(The views expressed in this article are those of the author and should not be attributed to IOSCO.)
The global financial system has seen its biggest stress event since the 2008 global financial crisis (GFC) as a result of the COVID-19 pandemic. Indeed, by some indicators, the stress has been more severe than the GFC.
Though the shock originated outside the financial sector, it gave rise to significant turbulence in the financial markets. Governments around the world resorted to lockdowns to address the health crisis, which resulted in an unprecedented shuttering of economic activity giving rise to solvency and liquidity concerns. The role of the authorities and the financial sector clearly was -- and continues to be -- important in supporting the economy.
Right from the beginning, IOSCO and its members -- who together regulate over 95% of the world’s capital markets -- emphasised the critical importance of keeping markets open in recognition of the role that markets play in financing the economy.
Access to funding
As IOSCO highlighted in its 25th March statement, continued functioning of equity, credit and funding markets supports the real economy in dealing with the crisis through access to funding and the ability to hedge risks. IOSCO expressed its clear commitment to ensuring that capital markets continue to function in an open and orderly manner to enable all participants to price and transfer risk across all traded asset classes.
The role of capital markets has significantly increased since the GFC as a result of higher capital requirements on banks as well as other factors such as low interest rates. Today, market-based financing comprises about half of global financing and so has an important role to play in mitigating shocks and funding the recovery.
Throughout the period of extreme market volatility, members of the IOSCO Board as well as its other committees met frequently; in fact, the IOSCO Board met weekly between March and May. Indeed, the GFC underscored the importance of regulators working together to address issues common to jurisdictions.
It was this spirit of collegiality that motivated IOSCO members to commit their time to prioritize international engagement through IOSCO to address stresses from the pandemic. To help focus on the challenges from the pandemic as well as to relieve untoward pressure on members, IOSCO decided to reprioritize its work programme.
Working together with the Basel Committee on Banking Supervision (BCBS), IOSCO announced a deferral of the final implementation phases of the margin requirements for non-centrally cleared derivatives to provide additional operational capacity for firms to respond to the immediate impact of the pandemic.
Members have been exchanging information about the measures they adopted to deal with market stresses through an IOSCO information repository, so that rather than “re-inventing the wheel,” member regulators could learn from the experiences of others.
They have also provided the appropriate regulatory flexibility to help market participants address the challenges posed by the pandemic while ensuring that market integrity and investor protection objectives are maintained.
In the first phase, measures were predominantly focused on keeping securities markets open and functioning through operational measures to support regulators and financial firms’ business continuity and operational resilience.
The extraordinary stress in capital markets also led to the triggering of other measures, such as trading halts and volatility control mechanisms.
Following a decline in the market stress, IOSCO members continued to focus on ways to support market functioning and address operational challenges (such as remote working) to reduce regulatory burdens by adjusting on-site inspections and oversight requirements and providing flexibility on requirements related to Annual General Meetings (AGMs), financial reporting and disclosure obligations.
The pandemic also highlighted the importance of globally coordinated regulatory reforms across sectors. Despite the exceptional volatility, trading generally remained orderly and capital markets remained open.
While a small number of funds were suspended, this was typically driven by uncertainty about valuation and overall, fund liquidity management tools operated as expected. This was in large part a result of the policies agreed by IOSCO in the last few years, including in the areas of liquidity risk management in the funds sector, volatility control mechanisms in the secondary markets, business continuity planning and cyber resilience.
In addition, standards that IOSCO produced jointly with the Committee on Payments and Market Infrastructures on Financial Market Infrastructure resilience and with the BCBS on margin requirements for non-centrally cleared derivatives, helped to address market vulnerabilities.
Indeed, the shift to central clearing has likely helped reduce the systemic risks during the peak of the turmoil. The banking sector has also largely been able to absorb the initial shock as a result of their global reforms.
Working together during the crisis also helped regulators engage with the fundamental objectives of why they regulate markets, namely investor protection, market integrity and systemic risk mitigation -- which are also IOSCO’s core objectives.
Serendipitously, at the IOSCO Board meeting in February 2020 -- just before the pandemic hit -- the Board established two Board level groups: the Financial Stability Engagement Group (FSEG) and the Retail Market Conduct Task Force (RMCTF).
These groups, which consist of members at the level of the principals, directly relate to the objectives of financial stability in capital markets and investor protection. They are now engaged in critical aspects of what the pandemic has meant for financial stability in markets and for retail investor protection.
The FSEG has been working closely with the Financial Stability Board, especially on issues regarding money market funds, other open-ended funds, as well as the analysis of initial and variation margin at central counterparties in response to the increased volatility.
The pandemic also increased retail investors’ vulnerabilities to scams, fraud and other misconduct; the RMCTF has developed a repository of issues relating to retail investors and the regulatory and supervisory responses in the light of the pandemic.
In the spirit of “never let a crisis go to waste,” the market turmoil has raised some very interesting questions about financing the economy.
The increased role of capital markets over the last decade was an intended consequence of the global reforms; however, the issue of high corporate debt -- which was identified by the Board last October as an important risk -- raises the question of finding the appropriate balance for financing the economy, including the relative role of equity and debt.
Also important is the need to look at the inter-connectedness between banks and capital markets as well as their connection to the real economy – that is to the ultimate savers and lenders.
Similarly, a few fundamental questions arise as to whether participants in the capital markets have the same understanding of products and traded instruments in terms of the risks relating to loss of capital or of liquidity - both funding liquidity and market liquidity.
Going forwards, IOSCO and its members will continue to monitor how the pandemic evolves and its effect on stresses in the financial system, as well as to examine lessons to be learnt from the events so far and their implications for markets and their regulation in the future.