ESMA's new guidelines: How do they affect AI in investment services for retail investors?

Background on the new guidelines

ESMA has issued guidance on the use of artificial intelligence (AI) in providing investment services such as portfolio management or investment advice to retail investors. The rapid development of AI presents significant opportunities for efficiency, innovation, and enhanced decision-making in the financial sector. However, it also introduces inherent risks such as data quality issues and potential lack of transparency. This guidance is one of the first of its kind and provides initial instructions to investment firms, including credit institutions covered by MiFID II regulations, to ensure that AI is used responsibly with a focus on clients' best interests.

What opportunities does AI offer in investment services?

AI has the potential to revolutionize various aspects of investment services. AI-driven chatbots and virtual assistants can, for example, improve customer support by answering queries and providing account information. AI tools can also analyze customer data to provide personalized investment recommendations and manage portfolios, processing large amounts of financial data to predict market trends and identify investment opportunities.

In the compliance area, AI systems can assist firms in summarizing and analyzing financial regulations, detecting non-compliance with MiFID II rules, and preparing compliance reports. Additionally, AI can evaluate risks associated with investment opportunities and monitor the overall risk in clients' portfolios. AI can also detect unusual patterns in transactions and communications that may indicate fraudulent activity and automate tasks such as data entry, report generation, and transaction processing, allowing employees to focus on more complex tasks.

What risks should companies be particularly aware of?

Despite the many advantages, AI also presents significant risks. Over-reliance on AI for decision-making without human judgment poses risks, particularly in unpredictable financial markets. AI systems often operate as "black boxes," meaning that their internal functions are not visible to the user. Thus, one can input data and receive output without being able to inspect the system's algorithms and the logic producing the output. This makes the decision-making basis of AI systems difficult to understand and adjust.

Moreover, the extensive data used by AI tools raises substantial privacy and security concerns as well as ESG considerations. AI can also produce incorrect, inaccurate, or biased results due to data quality issues and inherent algorithmic biases.

MiFID II requirements

When using AI in investment services, it is crucial to maintain the fundamental obligation to act in the client's best interest. Investment firms must clearly inform clients about the role of AI in decision-making processes and ensure that this information is presented clearly and fairly. Similarly, the use of AI in interactions with investors must be transparent.

When AI is integrated into investment services such as portfolio management or investment advice, the role of management is crucial to ensure compliance with MiFID II's organizational requirements. Effective risk management frameworks are needed to handle potential risks and biases.

Investment firms should also be aware of MiFID II's requirements regarding outsourcing of critical functions and ensure adequate due diligence when selecting third-party providers. Additionally, MiFID II requires that firms using AI maintain high-quality standards and implement strict controls to ensure the accuracy of the information provided. It is also important to establish clear documentation and reporting mechanisms to ensure transparency and accountability in AI-related risk management practices.

ESMA’s remarks

ESMA emphasizes that while AI presents significant opportunities, it also requires careful management to ensure compliance with MiFID II and protect investor interests. Therefore, firms are encouraged to seek additional resources and engage with supervisory authorities to effectively address AI-related challenges. ESMA and national supervisory authorities will continue to monitor the development of AI and relevant EU legislation to determine if further action is needed.

We also find it crucial that investment firms not only implement AI tools but also continuously assess and adjust their use to ensure they remain compliant with regulatory requirements and ethical standards. This ESMA initiative serves as an important reminder of the need for a balance between innovation and responsibility. By promoting transparency, implementing robust risk management practices, and ensuring compliance with legal requirements, firms can leverage the potential of AI while safeguarding investor trust and interests.

ESMA’s initiative acts as initial guidance for investment firms on the responsible use of AI in light of MiFID II obligations. Investing in staff training and maintaining a strong internal control structure will be essential for navigating the complex challenges posed by AI technologies. This is a step towards a future where AI can be used safely and effectively to enhance investment services for retail investors, while ensuring investor protection remains central.

Do you have questions?

If you have any questions or require further information about the use of AI in investment services and compliance with MiFID II regulations, please feel free to contact Partner Kim Høibye, Associate Partner Jakub Zakrzewski, or Assistant Attorney Honas Kader.