The Financial Conduct Authority (FCA) has identified “inappropriate technology-led asset management decisions” as one of five issues in the investment management sector that could undermine stability.
Writing in its annual “Sector Views” publication, the regulator said such decisions could result in “harmful side effects”.
The proportion of assets invested through technology-led decision-making was small but growing, and “[t]he speed of machine reactions could have serious consequences,” it said.
“If artificial intelligence using an algorithm were to make an inappropriate asset management decision, any resulting losses could be quickly compounded,” it added.
“Greater use of Big Data and developments in artificial intelligence are likely to see growing use of machine-based decision making by asset managers in security selection, asset allocation and trade execution.”
Another issue identified by the FCA was that “significant” harmful side effects could arise from failure or disruption at one or more of the small number of custody banks and administration service providers in the sector.
Significant harmful side effects could also result from failure at one or more of the small number of firms relied on for outsourced technology services, according to the FCA.
Outsourcing to third party technology providers was growing, which meant that the proportion of assets potentially affected was increasing, the regulator said.
“Any increase in levels of outsourcing, which could exacerbate the likelihood of firm or technology failure, may be offset by increased regulatory focus on third party service provision oversight,” it added.
The FCA also said barriers to successful cyber-enabled financial crime were falling due to technological advances, which increased “the availability and commoditisation of sophisticated cyber-attack tools”.
The general trend linking these issues, the regulator’s report suggested, was “increasing use of automation in financial services and greater outsourcing”.
“While these bring benefits to the industry they, and the oversight problems they can cause, also have the potential to threaten stability and resilience across the sector,” said the FCA.
The regulator also identified growth in funds investing in less liquid assets as a sector-wide issue.
However, it noted that the experience of real estate funds after the UK Brexit referendum in June 2016 showed “material consumer detriment” could be avoided by the use of liquidity management tools.
In addition, investments in less liquid assets were increasing at only a slow rate, the FCA said, regulators such as the International Organisation of Securities Commissions had moved to mitigate potential issues from such funds.
The FCA’s sector analysis will feed into its business plan for 2019-2020.