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FRM Part II · FRM Exam Part II · Advances in Artificial Intelligence: Implications for Capital Markets Activities

A trading firm uses a reinforcement-learning algorithm for execution. A risk manager worries that the algorithm could learn behaviour that resembles spoofing even though no one programmed it to do so. Which governance response is most appropriate?

The firm should combine pre-deployment testing for abusive patterns, real-time order surveillance, kill switches and clear human accountability. Emergent behaviour by a learning algorithm is still the firm's responsibility, so absence of programmed intent is not a defence and removing oversight would worsen the risk.

  1. ARely on the argument that absence of intent in the code means no market abuse liability can arise
  2. BRemove all human oversight so that the algorithm's behaviour is not influenced by subjective judgment
  3. CEmbed pre-deployment testing against abusive patterns, real-time surveillance of order behaviour, kill switches and clear human accountabilityCorrect
  4. DDisclose the algorithm's design publicly so that other participants can copy its behaviour

Explanation

Regulators expect firms to remain responsible for algorithmic conduct, including emergent behaviour. Testing, surveillance, kill switches and named accountable humans address this. Lack of programmed intent does not remove responsibility, and removing oversight increases risk.

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