Shane Worner, Senior Economist, IOSCO, looks at the major systemic threats facing markets, and how regulators can work together to mitigate the risk.
As far back as 2008, IOSCO recognised that systemic risk builds up in the securities markets through the overuse of products, whether through the overuse of a particular activity or within institutions themselves. A strategic review, which took place after 2008, recognised that systemic risk is something that securities market regulators should be concerned about, and so IOSCO implemented two new principles:
- Principle Six – which states that regulators should look beyond the boundaries of their regulatory remit to see where risks are building up, and;
- Principle Seven – which states that, if need be, those risks be brought into formal regulation to mitigate against possible future incidences.
We therefore set up the research department at the IOSCO secretariat, to look at issues of systemic risk at a global level (given we are a global organisation). Our aim is to inform our members of the areas they should be looking at, and providing them with more information on where they should focus their attention. Furthermore, as we are the securities market standard setter we have a unique view of what’s going on. We connect with the markets, the securities market regulators, and we’re involved with the banking regulators.
Creating the report
The processes involved in developing this report were particularly rigorous. This is the first time we have ventured into this area – a forward looking globally public report. As an organisation, we tend to focus on standard setting and policy work.
Whilst creating the report we visited and interviewed many market participants. We have our own committee responsible for emerging risk which is comprised of the 30 chief regulators of our major members, who were involved in the creation of the report, and we surveyed the broader community, both regulatory and industry. The risks from the low interest rate environment, risks from collateral management, derivatives risk, and emerging markets capital flows were clearly the four main areas that people were really concerned about.
We want this report to be an important part of the debate on risk mitigation in the market and we want to be seen as being engaged with the industry and the concerns of its participants. We have had a positive response from many of our regulatory members. Our Chairman, Greg Medcraft, has been championing this report as a means of demonstrating how we are thinking about issues beyond our core standard setting and policy work.
Regulatory arbitrage is one of the biggest issues that we’re going to have to tackle as a global organisation. The cross-jurisdictional aspect of regulation is huge, particularly as so many jurisdictions implement their own regulation which is incompatible with regulation implemented by other jurisdictions.
As the global standard setter we are mindful that we don’t want to see fragmentation in market regulation, as this will drive fragmentation of markets through ring-fencing assets etc.
One of the key challenges for the next couple of years is to how to globally converge the key regulators so that they are internationally consistent. If a regulator is the first to move when setting regulation, and then the standards come in afterwards, it’s hard to find common ground as a standard setter when you’ve got so many people who have moved first.
I think we must try to convince people to look at the standard first, to ensure globally consistent regulation based on globally consistent standards, and then to move forward from there.
I think that emerging markets have a relatively easy time of it: as emerging markets are not yet well-developed or established, it’s actually quite easy to set up from a lower base point. There are already principles and standards established to assist with the setting up of those markets and there are good technical assistance programmes in place at IOSCO.
It is far harder for developed markets. They need financial innovation at the margin in order to drive the industry forward. If you look at regulators in the UK, Singapore and Australia for example; their jobs are far more complex. They involve more regulatory challenges and also complexities within corporate governance. It is much easier to hide things in more developed markets than in emerging markets, which are far more transparent.
In conclusion, these are the issues that IOSCO is going be working on in order to better understand what’s going on, because essentially this is securities market activity. We should be providing analysis in order to provide better policy in this area.