IOSCO Staff Report Examines Potential Risks and Key Trends in Global Financial Markets

In a staff report titled IOSCO Securities Markets Risk Outlook 2016, IOSCO examined four potential areas of risk in the asset management industry and identified key trends in the global financial markets. The areas of risk include:

(1) Corporate Bond Market Liquidity.

• The report indicates that the interest rate environment has contributed to a surge in the issuance of corporate bonds, but also notes that market structure dynamics are changing as dealers step back from their historic role as market-makers.

• According to the report, "it is not clear that liquidity in corporate bond secondary markets is in fact declining," since certain measures (such as bid-ask spread and price impact) suggest an improvement.

(2) Risks Associated with the Use of Collateral in Financial Transactions.

• The report notes that various regulatory initiatives have led to the increased use of collateral, and examines the key characteristics and risks of those transactions to market participants and to the markets as a whole.

• The report cites the risk of over-collateralization, and observes that although collateral can diminish counterparty and credit risk, it also can raise liquidity risk.

• The report notes that the practice of "collateral transformation" (i.e., swapping lower-grade collateral for higher grade, with a fee) might raise concerns, and suggests that the practice could increase "contagion and systemic risk."

• The report observes that the "procyclicality issue" – i.e., the idea that in times of market stress, there will be a drive to higher quality assets, and increased haircuts and margin requirements – could pose a risk to financial stability and amplify stress.

(3) Harmful Conduct in Relation to Retail Financial Products and Services.

• The report focuses on sales practice and suitability concerns, particularly as they relate to complex and structured products and fraudulent investment management schemes.

(4) Cyber Threats.

• The report notes that cyber threats raise systemic risk concerns for large financial institutions and market infrastructures, and for smaller institutions due to their potential for spreading contagion.

(5) Asset Management.

• Although asset management wasn't identified as an area of risk in the responses to an IOSCO risk survey, the report notes systemic risk concerns relating to the industry that were raised by a number of "commentators and international organizations."

• The report found "very few" incidents of open-end mutual funds that were unable to meet redemptions. However, the report does note concerns about the use of "leverage and derivatives" by such entities.