Market stability remains a key focus for regulators who are battling to keep up as technology propels forwards, says latest Liquidnet report, ‘moving on from Mifid’.
As the market experiences a technological surge – with no end in sight as development continues to accelerate – the ‘Q3 2023 liquidity landscape’ report made clear that though regulators remain focused on ensuring stability in markets, there are questions as to the ability to empirically ensure this.
In particular, artificial intelligence’s potential impact on financial infrastructures is a notable consideration, earmarked as a “possible threat to resiliency, stability, and confidence in the financial system”.
There are clear and established benefits of AI, including in risk management, compliance testing, detecting greenwashing, and tracking bad actors, however regulators are particularly interested and focused on its role in price formation and market structure, said the report, which also highlighted how increases in cross-asset and cross-market could potentially exacerbate the levels of systemic risk.
More stringent regulation is expected across technology, data providers and users themselves.
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The report referred to ASIC chair Joe Longo’s speech in June of this year, wherein he asserted that concern regarding the use of AI’s to manipulate markets is a global phenomenon, not exclusive to European markets: “As with any new technology, to the extent that AI affects that ecosystem, to that extent we will be involved. As we realise the potential of tech, we have to do all we can to avoid negative disruption, learned market abuse, misinformation, discrimination, and bias—whether intended or unintended.”
Through analysing the regulatory focus on technology’s impact (specifically AI) on markets, one can glean the direction of travel going forward, said the report, which highlighted four specific areas of focus.
Firstly, attention to understanding the risks to digital infrastructure, particularly in light of the uptick in the use of the cloud. Secondly, ensuring the safety of, and responsibility for, operational resiliency which extends to those services which have been outsourced.
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Finally, the important aspect of data was addressed, specifically its role in model risk management and the potential for AI to affect risk through sample bias, model drift, and the black box effect.
“Responsible AI depends upon data quality, data management, data governance, data accountability and ownership structures, but also data protection,” said Liquidnet.
Elsewhere, the shift to T+1 was highlighted by the report as a key example wherein technology such as AI is expected to be leveraged by the market. ESMA’s recent consultation paper highlighted the importance of regulation stepping in to ease the move for EU participants as AI is set to bring together disparate systems, allowing for the essential communication across the trade lifecycle and greater operational efficiency.
Speaking broadly around regulators’ priorities, Liquidnet’s report suggests that despite various iterations of Mifid II in recent times, the industry is yet to have a clear outline of plans set in order to overcome existing challenges and are effectively going round in regulatory circles.
The report, compiled by Gareth Exton, head of execution and quantitative services EMEA at Liquidnet, stated: “[…] As technology moves to incorporate AI, the industry is standing at a crossroads. We cannot turn our back on technology but the question of how trading can best embrace technology with minimal risk is one that requires further industry clarification and regulatory reassurance.”