Key challenges to global markets: IOSCO

Since the financial crisis, the International Organization of Securities Commissions (IOSCO) has been pushing for global economic reform.

It recently held its stakeholders’ forum in Madrid, and Investment Industry Association of Canada president Ian Russell was in attendance. He outlines key takeaways of the meeting in his latest industry letter.

IOSCO agenda

• Since the 2008 financial crisis, IOSCO has been at the centre of global reform efforts. It is recognized as the key interlocutor for global capital markets. Read: Why supplementing CPP is unnecessary: IIAC

• The aftermath of the 2008 financial crisis has provided a unique opportunity for IOSCO to take a leadership role in the reform of capital markets, and it has executed its role effectively.

• The strength of the organization has proven to be its effectiveness in identifying the key risks in global financial markets and setting global standards for market participants.

• On the other hand, the organization has found it difficult to persuade individual jurisdictions to coordinate rule-making in the interests of a harmonized rule framework, and has been relatively unsuccessful in encouraging jurisdictions to simplify the overlapping and duplicative rules confronting firms trading and clearing securities in global markets.

• Simply put, IOSCO does not have the power or the authority to force greater rule coordination among its members. These weaknesses have made it difficult, for example, to resolve the rule differences in OTC derivatives markets.

Applying sanctions, building culture

• IOSCO has recognized that remedial action to improve conduct requires a two-track approach: 1) applying credible sanctions on wrong-doing to deter bad behaviour, and 2) encouraging firms to build good culture.

• Tough sanctions should be in place to deter bad behaviour, and rules and standards are necessary to promote fair and effective conduct, and build positive culture, with sufficient resources and procedures to oversee activity.

• Culture is recognized as a key ingredient to improved market conduct.

• While culture can differ across firms, there are several core principles consistent with good culture:

1) The right tone at the top that puts the client first, demands ethical behaviour and imposes stiff retributions for wrongdoing;

2) Clear accountability for wrongdoing (the Fair and Effective Markets Review emphasized firms taking greater responsibility for employee conduct and the most senior personnel in the firm held accountable);

3) Clear and open communication across the firm; and

4) Imposition of the proper incentives to influence behaviour. Firms would establish policies and procedures to ensure these principles are met.

Ensuring adequate liquidity

• There was general consensus among the buy-side industry at the IOSCO Stakeholders’ Meeting that, at least in certain circumstances, liquidity is sufficient.

• Many institutions have taken precautionary measures, such as improved access to repo financings and strengthening bank credit lines.

Read: OSC Dialogue addresses market liquidity risk

• Further, institutions have placed greater reliance on electronic trading platforms, are splitting transactions into smaller sizes to make execution easier, and are relying on more liquid managed investments in corporate debt, such as mutual funds and ETFs, as an alternative to direct investment in bonds.

• Some of the regulators in attendance had not taken a definitive position on the liquidity situation, emphasizing the need for further research and analysis, as well as stress testing.

Cross-border regulation

• The financial crisis exposed significant weaknesses in the over-the-counter (OTC) derivatives market. In the immediate aftermath of the crisis, the G20 Leaders agreed to improve the integrity of trading, clearing and reporting of OTC derivative transactions.

• Individual regulators responded—some more quickly than others—to introduce new rules for dealers and clearinghouses in the derivatives market.

• The problem is these reforms were introduced without much coordination among the regulators.

• The lack of coordination resulted in duplication and disparity in the rules governing similar types of transactions, and led to a fragmentation of liquidity pools in global markets. Markets have balkanized along regional geographic lines, with derivatives traders unable to execute with foreign counterparties, and clear through offshore clearinghouses, without being subject to multiple regulatory regimes. The global marketplace for OTC derivatives quickly became a regional marketplace.

• The balkanization of the global market has led to less choice, less liquidity and higher costs for derivatives users.

• Nations are gradually moving towards more engagement to address regulatory overlaps, gaps and inconsistencies.

• The solution may be to find a way to integrate the political process, namely the G20 Directive and the commitment of the participating governments to harmonize rules and regulations, directly into the rule-making and harmonization exercise managed by IOSCO. Doing so would put pressure on individual regulators to work constructively through bilateral or multilateral negotiations to resolve the cross-border regulatory obstacles stemming from an overlapping rule framework.

• If the G20 and IOSCO can initiate bilateral or multilateral negotiations on the key cross-border regulatory impediments to capital flows, the successful outcome of these negotiations could trigger a positive response from the other small jurisdictions, like Asia-Pacific countries, that have delayed rule-making and are on the sidelines. The negotiations would provide these jurisdictions with greater clarity on the direction of cross-border harmonization of derivatives regulation.

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