IOSCO has presented its Risk Outlook, the first of an annual series. The 84 page report aims to highlight important systemic risks and trends in the global securities market. In an admirable example of management-speak compression, IOSCO chairman Greg Medcraft said of the report “I see it as a great example of IOSCO being proactive, forward looking and ahead of the curve”. However, don’t be deterred by this, the report contains some genuine insights amongst the received wisdom. The report identifies four primary risks:
- In an effort to kick-start moribund economies, expansionary monetary policy may create potential risks for securities markets. The resulting yield-hunt raises the likelihood of global releveraging and the resuscitation of the CDO spectre. The report notes that CDO issuance has ballooned from $6 bn. in 2010 to approx. $35 bn. Although still below the heady pre-Lehman days, these instruments are highly sensitive to changes from the near-universal, near-zero current interest rates.
- Regulatory-driven demand for high-quality collateral has altered the balance of the system and could impact pricing. While this may not be a revelation, the report also highlights second-order effects such as collateral optimisationtransformation, and increased use of repo and hypothecation, citing their off-balance sheet opacity and the dangers of long-chain contagion and illiquidity.
- Other reforms, such as the obligation to clear through central counterparties, may also pose systemic risks via: CCP interconnection with the banking system, shared margin-model risk across CCP and competition leading to the acceptance of lower-quality collateral (CME group already accepts MBS). The report cautions that “shifting the risk from bilateral OTC contracts to a single point of infrastructure is a challenging balancing act.”
- The report also identifies Emerging Market risks, these economies having experienced significant capital inflows in the post-crisis era. Shorter-term debt securities and non-bank lending have overtaken bank lending and foreign direct investment as the primary sources of funding. IOSCO remarks that in the new period of monetary contractiontapering these securities markets require structural reforms to enhance their resilience.
The report is comprehensive, interesting and worth reading in full. The Outlook report is partnered by IOSCO’s recent paper on Cyber-crime, securities markets and systemic risk. It promises to complete the suite with forthcoming reports on crowd funding, corporate bond markets and incentive structures.Contact Us