Global securities regulators are worried the risks of a market downturn, and spillover into the global economy, may now be bigger than ever.
In his latest letter to the industry, Ian Russell, president and CEO, Investment Industry Association of Canada (IIAC), recounts the a meeting last month of the International Organization of Securities Commissions (IOSCO) with "a broad group of industry stakeholders."
At the meeting, global regulators concluded, among other things, "that the risks of a steep downward adjustment in asset prices, and the feed-back effects on the global economy, are more acute than ever before, reflecting changes in investor behaviour and the vulnerabilities of the underlying global economy," Russell says in his letter.
According to Russell, weak economic conditions, highlighted by continued high unemployment and a lack of inflation, "increase the risk of triggering a major shock to global markets." Moreover, global markets remain vulnerable to the effects of economic and geopolitical events.
"External shocks could trigger steep declines in asset prices," he says. "Banks and dealers have limited scope as market-makers to absorb panic selling, particularly by asset managers faced with massive exposure to falling asset prices, accelerating withdrawals of client funds as values plummet, and limited liquidity to avoid major asset sales."
"The accelerating collapse in equity values and steep rise in interest rates (as bond prices fall) would quickly reverberate in the real economy, pole-axing the incipient recovery, with potential for much worse," Russell warns.
Against this background, regulators are rightly focused on "reducing the balance sheet exposure of fund managers to falling asset prices, through such measures as limiting leverage and ensuring significant holdings of liquidity. Moreover, regulators continue to examine the liquidity of corporate bond markets under stressed market conditions."
Additionally, Russell reports that regulators are planning to study the risks posed by industry outsourcing practices; and, to develop a set of best practices in this area to help firms carry out proper due diligence and oversight of their outsourcing risks.