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IOSCO identifies potential risks to the financial system

IOSCO identifies potential risks

The International Organization of Securities Commissions (IOSCO) has published its 2016 edition of the Securities Markets Risk Outlook, which aims to identify and assess potential risks to the financial system stemming from activities in the securities markets.

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Four key risk areas

The Securities Markets Risk Outlook, published by the IOSCO, aims to identify and assess potential risks to the financial system stemming from activities in the securities markets. It includes risks relating to investor protection and market efficiency, as well as potential systemic risks. The four main risk areas identified in this year’s outlook are corporate bond market liquidity, the use of collateral in financial transactions, harmful conduct in retail products and markets, and cyber threats. 

With the expansion of corporate bond primary markets, will the secondary market structure be able to withstand periods of market stress going forward? Traditional measures of secondary market liquidity paint an inconsistent story, perhaps due to abnormal market conditions and changing market structure. Banks may be reducing their market-making role but non-primary dealers may be providing more liquidity.

Collateral is important for refinancing and for mitigating counterparty risk exposure.  Post-crisis regulatory reforms require the use of higher quality collateral for over the counter (OTC) transactions. This has led to increased demand for collateral optimization, transformation, re-hypothecation and re-use services, each of which entails different risks. Many are a zero sum gain and could increase opacity. They could result in increased interconnectivity, asset encumbrance and concentration. 

Harmful conduct in retail markets is conduct that may not be illegal but that could harm investors’ interests, jeopardize the operation of fair, efficient and transparent markets, or lead to potential systemic risk. Mis-selling of complex products was the most frequently cited and caused most harm to investors. Long-term unit-linked products and structured products come under particular criticism due to their complexity. 

Securities markets regulators around the world are focusing on identifying, analyzing and mitigating cyber risks and increasing the resilience of financial systems. Cybersecurity is seen as part of governance and operational management requirements. Regulators are examining and requiring self-assessments by financial institutions and are conducting market surveys. They are providing guidance to firms and to consumers.

Implications for firms

Taken together with the Financial Stability Board's and the European Supervisory Authorities' work programs, these documents set the scene for this year’s global and European regulatory agenda and priorities. IOSCO, regional and national regulators are seeking more data to be able to monitor developments and inform their analysis of the extent and possible impacts of these risks.  

For firms, the message is clear. Even if the amount of new regulation is now slowing after an intense period of post-crisis reforms, not only must all those new rules be embedded into firms’ operating models, but firms must respond to increasing data and information requests from regulators about what is happening in practice in the wholesale and retail markets. Also, they must be able to evidence that they are taking account of these risk in their stress testing and risk management processes.

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