Next let’s see what kind of legal problems will arise when AI technology is applied to stock trading.
Let’s show issues and domains in this figure.
This figure shows three domains of issues
(1) Relationship between investors and AI / API providers (problems of autonomy)
(2) Issues of the technology itself
(3)Issues with the market,
It is analyzed from each point of view.
(1) Autonomy of stock trading
If an investor uses autonomous stock trading systems to conduct stock tradings,it is the problem whether the investor has the whole the responsibilities of the trade ,or the provider of the system in operation is responsible of the trade.In other words, it is said that investors make investment decisions on their own. Legal issues in Robo Advisors service are also discussed from this point of view.
It means that such kind of service may fall under the Financial Instruments Businessas stipulated by the Financial Instruments and Exchange Act.
Article 2, para 10
the purchase and sale of Securities or intermediation, brokerage, or agency for it, using an electronic data processing system, conducted through any of the following price formation methods or other similar methods, with a large number of persons participating simultaneously as parties on one side of the transaction or as parties on both sides of the transaction (excluding those specified by Cabinet Order as transactions that are found to be inappropriate in terms of investor protection if conducted outside a Financial Instruments Exchange Market or an Over-the-Counter Securities Market (meaning an Over-the-Counter Securities Market provided for in Article 67, paragraph (2)));
Article 2, para 11
conclusion of a contract in which one of the parties promises to provide the other party with oral, written (excluding newspapers, magazines, books, or any other written work that is issued for sale to many and unspecified persons and which many and unspecified persons can buy as needed), or any other form of advice about the following things, and the other party promises to pay remuneration for this (such a contract is hereinafter referred to as an “Investment Advisory Contract”), and provision of advice under such Investment Advisory Contract;
Article 2, para 13
agency or intermediation for the conclusion of an Investment Advisory Contract or a Discretionary Investment Contract;
Article 2, para 14
the management (excluding management that falls under the category of act set forth in (xii)) of money or other property contributed by a person that holds rights indicated on the Securities specified in paragraph (1), item (x) or other rights specified by Cabinet Order, as an investment in Securities or in rights connected with Derivatives Transactions, based on investment decisions that are grounded in an analysis of the values, etc. of Financial Instruments;
Article 2, para 15
the management (excluding management that falls under the category of act set forth in (xii)) of money or other property invested or contributed by a person that holds the following rights or other rights specified by Cabinet Order, as an investment mainly in Securities or in rights connected with Derivatives Transactions, based on investment decisions that are grounded in an analysis of the values, etc. of Financial Instruments;
Interpretation details will be discussed in another opportunity.
FSA publishes “Comprehensive Supervision Guidelines for Financial Instruments Business Operators” (September 28, 2008) and VII – 3 Procedures (Investment Advice, Agency Business) 1 Registrationof the guideline set out when registration is required in general.
According to the guideline, “To provide investment information for analyzing the value etc. of securities or the value of financial products, etc for unspecified large number of people by the way which number of people can purchase at any time from time to time” is only assisting investors’ voluntary judgment, that is, investment judgment is considered to be done by investors by themselves. Therefore, even if such a judgment is provided as a program based on an algorithm, it can be said that the provider does not need to register investment advice / agency business. Even if investors are damaged by doing business based on that program, it is considered that no responsibility will be pursued from any person.
On the other hand, when using software, it may be necessary to continuously receive data, such as investment information etc., from other distributors etc, and other support. In such cases,the provider need the registration of the business.
In addition, there is the case where a company providing such a program is entrusted with the ID and password of the account the investor uses for the transaction, and the company uses the system to place orders for trading (Administrative disposition against Investment College on October 20, 2013 FSA). In the case, it is considered to be in a situation where the ordering authority is delegated to the provider. In this case, the program provider is not only not only providing the program to the customer but also the business related to the investment management business (Article 28, paragraph 4 of the Financial Instruments and Exchange Act) . So, in such a case, the provider have to register for the investment management industry.
Especially when thinking about individual investors, if autonomous decisions based on investment decisions made by such AIs can cause significant damage that goes beyond the assumption, there arises a problem of how to protect them.
(2) Problems of the stock trading system itself
The issues of the stock trading system itself is whether nad how to prepare a mechanism to prevent such problems in autonomous stock trading systems themselves which would damage investor’s property far beyond their imagination.
Specifically, this problem, , are discussed in Japan under the “Chapter 3 High-Speed Algorithmic Trading” in the report of Market WG of the Financial Council (Report by the Working Group on Financial Markets under the Financial System Council —Initiatives toward Stable Asset Building and the Development of Institutional Systems related to Markets and Exchanges—) together with the problems related to securities transactions and markets as described later.
So, here it will be helpful to look at the description of “Chapter 3 High-Speed Algorithmic ” in that report. There, it is said that “In response to these trends, the share of orders through the co-location area among all orders at the TSE in 2016 amounted to around 70%, and that of transactions executed reached 40-50%. This indicates a greater share of automatic high-speed algorithmic trading typically utilized at the co-location area to place, modify and cancel orders concerning financial products.”(page )
Then,”it is appropriate to develop a regulatory framework in which high-speed algorithmic traders are required to be registered with the authority while giving consideration
to regulatory responses taken by other jurisdictions. This framework is intended to require high-speed algorithmic traders trading in the Japanese markets to meet organizational/system requirements including risk controls, and to allow the authority to identify transactions and trading strategies of such traders.”(Page 18)
And in the WG report, as for technology,
a)Whether high-speed algorithmic trading responds to a market event in a way that it is involved in one-sided movement in the market resulting in markrt disruption.
b)In the event of emergencemergencies such as abnormal order placements/executions and and a cyberattack, whether the impact would be exacerbated by high-speed algorithmic trading to spread throughout the entire market instantly and whether system vulnerabilities of high-speed algorithmic traders cause system trouble to develop into a develop into a develop into a develop into a serious market-wide problem
are pointed out.
(3) Relationship between securities transactions and markets
This is the legal issues whether the autonomous algorithm of stock trading shoul be subject to regulation in relation to the securities market, what is the responsibility in that case, and how to think about cases if they have a market power in the market.
In the aforementioned WG report,
c) Whether high-speed algorithmic trading causes a sense of unfairness that individual investors and institutional investors making investment decisions from the medium – to long -term perspective cannot compete with speed algorithmic traders and discourage those general investors from investing in the market;
d)Whether high -speed algorithmic trading undermines the price discovery functions of the markets based on medium – to long-term profitability or enterprise value where high-speed algorithmic trading, some of which takes short, some of which takes short , some of which takes short , some of which takes short , some of which takes short, some of which takes short , some of which takes short term strategies, accounts for the majority of market transactions.
e)Whether high-speed algorithmic trading undermine the market integrity at a time when some cases of the inappropriate trading, such as market manipulation , areare reported to use algorithms in Japan as well as the United States and Europe in Japan as well the United States and Europein Japan as well in the United States and Europe in Japan as well the United States and Europe in Japan as well the United States and Europe.
The problem are raised.
Based on these discussions, “Law to amend part of the Financial Instruments and Exchange Law” was proposed, passed by the National Assembly, and passed.
Let’s consider the actual incident on these issues and the contents of this revision method with the following entry.