The FCA released its Sector Views report for January 2019. It identified a number of risks for wholesale financial markets.
In the Investment Management Section, the FCA identified automation as a threat to stability and resilience: “Increasing use of automation in financial services and in outsourcing, and the oversight problems this can cause, are contributing to a greater potential for stability and resilience to be threatened.”
“Failure or disruption at one or more of the small number of custody banks and investment administration service providers could result in significant harmful side effects. All assets under management in this sector are held for safekeeping by a small number of ancillary service providers. Serious failure or disruption at one or more of these could result in widespread harmful side effects which could threaten stability and resilience.”
“Significant harmful side effects could result from failure at one or more of the small number of firms relied on for outsourced technology services. Outsourcing to third party technology providers is growing, meaning that the proportion of assets potentially affected is increasing.”
“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.”
“Technological failure or disruption, including from cyber crime could threaten market confidence and participation. Barriers to successful cyber-enabled financial crime are reducing due to technological advances. This increases the availability and commoditisation of sophisticated cyber-attack tools. Gaps in controls and oversight could also make cyber crime attacks more likely.”
The FCA also said that 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.
“Inappropriate technology-led asset management decisions could also result in harmful side effects. The proportion of assets invested through technology-led decision making is currently small but growing. The speed of machine reactions could have serious consequences. If artificial intelligence using an algorithm were to make an inappropriate asset management decision, any resulting losses could be quickly compounded.”
In the General Insurance and Protection Section, the FCA noted that continuous developments in data and technology create new opportunities and risks.
“Data can give insurers (and also distributors) the means to commercial advantage through pricing, underwriting and marketing. How firms use data is now subject to tighter regulation under the General Data Protection Regulation (GDPR), which increases the penalties and means of redress for misuse.”
“Blockchain technology is enabling innovative products and platforms. These include a platform for marine cargo transactions and a flight delay policy to pay claims without the need for notification by customers.”
“Insurance products are coming onto the market that link with connected home technology to incentivise behaviour that lowers the likelihood or severity of claims. These include leak detectors in homes and wearable fitness monitors with health insurance.”
“We expect artificial intelligence (AI) to have significant future application in the sector, including possibly in claims functions. AI has the potential to reduce costs and increase productivity, but also the potential for negative outcomes, for instance if algorithms are used that exploit behavioural biases.”
Regulation, the FCA wrote, is driving increased accountability. “New regulations in 2018 have increased the accountability of firms and individuals for product governance and oversight (Insurance Distribution Directive) and data (General Data Protection Regulation).”
“Accountability in the sector will also be further extended by the inclusion of insurers within the scope of the Senior Managers and Certification Regime from December 2018.”