By Franz Kerstens

The International Organization of Securities Commissions (IOSCO) just released its view regarding significant potential threats to financial stability. The IOSCO has identified four main areas of potential risksThe International Organization of Securities Commissions (IOSCO) just released its view regarding a significant potential threat to financial stability. The IOSCO has identified four main areas of potential risks:

  • Corporate bond market liquidity:

The recent turmoil in US High Yield corporate bonds, characterized by the funds redemptions run has raised some concern about the capacity of this markets ability to sustain a long period of stress.  The very low rates environment emphasized the herding effect by investors who are searching for yields, as well as regulatory constraints (Solvency II) pushing institutional investors to buy government bonds. Banks have dramatically reduced their market-making and proprietary portfolio activities, which further contributes to a substantial reduction in financial market liquidity.

  • Risks associated with the use of collateral in financial transactions:  

Regulatory reforms such as the Dodd-Franck act and EMIR in Europe have transformed collateral management into a series of complex and costly challenges.  The need for urgent access to high quality assets and a risk/return optimization has contributed to an increase in the securities services offering by non-banking institutions such as ICSD or global brokers/dealers.  The IOSCO underlines the following services such as collateral optimization, collateral transformation, collateral arbitrage, re-hypothecation and reuse will continue to increase, and may create the potential of risk concentration in those participants that provide such services. Of course, transparency and standardization of the derivatives transactions, as well as CCPs involvement will mitigate counterparty risk compared to bilateral (OTC) transactions.

  • Harmful conduct in relation to retail financial products and services:

The internal code of conducts and governance regarding business with retail clients, has been highlighted by national authorities and regulations such as the MiFiD or UCITS directives.   Retail clients should also be informed and educated in order to have a responsibility when investing in financial products, complex or not.  As emphasized by IOSCO, “A frequently cited case involves the mis-selling of unit-linked products and structured retail products. These products are inherently complex and many investors and advisers fail to understand them sufficiently. High commissions on these sales also can drive investment advisers to “push” these products, to the detriment of some investor classes.”  Margin squeeze in the banking sector could partially explain a push towards high fees products, these include structured and equity linked products compared to bonds or plain vanilla products. 

  • Cyber threats:

Finally, the IOSCO pointed out, “In securities markets, cyber threats have increased in frequency, sophistication, and complexity over the past few years and have become a systemic risk.  Securities markets regulators around the world are focusing on mitigating cyber risks and increasing the cyber resilience of financial systems”.  All financial institutions take this risk very seriously and in doing so, have increased their security to prevent cyberattacks.

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