment of advanced AI/ML technology or tools for outlining comprehensive guidelines and system to identify and analyse content or advertisement related to securities market and one such curative measure is to deploy such AI/ML technologies or tools for identifying and analyzing any violative content and advertisement and take appropriate measures.7
By encouraging digital platforms to use AI/ML techniques, various uncontrolled information relevant to the securities market may be simply processed.
- Responsibility on Investment Advisers (IA) and Research Analyst (RA)
SEBI published a consultation paper dated August 06, 20248 for reviewing the existing regulatory framework for investment advisors and research analyst on their usage of AI tools in IA and RA services.
Investment Adviser is any person who is engaged in the business of providing investment advice according to the client's specifications whereas Research Analyst is a person who is involved in preparing and publishing research reports, making recommendation and opinion concerning public offers among others.
As IA and RA provides services using AI/ML technologies, SEBI emphasizes on complete disclosure requirement on them to the extent of use of such tools and also imposes responsibility of data security and compliance with regulatory provisions under SEBI.
Way Forward
While AI is easily explored in all the sectors, its use in the
securities market is beyond impressive and beneficial. As
discussed, SEBI has made some remarkable initiatives for regulating
AI technology across its framework. SEBI not only emphasizes on
imposing responsibility on MIIs, Intermediaries and others for the
usage of AI/ML technologies but also mandates on complete
disclosure requirements by Depositories, Mutual Funds and IA/RA for
investors to take informed decisions. However, presently it is
observed that SEBI has not deliberated upon the responsibility of
IA/RA for any loss or damage incurred to the investor/
stakeholders due to such advice or recommendation by IA/RA when
they use AI/ML technique or tools as done for MIIs and
Intermediaries. India follows the lead of EU for inclusion of AI as
EU has already enacted and enforced AI law which came in force on
August 01, 2024. The EU law bifurcated AI technology on the basis
of risk, namely, prohibited, high risk, limited risk and minimal
risk categories. Moreover EU law has zero tolerance policy for AI
models that engages in manipulative activities. India can
incorporate such AI bifurcation for setting different compliance
requirements. This risk- based approach can help to create a
balance between innovations and safeguard public interest.It is
expected that 2025 is the year of hope where SEBI might confirm all
the regulatory changes and put strict responsibilities on the
regulated entities following which investors/ stakeholders and
other users may feel confident for AI use.
Originally published in January 2025.
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.
