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.

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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

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Risks

• Low interest rate environment

• Collateral in a stressed funding environment

• Derivatives markets

• Cyber-crime

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Risks

• Low interest rate environment

• Collateral in a stressed funding environment

• Derivatives markets

• Cyber-crime

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Low interest rate environment Economic recession is deep in various parts of the Eurozone but recovery

expected in 2014.

Graph 1: GDP growth (%)

-4

-2

0

2

4

6

8

Perce

nt (%

)

2010 2011 2012 2013 2014Source: IOSCO Risk Dashboard, IMF

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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 (%)

Source: IOSCO Risk Dashboard, Bloomberg

-4

-3

-2

-1

0

1

2

3

4

5

6

2005 2006 2007 2008 2009 2010 2011 2012 2013

Perc

ent (

%)

UK Eurozone Germany US

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Low interest rate environment • Cheap borrowing for big firms (not SME´s) drive corporate bond issuances

up… Graph 3: Corporate bond issuances ($ M)

Source: Dealogic

0

30,000

60,000

90,000

120,000

150,000

180,000

210,000

240,000

270,000

300,000

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2007 2008 2009 2010 2011 2012

$U

S (m

illio

ns)

$U

S (m

illio

ns)

Australasia Europe Latin America MENA Asia North America (RHS)

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Low interest rate environment • While IPOs on the equity markets seems less attractive for firm´s funding…

Graph 4: IPO activity ($ M)

Source: World Federation of Exchanges

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

2007 2008 2009 2010 2011 2012

$U

S(m

illio

ns)

Americas Asia Pacific Europe

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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)

Source: IOSCO Risk Dashboard, Dealogic

$0

$10

$20

$30

$40

$50

$60

2007 2008 2009 2010 2011 2012 2013

$US

(Bill

ions

)

Europe North America

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Low interest rate environment

Graph 6A .Private sector spreads over 10yr Government treasuries (percentage points), US

Graph 6B. Private sector spreads over generic Iboxx 10yr yields (percentage points), Euro area

0

100

200

300

400

500

600

700

2007 2008 2009 2010 2011 2012 2013

bp

s

BBB Spread AAA Spread

IOSCO Risk Dashboard, Bloomberg

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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?

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Risks

• Low interest rate environment

• Collateral in a stressed funding environment

• Derivatives markets

• Cyber-crime

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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…

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Deposits MMFs Structured products

Repo Securities

lending

Structured retailprod.

Equity

Bonds

Collateral transform

Re-hyp. Central

Bank

Funding trend:

Assets as collateral for cash placed with Central

Banks

Debt titles placed with

Money Market Funds

Asset backed securities (CDO ↓ covered

bonds ↑) sold to

investors

Assets lent out under temporary repurchase agreem. w. investment

banks

Securities lent out for a

fee to brokers and investment

banks

Securities borrowed

from investors

and lent-out for a fee

Collateral packaged

and upgraded

sold to clients

Off-balance sheet, bi-lateral transactions and contracts

On-balance sheet, if publicly offered, prospectus

Partly off-balance sheet, if publicl offered

prospectus

?=

B:

Funding source:

Transparency:

? E:= D:

S:

Collateral in a stressed funding environment

Retail Wholesale

Source: IOSCO Research Department 18

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)

Source: IOSCO Risk Dashboard, Bloomberg, ICI

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013

$US

(Bill

ions

)

US MMF AUM

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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)

Source: IOSCO Risk Dashboard, Dealogic

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2007 2008 2009 2010 2011 2012

$US

(Bill

ions

)

Europe North America

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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)

Source: IOSCO Risk Dashboard, Dealogic

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

2006 2007 2008 2009 2010 2011 2012

$US

(Bill

ions

)

Europe Latin America North America North Asia Australasia

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Collateral in a stressed funding environment

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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

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?

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Risks

• Low interest rate environment

• Collateral in a stressed funding environment

• Derivatives markets

• Cyber-crime

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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

Jan 2012; 25

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?

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Risks

• Low interest rate environment

• Collateral in a stressed funding environment

• Derivatives markets

• Cyber-crime

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Cyber crime

Issues: – Financial system relies on technological infrastructure.

– Nature of cyber-crime is changing – more sophisticated.

– Methods, motives, purposes and consequences not clear.

– Attack: not an ‘if’ but a ‘when’ question.

Questions: – Systemic impact?

– How vulnerable are financial market infrastructures?

– Awareness is growing, but are regulators prepared?

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