IOSCO Launches Its First Securities Markets Risk Outlook

The International Organization of Securities Commissions (IOSCO) today published the IOSCO Securities Markets Risk Outlook for 2013-2014. The report highlights important trends, vulnerabilities and risks in securities markets that may be of concern from a systemic perspective.

The Outlook is the result of a joint effort between the IOSCO Research Department and the Committee on Emerging Risks (CER), which is comprised of senior researchers, chief economists and risk officers of almost 30 securities markets regulators from around the world.  The information and data were drawn from extensive consultation with experts, industry and other market participants; a survey to regulators, industry and academics; roundtables; and robust data analysis and literature review.

The Outlook is the first published edition of an annual series. Its aim is to provide IOSCO members with the information they need to adopt a forward looking approach in dealing with potential vulnerabilities and risks to global securities markets and the global financial system as a whole.

The four main risks it identifies and analyzes in depth relate to the following:

1. Risks related to low interest rate environment. Expansionary monetary policies have reduced interest rates to the point that real rates are at times negative. While these policies may help stimulate the real economy, spill-over effects may create potential risks for securities markets. A search for yield is turning investors towards leverage products such as CDO´s and leveraged real estate investment funds.
2. Risks related to collateral management. In response to global policy requirements, demand from investment firms for high quality collateral has increased significantly. More generally, bank holding companies with over the counter (OTC) dealer operations must locate high-quality collateral to meet initial and variation margin requirements for their OTC trades. Additionally, central banks have been absorbing collateral to provide needed bank funding. This growing demand has altered the balance of collateral in the system, diminishing availability of high-quality collateral and could impact pricing.
3. Risks related to derivatives markets: OTC derivatives markets have undergone significant reform since the financial crisis. This reform entails the mandatory clearing of derivative contracts through central counterparties (CCPs). CCPs are designed to reduce systemic risk in the derivatives market by reducing counterparty risk. But shifting the risk from bilateral OTC contracts to a single point of infrastructure is a challenging balancing act.
4. Risks related to capital flows of emerging markets: Emerging Market Economies have experienced significant capital inflows in the post-crisis era. Debt securities and non-bank lending have overtaken foreign direct investment and banking lending as the main source of these capital inflows. After the announcement of the tapering of the expansionary monetary policies of the FED, a sudden reversal in capital inflow occurred,  highlighting the need for further structural reforms aimed at making securities markets more resilient. 

The Chair of the IOSCO Board, Greg Medcraft, presented the Risk Outlook in London. Accompanying him were IOSCO Secretary General David Wright, the Vice-Chair of the Growth and Emerging Markets Committee, Bert Chanetsa, the Chair of the Committee on Emerging Risks, Carlos Tavares, and the Chair of the IOSCO Africa/Middle-East Regional Committee, Arunma Oteh.

Speaking of the Outlook, Mr. Medcraft said: I see it as a great example of IOSCO being proactive, forward looking and ahead of the curve in assisting us to achieve our objectives of protecting investors, ensuring markets are fair, efficient and transparent and reducing systemic risk.

He added: I would urge all IOSCO members and policy makers globally to carefully reflect on the Outlook’s observations and understand – and act on – the implications of the trends and risks it identifies for their markets.

Background to the Report:

Following the outbreak of the current financial crisis, IOSCO adopted a new strategic direction that emphasized the need for securities regulators to identify, monitor and manage systemic risks.  To that end, IOSCO established a research function comprised of a Research Department at the General Secretariat and the CER.

The Outlook represents one aspect of IOSCO’s new role in the assessment and mitigation of global systemic risks. Its launch comes at a time when the world is moving inexorably towards a more market-based, interconnected, financing model, as credit institutions face higher capital requirements, constraining their ability to lend. 

In this context, strong, transparent and appropriately regulated securities markets are essential to the sound functioning of the global economy and its recovery.

IOSCO recently published the report Cyber-crime, securities markets and systemic risk. Going forward, it will publish reports on crowd funding, corporate bond markets and incentive structures in supervision.