The Rise of Cyborg Finance

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Can regulators keep up with the financial industry’s changing landscape?

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Complex supercomputers, mathematical algorithms, and artificial intelligence—the typical ingredients for a riveting science fiction movie—have found their new home on Wall Street.

As artificial intelligence continues to accelerate, new computer trading programs operate at increased profitability without human intervention or oversight. These new technological advances in the financial industry have led some scholars to argue that in more global and inter-connected financial networks, a “human” touch will soon be replaced.

In an effort to guide regulators in an increasingly complex financial industry, Tom C.W. Lin, a professor at Temple University Beasley School of Law, examined potential ways for regulators to adapt current regulatory principles for a technologically evolving securities regime.

Lin’s recent paper describes the consequences of the financial industry’s transformation, explains some of the current regulatory approach’s shortcomings, and provides guiding principles for regulators moving forward.

Lin characterizes the impact of rising computerization and artificial intelligence in the financial industry as cyborg finance, or “cy-fi.” He points to this new regime’s alterations in traditional financial structures, growth in shadow banking, and increasingly limited roles for humans in finance. He explains that with continued technological and financial innovations, like electronic trading, the industry is less “human,” but that humans are still critical in the new system.

Key features in the new financial industry include using supercomputers to analyze risk, manage assets, and execute trading at enhanced speeds. Increasing artificial intelligence, Lin argues, will continue to lower barriers to market entry and make traditional frameworks, like stock exchanges, less relevant. However, enhanced speed and inter-connected networks might make industry participants more vulnerable to industry crashes or cybercrimes.

Lin also claims that the financial industry’s concern with systemic risk will create new risks because financial institutions will become “too linked to fail” and “too fast to save.” He distinguishes a “too linked to fail” systemic risk as including smaller participants that might affect the system because of their linkages despite small size or value. He also highlights that while accelerated speeds in finance increase efficiency, speeds also increase error risks, volatility, and market fragmentation before regulators or other parties can respond effectively.

Although an increasingly inter-connected and global network without substantial human oversight exacerbates regulators’ concerns, Lin suggests financial regulators and policymakers should embrace the new realities of the financial industry to provide a better regulatory framework for the new industry.

Specifically, Lin advises that regulators should enhance existing disclosure rules, create ways to regulate safer speeds in finance, coordinate through inter-agency cooperation, develop improved governance tools, design customized rules whenever possible, and encourage industry participants to behave responsibly without providing public bailouts.

He also recommends that policymakers modify existing frameworks to favor pre-determined re-assessment—where temporary rules with sunset provisions and ample opportunities for review are chosen over lasting rules. He argues this framework will allow financial regulation to reflect current market realities and information, even as cy-fi continues to rise.