Sen. Peters releases report on how AI informs hedge funds trading decisions

A report examining how hedge funds use artificial intelligence (AI) to inform trading decisions was released this week by U.S. Sen. Gary Peters (D-MI), chair of the Senate Homeland Security and Governmental Affairs Committee.

The report had several broad takeaways, including that AI technology is outpacing the work of regulators, who have only recently begun to examine how AI is used in their respective industries and how regulations may apply to AI use.

Further, it found a lack of baseline standards to ensure these systems do not produce unintended risks. As more hedge funds use AI for increasingly diverse and more advanced purposes, the risks could increase without sufficient baseline requirements and safeguards.

In addition, it identifies needed reforms to mitigate current gaps in protocols and to update existing requirements to ensure hedge funds are safely adopting evolving technologies.

“As hedge funds and the financial sector at large increasingly use AI to inform trading decisions, it is critical that there are safeguards in place to ensure the technology is being used in a way that minimizes potential risks to individuals and to market stability itself,” Peters said. “My report and recommendations will help encourage responsible development, use, and oversight of AI across the financial industry by identifying needed reforms to establish a cohesive regulatory framework.”

More specifically, the report featured the following points:

• Hedge funds use different terms to name and define their AI-based systems. They use AI to inform aspects of trading decisions such as pattern identification and portfolio construction. A variety of terms are used to name their systems, such as expert systems, algorithmic systems, and optimizers.
• Hedge funds do not have uniform requirements or an understanding of when human review is necessary in trading decisions.
• Existing and proposed regulations concerning AI in the financial sector fail to classify technologies based on their associated risk levels.
• Regulators have begun to examine regulations for potential gaps in authority but have not sufficiently clarified how current regulations apply to hedge funds’ use of AI in trading decisions.

It also made the following recommendations:

• Create common definitions for hedge funds’ systems that utilize AI. The U.S. Securities and Exchange Commission and Commodity Futures Trading Commission should define guidelines and standards for how hedge funds name and refer to trading systems that utilize AI.
• Create AI operational baselines and establish a system for accountability in AI deployment: Regulators should create operational baselines that address testing and review of AI systems by hedge funds to inform trading decisions.
• Require internal risk assessments that identify levels of risk for various use cases.
• Clarify authority of current regulations. Regulators should also continue to examine potential gaps in regulations and propose rules to address unique concerns posed by AI and AI related technologies. These reviews should examine risks to both investors and larger financial market impacts.

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