ARTIFICIAL INTELLIGENCE, BIG DATA AND BLOCKCHAIN: CONSIDERATIONS FOR FUND DIRECTORS JAY BARIS NATHAN GREENE

Transcription

1 September 11, 2018 ARTIFICIAL INTELLIGENCE, BIG DATA AND BLOCKCHAIN: CONSIDERATIONS FOR FUND DIRECTORS JAY BARIS NATHAN GREENE

2 AGENDA BACKGROUND 03 Artificial Intelligence Big Data Blockchain OVERSIGHT BY FUND DIRECTORS 16 RESOURCES 22 SPEAKERS 25 Shearman & Sterling LLP 2

3 BACKGROUND Shearman & Sterling LLP 3

4 ALL MARKET SECTORS INCL. ASSET MANAGEMENT ARE GRAPPLING WITH RAPID CHANGE Disruptive Technologies 1. Artificial Intelligence 2. Big Data 3. Blockchain From a PM s perspective Sectors in which the funds invest may be fundamentally changed (as examples FANG stocks are AI/Data plays) New asset classes and investible instruments (crypto just the beginning) New factor-driven thinking New abilities to source and crunch data Marriage of quant and fundamental strategies From senior management s perspective New product thinking and new modes of customer interaction Personnel challenges Operational challenges Rapid change at service providers Fear of falling behind Fear of new entrants Shearman & Sterling LLP 4

5 ARTIFICIAL INTELLIGENCE: KEY CONCEPTS DEFINITIONS SELECT EXAMPLES MACHINE LEARNING Encyclopædia Britannica AI is the ability of a computer to perform tasks commonly associated with intelligent beings The Economist Modern artificial intelligence is much feted. But its talents boil down to a superhuman ability to spot patterns in large volumes of data Autonomous cars Intelligent routing in content delivery networks Interpreting complex data Visual perception Speech recognition Diagnosis and decision-making Competing in strategic games at a high level (such as chess or Go) Machine learning: Subset of AI that uses statistical techniques to give computer systems the ability to "learn" (e.g., progressively improve performance on a specific task), often without being explicitly programmed. Supervised: All data is labeled and the algorithms learn to predict the output from the input data. Unsupervised: All data is unlabeled and the algorithms learn to intuit structure from the input data Shearman & Sterling LLP 5

6 ARTIFICIAL INTELLIGENCE WHY SO OFTEN VIEWED THRU A DARK LENS? Human Resistance There will always be resistance to new technological developments Especially so when there is a perception of replacing the human or unleashing the demon Organizational Challenges Complexity, jargon, etc. stand in the way of understanding New skill sets and modes of thinking required Implementation costs remain high (but falling) Risks Are Real Trading algorithms can make compounding and repeating errors Lending algorithms can discriminate Chatbots can offend, make false or incomplete statements, etc. Shearman & Sterling LLP 6

7 BIG DATA: KEY CONCEPTS SPEED & SCALE DATAFICATION BIG DATA SKILL SETS A big data strategy leverages these principles: increasing volumes of data that can be incorporated into models, increasing variety of types and breadth of available data, increasing velocity at which data can be processed, the value added by use of big data. In the past much data could not be digitized. No more. In 2000 only 25% of stored data was digitized; today it s 98%. Migration from structured and scrubbed data sets to natural data sets. Data scientists Data sourcing Data security Domain experts Data analysts Computing Note: The authors credit this slide to Citi s Big Data in Investment Management White Paper (see our resources page). Shearman & Sterling LLP 7

8 AI AND BIG DATA AT ASSET MANAGERS ENHANCING THE CUSTOMER EXPERIENCE Through chatbots, roboadvising, and other enhancements, AI can streamline and customize the customer experience REDUCING BACK-OFFICE COSTS AI can automate back- office functions, increasing efficiencies, and enhancing compliance efforts (RegTech) COMMERCIAL APPLICATIONS AI and big data drive new approaches to trading and research AI and big data allow for discovery of new investible asset classes and new factordriven investment approaches AI and big data accelerate customization trends in delivery of services Shearman & Sterling LLP 8

9 AI AND BIG DATA AT REGULATORS (EXAMPLE: THE SEC) INNOVATION OR NECESSITY? Oversight responsibility is massive: over 4,000 public companies and 28,000 registrants Keeping pace with sophistication of market participants and practices Reduced budgets and staffing demands risk-based approach to oversight AI / BIG DATA AT THE SEC Analytical methods allow review of previously opaque disclosures Machine learning and text analytics Data sources Teaching the machine Limitations (and need for humans) WHERE IS IT GOING? Investment adviser examinations Financial reporting misconduct Insider trading Market oversight and surveillance Public company reviews Shearman & Sterling LLP 9

10 WHAT IS A BLOCKCHAIN? An immutable, decentralized ledger A blockchain ledger is like any ledger in some ways Can be public (anyone participates) or private ( permissioned ) Flexible application (wide variety of use cases, not limited to financial transactions, digital currencies) but also fundamentally different from existing ledger techniques: Immutable Cryptography restricts tampering or manipulation Decentralized No single entity controls ledger Transactions authenticated and tracked via networked nodes that determine if a transaction is valid and follows consensus rules for verification Transactions stored on a network of computers Shearman & Sterling LLP 10

11 WHAT IS A BLOCKCHAIN? (CONT.) Blockchain networks use digital tokens to exchange value through the network Cryptocurrencies such as Bitcoin and Ethereum rely on blockchain technology Bitcoin is primarily a payments or store of value network Ethereum is designed flexibly to permit many uses, including smart contracts Shearman & Sterling LLP 11

12 WHAT IS A SMART CONTRACT? An automatically executing computer program linking digital transactions on a blockchain that is enforced by participants of the network/blockchain Triggering if/then variables (the contracting conditions) are coded within the program When the program recognizes that contracting conditions are met, the resulting transaction is automatically executed and recorded Allows more complex transactions than a straight transfer of value for a product or service Shearman & Sterling LLP 12

13 JAN SEC STAFF OPEN LETTER TO INDUSTRY Funds investing in cryptocurrency require special care around: Valuation Liquidity Custody Effectiveness of arbitrage mechanisms for ETFs Risks of underlying market manipulation The staff closed with this: Until the questions identified above can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products, and we have asked sponsors that have registration statements filed for such products to withdraw them Shearman & Sterling LLP 13

14 JULY 2018 SEC REJECTS BITCOIN TRUST LISTING SEC has not yet authorized listing any vehicle dedicated to cryptocurrencies Rejected applicant s factual assertion that Bitcoin markets are deep enough to inherently resist manipulation Did not believe listing exchange had sufficient surveillance sharing agreements with markets where the underlying crypto assets trade Commissioner Peirce dissented, said SEC was missing an opportunity to foster institutionalization of Bitcoin market Shearman & Sterling LLP 14

15 HUNDREDS OF USE CASES FINANCIAL SERVICES USE CASES ADDITIONAL USE CASES Trade execution and settlement, including for swaps, derivatives, repos, etc. Payment systems, cash remittances Transfer agency Loans and escrow KYC/AML checks (verified digital identities ) Trade finance (e.g., letters of credit) Asset finance Loan syndication Proxy and other voting Tax reporting and collection Medical records Supply chains Disbursement tracking (e.g., international aid transfers) Art sales and provenance Real estate transactions Fractionalization of almost anything (time shares, etc.) Royalty payments Insurance payouts Voting Shearman & Sterling LLP 15

16 OVERSIGHT BY FUND DIRECTORS Shearman & Sterling LLP 16

17 By far the greatest danger of Artificial Intelligence is that people conclude too early that they understand it. AI researcher Shearman & Sterling LLP 17

18 Director oversight can be thought about first in broad categories: Oversight of use of AI, Big Data and Blockchain in the management of the funds and the investment process Oversight of other service provider s use of these technologies in their systems and administration of the funds Oversight of investments in digital assets, including cryptocurrencies and tokens and related derivatives Oversight of management s preparedness for technologydriven industry change And then a set of high level questions that might be asked follows Shearman & Sterling LLP 18

19 How are we using AI, Big Data and Blockchain today? What about our service providers? How will that change in the next five years? How will the role of portfolio managers change? Will AI augment or replace? Will funds with AI elements be characterized as active or passive? What investments will be required (in terms of technology, personnel, training, etc.)? How will we enhance the shareholder experience? Where do we see competitive threats and opportunities? Shearman & Sterling LLP 19

20 CHALLENGES WITH AI Controls to ensure model accuracy Sufficient resources and tools to implement AI elements Disclosures in prospectuses and other public documents Reporting Compliance Regulatory oversight Recordkeeping and audit trails Oversight of intermediaries and third-party vendors Managing public perceptions Skillsets among management, service providers, etc Shearman & Sterling LLP 20

21 CHALLENGES WITH CRYPTOCURRENCY INVESTING Valuation Liquidity Custody Disclosures in prospectuses and other public documents ETF arbitrage Risks of underlying market manipulation Codes of ethics and policing personal trading Managing public perceptions Skillsets among management, service providers, etc. Shearman & Sterling LLP 21

22 RESOURCES Shearman & Sterling LLP 22

23 AI AND BIG DATA RESOURCES ESMA, EBA and EIOPA Final Joint Committee Report on the Use of Big Data by Financial Institutions (March 2018), available at Financial Stability Board, Artificial Intelligence and Machine Learning in Financial Services (Nov. 2017), available at UK Information Commissioner s Office (Sept. 4, 2017), Big Data, Artificial intelligence, Machine Learning, and Data Protection, available at Oren Etzioni, New York Times Editorial: How to Regulate Artificial Intelligence (Sept. 2017), available at Hedge Funds See a Gold Rush in Data Mining, Financial Times (Aug. 2017), available at SEC Staff Speech (June 21, 2017), The Role of Big Data, AI and Machine Learning in Assessing Risk: A Regulatory Perspective, available at Whatever Happened to the DeepMind AI Ethics Board Google Promised, The Guardian (Jan. 2017), available at In Two Moves, AlphaGo and Lee Sedol Redefined the Future, Wired (March 2016), available at Citi, Big Data in Investment Management (2015), available at Shearman & Sterling LLP 23

24 BLOCKCHAIN RESOURCES The Hedge Fund Law Report, Unique Security Risks Posed by Cryptocurrency Investing: Steps Fund Managers Must Take to Protect Individuals With Access to Client Assets (June 2018), available at SEC Staff Speech (June 2018): Digital Asset Transactions: When Howey Met Gary (Plastic), available at Jay Baris and Joshua Ashley Klayman, Blockchain Basics for Investment Managers: A Token of Appreciation, The Review of Securities & Commodities Regulation (March 2018), available at Deloitte, Blockchain: A Technical Primer (Feb. 2018), available at KPMG, Regulating Virtual Currencies (Feb. 2018), available at SEC Staff Letter (Jan. 2018): Engaging on Fund Innovation and Cryptocurrency-related Holdings, available at Citi Business Advisory Services, Industry Revolution Series Part I: The New Building Blocks: Moving Beyond Equities and Bonds, The Emergence of Robo-Beta & Democratizing Access to New Alpha Sources (2018), available on request by ing business.advisory@citi.com CFTC Primer (Oct. 2017): A CFTC Primer on Virtual Currencies, available at SEC Staff Report (July 2017): SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities, available at Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (Oct. 2008), available at Shearman & Sterling LLP 24

25 SPEAKERS Shearman & Sterling LLP 25

26 PRACTICE Jay Baris is a partner in the Investment Funds practice resident in the firm s New York office. Jay represents registered funds, investment advisers, financial institutions, broker-dealers and independent directors. An active speaker and writer, Jay has been published in a variety of trade and general interest publications: Insights: The Corporate & Securities Law Advisor, The New York Times, The Wall Street Journal, The Review of Securities & Commodities Regulation, Fund Action, The Review of Banking & Financial Services, Fund Directions and Fund Board Views. Awards and Accolades: JAY G. BARIS Partner, New York NEW YORK T jay.baris@shearman.com Ranked in Band 2 in Chambers USA 2018 for Nationwide: Investment Funds: Registered Funds Recognized as a Leading Lawyer and in the Hall of Fame by Legal 500 US for Investment Fund Formation and Management: Mutual/Registered/Exchange Traded Funds (2018) BAR ADMISSIONS New York District of Columbia New Jersey EDUCATION Hofstra University, J.D., Stony Brook University, B.A. Shearman & Sterling LLP 26

27 PRACTICE Nathan Greene is a partner in the Investment Funds practice resident in the New York office. Nathan represents fund management organizations, fund families and fund directors. As a sought after commentator on industry developments, law and policy, he is regularly quoted in prominent publications and news services, including BoardIQ, Bloomberg, Fund Board Views, Hedge Fund Law Report, Reuters and the Wall Street Journal. NATHAN GREENE Partner, New York Awards and Accolades: Ranked in Band 3 by Chambers USA in category of Investment Funds Registered Funds (2018) IFLR1000 Financial & Corporate Rising Star in area of Investment Funds (2018) NEW YORK T ngreene@shearman.com BAR ADMISSION New York EDUCATION Georgetown University Law Center, J.D., magna cum laude University of Maryland, College Park, B.A. Shearman & Sterling LLP 27

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