Daniel Leon, Head of MACS Engineering and Execution, AXA IM gives the buy side perspective, and calls for a collective approach to prepare for the next crisis.
In 2008, many of the certainties and truths we took for granted in the financial industry were suddenly questioned and battered. What happened back in 2008 seemed at the time inconceivable to most people: the speed, magnitude, and brutality of the contagion to the global economy took everyone by surprise. As we look back today and focus on the lessons learned, we should remember that beyond the distortions, equity markets exchanges have shown a resilience in maintaining liquidity throughout the crisis.
Where do we stand today?
We all worked together to strengthen risk management. Over the past 10 years, a number of measures have been implemented to improve financial markets, and institutions’ stability and robustness. Banks are stronger now and have been recapitalised primarily due to new regulation. On an international level, the coupling of tighter Central Bank cooperation, renewed political momentum stemming from the G20, and the mandate given to the Financial Stability Board has produced encouraging results.
All of these actions have contributed to a better-informed decision-making process, in the interest of investors’ protection.
However, one of the main challenges that remains is ensuring that the regulatory environment does not delay financial institutions’ ability to continue to serve their investors’ needs, especially in the face of new societal challenges. For instance, the new MiFIR European Regulation has impacted the structure of the market, but challenges on transparency around execution of block trades remain. Finding a satisfactory tradeoff between our fiduciary duties of best execution on behalf of our clients vs. keeping the market informed on executed trades is difficult to find. This is a collective challenge where all stakeholders have to effectively engage.
Given this, two main take-aways should be taken into account in the future. Firstly, regarding the legislative process, we want EU institutions to revert to the Lamfalussy approach i.e. to principle-based legislation instead of rule-based legislation. Secondly, the pace of the delivery of regulations should be slowed down and targeted only to fixing issues where they have been objectively identified: permanent legislative instability should be avoided, as this will benefit both investors and market participants.
About OTC markets
We appreciate the efforts of regulators to achieve sound OTC markets in the aftermath of the financial crisis, while keeping the key role of exchanges and CCPs as contributing to market liquidity and post-market safety respectively. As an asset manager, we search not only for guarantees for our transactions, but also for tangible solutions to mitigate counterparty risks as well as the best quality of execution. As a collective effort, we believe that the end-user voice should be heard more by CCPs and clearing members on two fronts. First, to increase CCP transparency to end users, notably on the risk models, to the benefit of the end users to facilitate our own assessments. This way, we will all better assess risk and reduce potential systemic risk. Second, to further engage buy-side dialogue with CCPs, expecting them to develop services that match buy side specificities and needs (securities as collateral, collateral transformation, account segregation and asset tagging, direct access without associated capital requirement).
Get prepared for the next crisis
Crisis are recurrent; this is one constant in economic history, and we need to use our common sense to get prepared.
We all have to embrace this fast-changing environment with vigilance and flexibility: by leveraging new technologies, like blockchain, to the benefit of investors, and by adapting our models to the society evolutions regarding sustainability growth, like ‘low carbon benchmarks’ for example.
And while it is tempting to lower one’s guard, we need to better understand new risks to avert the next crisis. In particular, we need to seek to better understand the nature of emerging risks and how to manage them, as well as pay specific attention to operational risks within exchanges. The next crisis could have a non-financial cause, perhaps even a cyber one, and we think this risk is still underestimated as a global systemic risk today.
Several initiatives have made it possible to better regulate the market in order to better accommodate the next crisis. As collective challenges can only be met with a collective effort, it is essential to ensure that all stakeholders do and can effectively engage. We all collectively need to find the right balance between transparency, liquidity split, and healthy competition leveraging innovation.