FCA maps out ‘inherent risks’ in growth of algo and AI-based trading

Investment management firms have been warned by the FCA that further adoption of technologies to facilitate trading presents various risks. 

The UK’s financial watchdog has warned that increased use of artificial Intelligence (AI) and algorithmic decision-making trading could lead to widespread market failures and flash crashes.

In the investment management section of its annual sector view report, the Financial Conduct Authority (FCA) outlined the potential risks that come with accelerating trading speeds through technology and algo trading activities.

The FCA said an increasing share of liquidity is now being provided by highly technology-reliant, non-bank proprietary trading firms, which could increase risks further if an algorithm fails. At the same time, firms using the same AI and algo systems could encourage “herd behaviour” leading to similar trading decisions.  

An increasing number of asset managers and hedge funds are looking to adopt AI and other technologies to gain efficiencies and to automate certain business functions. In early 2019, a survey found that 61% of the buy-side expected to increase spending on AI technology over the course of the year.

Elsewhere, the FCA’s report said that there are benefits to using AI in terms of regulatory compliance through automation and by alerting firms to potential gaps. Technology could help simplify risk management, but the regulator warned that firms need to do “significantly more” to deal with online threats to the business.

The FCA also saw a 7% increase in technology outages in 2019 compared to the year prior, adding that these shortcomings remain a key challenge across the UK’s financial services sector.

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