Risks Werner Bijkerk Head of the Research Department European Regional Committee Lisbon, 7 March 2013
Disclaimer The views and opinions presented in this presentation are of the presenter only and do not necessarily reflect the views and opinions of IOSCO or its individual members. 2
Agenda • Introduction • Risks 3
Agenda • Introduction • Risks 4
Introduction • Research Function of IOSCO working on emerging risks (SCRR; Research Department) • Work Plan: – Risk Outlook – Risk Identification Methodology – Risk Dashboard – Risk Roundtables – Risk Surveys – Market Intelligence – Consultation of IOSCO Committees 5
Agenda • Introduction • Risks 6
Risks • Low interest rate environment • Collateral in a stressed funding environment • Derivatives markets • Cyber-crime 7
Risks • Low interest rate environment • Collateral in a stressed funding environment • Derivatives markets • Cyber-crime 8
Low interest rate environment Economic recession is deep in various parts of the Eurozone but recovery expected in 2014. Graph 1: GDP growth (%) 8 6 4 Percent (%) 2 0 -2 -4 2010 2011 2012 2013 2014 Source: IOSCO Risk Dashboard, IMF 9
Low interest rate environment Expansionary monetary policies reduce real interest rates to maintain the functioning of the financial markets and to combat the recession Graph 2: Real interest rates (%) 6 5 4 3 Percent (%) 2 1 0 -1 -2 -3 -4 2005 2006 2007 2008 2009 2010 2011 2012 2013 UK Eurozone Germany US Source: IOSCO Risk Dashboard, Bloomberg 10
Low interest rate environment • Cheap borrowing for big firms (not SME´s) drive corporate bond issuances up… Graph 3: Corporate bond issuances ($ M) $US (millions) $US (millions) 100,000 300,000 90,000 270,000 80,000 240,000 70,000 210,000 60,000 180,000 50,000 150,000 40,000 120,000 30,000 90,000 20,000 60,000 10,000 30,000 0 0 2007 2008 2009 2010 2011 2012 Australasia Europe Latin America MENA Asia North America (RHS) Source: Dealogic 11
Low interest rate environment • While IPOs on the equity markets seems less attractive for firm´s funding … Graph 4: IPO activity ($ M) $US(millions) 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 2007 2008 2009 2010 2011 2012 Americas Asia Pacific Europe Source: World Federation of Exchanges 12
Low interest rate environment • Certain segments of bond markets show high volumes of issuance, especially high yield in the US – EU shows moderate levels … Graph 5: High yield corporate bond issuance per month ($ bn) $60 $US (Billions) $50 $40 $30 $20 $10 $0 2007 2008 2009 2010 2011 2012 2013 Europe North America Source: IOSCO Risk Dashboard, Dealogic 13
Low interest rate environment Graph 6B. Private sector spreads over generic Graph 6A .Private sector spreads over 10yr Government treasuries (percentage points), US Iboxx 10yr yields (percentage points), Euro area 700 600 500 400 bps 300 200 100 0 2007 2008 2009 2010 2011 2012 2013 BBB Spread AAA Spread IOSCO Risk Dashboard, Bloomberg 14
Low interest rate environment Trends: • High yield bonds sold through collective investment schemes and retail structured products/exchange traded funds and products (ETF, ETP). • In certain European countries search for yield goes into real estate and real estate funds (e.g. Germany, Nordic countries, Switzerland). Some questions about the risks: – Do investors know the risks? – What if interest rates go up or stay low for a very long period? – Could there be problems of investors being locked in? And a question about an opportunity for the stimulation of financial stability/global economy: – What are the ideas for the inclusion of SME´s? 15
Risks • Low interest rate environment • Collateral in a stressed funding environment • Derivatives markets • Cyber-crime 16
Collateral in a stressed funding environment Trends: • Available high quality collateral has shrunk from $ 10 trillion in 2007 to $ 6 trillion in recent years (IMF) • Shift from unsecured to secured financing as confidence has dropped • Funding environment changed by regulation: – Basel capital rules (huge impact on collateral) – MMF rules (e.g. shortened maturities) – Margin requirements OTC derivatives (expected huge impact on collateral) – Rules on structured finance products • Collateral squeeze … 17
Collateral in a stressed funding environment Wholesale Retail Funding source: Central Structured Securities Collateral Deposits Equity MMFs Repo Re-hyp. Bank products lending transform Asset backed Assets lent Securities Securities Collateral Structured Assets as Debt titles securities out under Bonds lent out for a borrowed packaged retailprod. collateral for placed with (CDO ↓ temporary fee to from and cash placed Money covered repurchase brokers and investors upgraded with Central Market bonds ↑) agreem. w. investment and lent-out sold to Banks Funds sold to investment banks for a fee clients investors banks D: E:= ?= ? Funding trend: S: B: Partly off- balance On-balance sheet, if publicly offered, Off-balance sheet, bi-lateral transactions and sheet, if publicl Transpa prospectus contracts offered rency: prospectus 18 Source: IOSCO Research Department
Collateral in a stressed funding environment • MMFs AUM is back at pre-crisis levels after huge outflows Graph 7: Asset under management of US MMFs ($ bn) 4,500 $US (Billions) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 US MMF AUM Source: IOSCO Risk Dashboard, Bloomberg, ICI 19
Collateral in a stressed funding environment • Issuance of structured products (ex. covered bonds ) has fallen… Graph 8: Issuance of structured products in EU and US ($ bn) 1,800 $US (Billions) 1,600 1,400 1,200 1,000 800 600 400 200 0 2007 2008 2009 2010 2011 2012 Europe North America Source: IOSCO Risk Dashboard, Dealogic 20
Collateral in a stressed funding environment • Issuance of covered bonds has grown from 2007 to 2012, and is a merely European funding vehicle … Graph 9: Issuance of covered bond ($ bn) $450 $US (Billions) $400 $350 $300 $250 $200 $150 $100 $50 $0 2006 2007 2008 2009 2010 2011 2012 Europe Latin America North America North Asia Australasia 21 Source: IOSCO Risk Dashboard, Dealogic
Collateral in a stressed funding environment before crisis now Collateral $ 10 trillion $ 6 trillion Money Market Funds (US) $ 2.5 trillion $ 2.7 trillion Structured products (US) $ 1.6 trillion $ 600 billion Structured products (EU) $ 420 billion $ 100 billion Covered bonds $ 300 billion $ 400 billion Securities lending $ 1.7 trillion $ 1 trillion Triparty repo (US) $ 2.5 trillion $ 2 trillion Repo market (EU) € 4.6 trillion € 6.2 trillion Collateral transformation ? ? G7 GDP $ 32.4 trillion $ 35.7 trillion Source: IOSCO RD, IMF, M. Singh (2013), Dealogic, Bloomberg 22
Collateral in a stressed funding environment • Collateral transformation is a new service and we don´t know exactly what it is, nor how big it is … • We know that it is off-balance sheet • Just as certain structured products, repo, securities lending and re-hypothecation Some questions about the risks: – Is there (implicit) leverage being created by banks? – Are risks being hide or shifted out of the regulator´s sight? – How long are the collateral chains? – Where do the risks pool? – How big are the interdependencies with CCPs? 23
Risks • Low interest rate environment • Collateral in a stressed funding environment • Derivatives markets • Cyber-crime 24
Derivatives markets CCPs concentrate risks and provide transparency. Last years’ CCP usage increased considerably. Table 2: Notional volumes of selected CCPs around the globe 2011 - 2012 CCP Region Product Dec-11 ($US, billions) Dec12 ($US, billions) % Chg CME US IRS $114 $1,300 1040% SGX ASIA IRS $184 $251 36% LCH EU IRS $283 $339 20% Japan SCC Asia IRS - $1,280 n/a CME US CDX $15 $98 553% LCH EU CDS & ITRAXX $68 $135 99% ICE US CDS & CDX $12,000 $21,000 72% ICE EU CDS & ITRAXX $8,000 $12,000 40% Japan SCC Asia CDS $3,300 n/a - CLS Global FX $4,380* $4,610 5% LCH EU FX $115 n/a - Source: CME, Singapore Stock Exchange, LCH Clearnet, ICE, CLS, SCC, theOTCspace; compiled by IOSCO Research Notes: * Data as at 25 Jan 2012;
Derivatives markets Issues: – Collateral absorbed by CCPs. Further squeeze? – CCPs following similar risk management model – amplification? – CCPs accepting lower quality collateral – race to the bottom? – CCPs becoming active derivatives shops? – Enhanced interconnection with banks – more concentrated risk? – What is the resilience of the system: • In the case of a huge margin call? • In the case a big trader/bank fails? – Where are the weak spots in the network? 26
Risks • Low interest rate environment • Collateral in a stressed funding environment • Derivatives markets • Cyber-crime 27
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