The world’s market watchdogs take aim at AI washing

No one wants to miss the artificial intelligence (AI) wave, least of all the financial markets. Investment banks, analyst firms and advisors have accelerated its use, while market watchdogs are trying not to be left behind. Supervisors are issuing a battery of warnings about its abuse and are working to prevent the use of AI from inducing savers to change their investment behavior, or even from one day becoming a systemic risk, capable of shaking the market.

Gary Gensler, chairman of the U.S. Securities and Exchange Commission (SEC), recently warned companies to avoid false claims about the use of this technology that could benefit their stock. Moreover, he urged companies to avoid the practice of greenwashing and to shun the AI washing phenomenon.

The S&P 500’s third-quarter earnings season perfectly illustrates companies’ eagerness to showcase their use of AI. According to a Reuters survey, more than 30% of the index’s constituents used the term AI in their presentations to analysts, compared to just over 10% who mentioned it a year earlier. Among the ratings firms, Moody’s and S&P Global used the term a total of 58 times in their meetings with analysts. Three months earlier, Moody’s mentioned it only once and S&P Global 10 times.

One of the companies that is being most affected by artificial intelligence is Microsoft. The tech company was first hit by the sudden departure of the artificial intelligence guru Sam Altman from OpenAI, only to reach new record highs a few days later as the high-profile conflict was resolved. This kind of roller coaster ride was also seen some time ago in the midst of blockchain euphoria or even over marijuana, when there were cases of shares soaring in a single day as a race unfolded to get hold of the POT ticker or simply to incorporate the word blockchain into the company name and promise new investment opportunities with this technology, like smoke peddlers.

Investor protection

Beyond specific examples, market watchdogs want to be prepared for the fronts opening up due to the increasingly frequent use of artificial intelligence and to prevent it from becoming a trigger for a future crisis in the financial system.

In Europe, the European market supervisor, ESMA, is cautious about the advance of AI. Its chairwoman, Verena Ross, has acknowledged its potential benefits “for investors and the market” but has been cautious about its potential risks in terms of data privacy, market manipulation — leading to distorted prices — and more ethical concerns, with regard to possible investment decisions that go against consumer welfare. Hence, the supervisor urges for algorithms used by AI to be transparent and free of bias.

ESMA admits that asset managers are increasingly using AI for their investment strategies and risk management but that “few have a fully AI-based investment process in place and publicly promote its use,” Ross admitted. Similarly, brokers and financial institutions use these tools to reduce the market impact of large orders and minimize settlement failures.

However, the European supervisor has pointed out that the concentration of AI tools in a few systemically important providers could pose a risk and endanger financial stability.

In contrast to European caution, in the U.S. the SEC and the financial industry have become embroiled in a dispute over the future regulations that will govern the use of AI on Wall Street. This aims to address potential conflicts of interest that may arise from its use, even pushing investors to change their financial habits. The industry has been using this type of technology for years to prevent fraud and monitor the market, although more recently it has been applying AI to manage assets or even recommend transactions. The U.S. supervisor notes that the scalability of this technology may cause any resulting conflicts of interest to cause “harm to investors more pronounced and on a broader scale than was previously possible.”

Greenwashing

While the debate about the dangers of AI in financial markets still remains at a very theoretical level, the fight against greenwashing is already a reality. “Greenwashing undermines the fundamental trust in sustainable finance. To ensure the health of the global sustainable finance market, reliable, consistent and comparable sustainability information is needed, while ESG products must be marketed and managed in a way that does not undermine investor confidence,” recently acknowledged Rodrigo Buenaventura, chairman of Spain’s securities watchdog CNMV, who is leading a working group within the International Organization of Securities Commissions (Iosco) to tackle investment sustainability issues.

It is an endeavor that seeks to address all the loopholes that have arisen around the sustainable investment boom and seeks to prevent financial products from being marketed under a green label when they are far from being so.

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