A. Securities, Derivatives, and Financial Stability

Securities and derivatives markets are an important driver and enabler of economic activity as well as a source of wealth for investors and financial institutions; hence, stress or disruption therein can pose material risks to financial stability. Capital markets provide a significant source of funds for economic activity and a means for investors to generate wealth. Derivatives are an important tool for hedging risk. The largest capital market in the world, in the United States, accounts for 73 per cent of that country’s funding of nonfinancial firms.¹ In the second half of 2020, the notional amount of interest rate derivatives contracts outstanding was USD466.5 trillion.² However, several events—from the recapitalization of the hedge fund Long-Term Capital Management in 1998, to the failure of Lehman Brothers in 2008 with significant open positions in over-the-counter (OTC) derivatives markets and the attendant “breaking of the buck”³ by the Reserve Primary money market fund—have shown the potential for financial stability challenges.

After the GFC, and consistent with G20 commitments, significant enhancements were made to the international regulatory standards for these markets. The standards sought to give effect to commitments which included ensuring that all firms whose failure could pose a risk to financial stability should be subject to high-quality regulation and supervision; OTC derivatives should be centrally cleared through CCPs and higher capital charges applied where they are not; and enhanced tools should be in place for the resolution of systemically important financial institutions, including those operating across borders.⁴

Since the GFC, there has been growing recognition that risks to financial stability can arise in or be transmitted through nonbank financial institutions and through securities and derivatives markets. This recognition has been reflected in policy work by the Financial Stability Board (FSB), for example, on shadow banking,⁵ and in enhanced international standards for financial market infrastructures (Principles for Financial Market Infrastructures—PFMIs) by the International Organization of Securities Commissions (IOSCO) and the Committee on Payments and Market Infrastructures (CPMI).⁶ The need for continuing international focus in this area has been highlighted by events during the COVID-19 pandemic, such as the instability experienced in short-term funding and bond markets in 2020, including significant outflows from emerging market bond funds and default on bond payments by potentially systemically significant issuers.⁷

B. Insight on Progress and Emerging Issues

This paper draws on common themes from securities and derivatives markets assessments carried out in the context of the FSAP during 2015–20 to establish where countries stand and identify key remaining challenges.⁸ The paper sets out the core risks to financial stability which the assessments initially sought to address in the light of post-GFC reforms and key findings in relation to vulnerabilities, regulation, and supervision. It discusses findings in relation to those issues that emerged after 2015 and were covered in some of the assessments and identifies newly emerging issues which may also warrant consideration by regulators. A consistent theme in the paper is that individual countries’ circumstances have an impact on the relevance of particular topics for financial stability, which is a key consideration when FSAPs scope their approach. Therefore, different themes have been covered in different jurisdictions for the sample of FSAPs considered, see Figure 1.

How FSAPs Addressed Post-GFC Securities Reform Agenda

Citation: Departmental Papers 2022, 012; 10.5089/9798400208072.087.A001

Source: IMF staff.

• Download Figure
• Download figure as PowerPoint slide

View Full Size

How FSAPs Addressed Post-GFC Securities Reform Agenda

Citation: Departmental Papers 2022, 012; 10.5089/9798400208072.087.A001

Source: IMF staff.

• Download Figure
• Download figure as PowerPoint slide

How FSAPs Addressed Post-GFC Securities Reform Agenda

Citation: Departmental Papers 2022, 012; 10.5089/9798400208072.087.A001

Source: IMF staff.

• Download Figure
• Download figure as PowerPoint slide

The paper discusses key themes regarding these core issues and other emerging issues for the period ahead arising from this horizontal review. Chapter 2 sets out key findings of assessments in relation to the institutional framework underpinning regulation and supervision. Chapters 3, 4, and 5 summarize key findings in relation to the regulation and supervision of asset management, market intermediaries, and market infrastructure respectively. Chapter 6 discusses the treatment of key issues which came to prominence since 2015 and identifies newer emerging issues for the period ahead. Chapter 7 reflects on conclusions from the review on core and emerging issues and their potential implications for securities regulators.

A. Context

Post-GFC, concerns about the impact of failure of a significant counterparty on the OTC derivatives market became the focus of regulatory consideration of market intermediaries, and CPSS-IOSCO developed international standards to address relevant risks.²⁴ Specifically, the concern about failure of counterparties translated into a focus on the arrangements for handling the failure of a significant dealer and the triggers that might prompt such a failure, which included both a prudential failure and a conduct event of such significance as to prompt a widespread loss of investor confidence. CCPs are now covered by enhanced regulatory oversight, and certain OTC derivatives contracts are subject to mandatory clearing, reinforced by incentives to clear centrally in the capital regime for banks.²⁵ Regimes aim toward CCPs being able to withstand shocks, including the failure of one or more major participants.

Assessments in this period explored two key challenges. First, whether the scope of FMI supervision was sufficient to meet post-GFC expectations, and second, whether the infrastructure for trading, clearing and settlement was sufficiently resilient to operational challenges and extreme market conditions including, for CCPs, the failure of major participants. Key reforms to the regulatory oversight of market infrastructure took effect during this period although in many jurisdictions detailed implementation is still ongoing. Growing recognition of the importance of infrastructure’s operational resilience to the functioning of markets made this an area of focus in some FSAPs in larger markets towards the end of the period.

B. Central Counterparties

The increased prominence of central clearing activity puts greater focus on sound regulation, supervision, and oversight of CCPs to ensure financial stability. Recovery and resolution arrangements for CCPs, as well as crisis management planning and communication, remain priorities. There is also merit in strengthening cooperation frameworks, both domestically—in the case that multiple authorities are involved in the supervision and/or oversight of CCPs—and across jurisdictions, especially where a foreign infrastructure provides clearing services for market participants to such an extent as to render it systemically important. While there has been much progress in adopting and adhering to the international standards set out in the PFMI, for many jurisdictions there is still progress to be made to improve the robustness of CCPs. Stress testing methodologies can be strengthened via the further inclusion of sufficiently extreme market scenarios, and financial system interconnectedness should be sufficiently taken into account to ensure that system-wide risks are adequately analyzed. This may require efforts to expand the coverage and quality of the available data.

Analyzing interdependencies is important to assess the resilience of CCPs, including the robustness of risk management frameworks and adequacy of recovery and resolution planning. The high concentration and cross-border nature of central clearing activity make it increasingly relevant to have a clear picture of the interdependencies that exist due to shared clearing member participation across CCPs, as well as the reliance on a small number of financial institutions for critical (for example, custodial) services. These interdependencies should be taken into account when considering, for example, operational risk and ensuring continuity of services in the case of a crisis event.²⁶

There is generally room for CCP risk management frameworks to be improved and made more robust. In particular, margin models should adequately and holistically address concerns over procyclicality to avoid exacerbating financial strain for clearing members and their clients during times of stress. Sensitivity analyses of models should be performed regularly, and authorities should conduct validation assessments to make sure that models are sufficiently robust. Beyond this, risk management frameworks should include a consideration of a wide range of risks, beyond those of credit and liquidity, including reputation and competition risk. Stress testing should be an integral part of the framework incorporating scenarios that are sufficiently extreme.²⁷

Increased regulatory focus is being placed on the adequacy of crisis management and on recovery and resolution planning for CCPs. Common areas for improvement include the formation of crisis management groups that allow for coordination across authorities—within and across jurisdictions—and the creation of tools supported by binding rules and regulations or backed by formal agreements. Any plans and processes need to be regularly tested and interdependencies be properly considered to ensure continuity of critical services.

Increasing CCP access to central bank services is a priority in several jurisdictions. The FSAP for Sweden, for example, called on the Riksbank to consider offering FMIs central bank access to collateralized overnight liquidity, in particular for CCPs. The assessment for the euro area called on the Eurosystem to harmonize its policy on CCP access to central bank deposit accounts and liquidity facilities to allow for a level playing field, regardless of whether a given CCP has a banking license.

C. Trading Venues

While a number of countries have implemented reforms to enhance the oversight of secondary markets, including more forms of trading venues across a wider range of asset classes, gaps and challenges remain. For example, by the 2020 FSAP the US Commodity Futures Trading Commission had moved to a final registration regime for “swap execution facilities,” while the US Securities and Exchange Commission had yet to put in place a regime for securities-based swaps. The Securities and Exchange Commission requires enhanced disclosures of the operating model of equity alternative trading systems (ATS), and very recently proposed extending the scope of regulation of ATS to include systems trading government debt, repurchase agreements, and reverse repurchase agreements.²⁸ The China FSAP found that a regulatory regime needed to be developed for non-exchange equity trading venues in China. In the EU, a wider range of bond and derivative trading venues now fall within the scope of regulation. Across several jurisdictions, frameworks are more robust in the face of potential drivers of risk in equity market trading, including algorithmic trading and associated practices, and requirements governing the suspension and resumption of trading in times of unusual volatility or other extreme market conditions. Ensuring appropriate coverage of venues across equity, bond, and derivative markets, taking account of the characteristics of those markets, will remain important as markets and trading practices evolve.

D. Operational Resilience

While many authorities recognize the importance of operational resilience, fewer have implemented a systematic response; hence, challenges remain in relation to prevention and ensuring understanding and mitigation of the adverse impact of infrastructure outages.²⁹ The heavy reliance on technology of trading venues and other FMIs has increased awareness of the need to not only avoid operational outages, but also manage the impact and ensure an orderly recovery where an incident occurs. In this regard, the dedicated IT resilience supervisory programs in place in several jurisdictions are beneficial despite their differing degrees of sophistication and intensity.³⁰ It is also possible to address the issue as a subset of business continuity or crisis management contingency planning. In some jurisdictions changing patterns of trading further concentrates risk arising from trading venue disruption at specific parts of the day, particularly opening and closing auctions. Where opening or closing prices are not available, there can be consequences for funds and derivatives instruments that depend on them for valuations. This issue is likely to be relevant in more markets over the forthcoming period. In the meantime there is value in ensuring that operational resilience supervision pays sufficient attention to these potential stress points; that authorities and FMIs understand the wider implications of operational outages and how to reduce or manage them; and that crisis simulation exercises are considered for plausible events that could give rise to significant disruption, such as simultaneous failure to close in multiple key venues, to ensure that the full range of dependencies are understood and means to reduce impact are identified and implemented.

A. Fintech and Cyber-Resilience

Supervisors have been addressing the implications of fintech in securities markets, particularly the emergence of alternative platforms for start-up capital raising and intermediation in relation to the offer of securities through crowdfunding platforms.³¹ Authorities typically seek an appropriate balance between facilitating capital-raising by companies not yet large enough to list their securities on exchanges, and the need to protect investors appropriately given the elevated potential for capital loss in such investments. While these entities are often complex to regulate and supervise, fintech activities in securities markets have—until recently—rarely been of a scale or nature to pose material financial stability risks. While it seems unlikely at present that crowdfunding specifically will need further significant attention in the near-future, regular horizon scanning vis-à-vis other fintech innovations and assessments of financial stability and investor protection implications of new capital-raising strategies remain paramount.

Jurisdictions continue to assess how to address the challenges posed by more mainstream use of crypto assets, and this looks set to be a continuing area of focus.³² Crypto assets³³ play an increasingly prominent role in the financial sector. As is often the case with the provision of financial services through novel and innovative means, for example, through new technology, a first challenge for authorities and market participants is to determine the extent to which existing regulations apply, and whether any adjustments to the perimeter and to the formulation of detailed requirements is needed. In a number of jurisdictions there is clarity that at least some services in relation to some crypto assets that have the characteristics of securities (for example, by conferring ownership or profit rights in an enterprise) are covered by existing laws relating to securities and/or derivatives.³⁴ However, practical challenges arise in their application, for example in relation to how custody or safeguarding rules apply where regulated firms hold private keys for assets, or whether there is a need to adapt settlement finality provisions to reflect the particular role played by “miners” in finalizing transactions. Importantly, many crypto service providers operate across borders, making the task for supervision and enforcement more difficult. Some jurisdictions³⁵ are also exploring regimes, particularly for actors or assets whose status under existing regulations is less clear, prompted in part by the Financial Action Task Force standards in relation to anti-money laundering requirements for virtual asset service providers.³⁶ This issue is likely to remain an area of focus as crypto assets continue to move into the financial mainstream.³⁷

The related issue of Distributed Ledger Technology (DLT) is of particular relevance to FMIs and is likely to remain material in the period ahead, alongside consideration of the emerging role for “decentralized finance” (DeFi).³⁸ Authorities and FMI operators alike are exploring the benefits and risks of implementing DLT, particularly for payments and securities clearing and settlement systems via permissioned platforms. A key issue in the application of this emerging technology is an evaluation of how appropriate existing regulatory frameworks are in ensuring sufficient supervision over FMIs that employ such novel systems. To the extent possible, international standards are used to evaluate the risks and benefits with an aim to ensure that application of DLT in FMIs will be compliant with the PFMI.³⁹ Going forward, authorities are keen to see standardization in DLT to avoid operational fragmentation and lack of interoperability. Though adoption has thus far been limited, DLT can potentially provide market efficiencies through digitization and automation of processes. Other applications of DeFi may require consideration in the period ahead and may pose challenges for regulators and supervisors alike, for example, some distributed ledgers support self-executing “smart contracts.” As the FSB has noted, these developments carry potential efficiency benefits as well as potential financial stability risks. For example, they may challenge supervisory authorities in determining accountability and ensuring resolvability in a devolved system where a responsible party may be difficult to identify and subject to limited regulatory grip.⁴⁰ Further, smart contracts and other DeFi applications may not be easy to link to a particular jurisdiction and may operate across jurisdictional boundaries, making international consensus and collaboration on regulation and supervision potentially challenging, even as it becomes crucial to effective risk mitigation.⁴¹ IMF analysis suggests that the amount of collateral “locked” in DeFi platforms has risen significantly, reaching USD100 billion as of September 2021.⁴²

Cyber-resilience is an area deserving of enhanced focus, while broader operational resilience merits continued attention in the period ahead. Authorities in jurisdictions with the largest and most developed markets are generally acutely aware of the need for cyber-resilience and address these issues explicitly in their supervisory oversight. In some cases, authorities are also well integrated into wider national efforts to combat cyber-threats. Some implement very structured and targeted supervisory programs, with cyber-security considered as part of wider operational resilience. Nevertheless, it is not always easy for supervisory authorities to access the necessary expertise in-house, and some over-rely on either their existing staff responsible for the authority’s own information technology, or on ad hoc external expertise. In some instances, the supervisory response does not seem commensurate with the threat or potential impact on the financial system if an attack on market infrastructure were successful. In the period ahead, cyber-resilience will continue to need to be considered alongside other aspects of operational resilience. These include effective management of technological change, recovery from incidents driven by causes other than cyber-attacks, and other external factors well-illustrated by the change in operating conditions and methods triggered by the global pandemic.

B. Benchmark Transition

Interest rate benchmarks are widely referenced in interest rate swaps and a range of other financial contracts. For some benchmarks, such as LIBOR, with insufficient transactions in the underlying market, participant banks’ submissions used to calculate the benchmark were increasingly judgement-based estimates rather than transaction data. This reliance on estimates can make the benchmarks susceptible to manipulation. In 2012–16 authorities in several jurisdictions brought enforcement actions against financial institutions for such manipulation.

Experiences such as the discovery of historic manipulation and the increasing fragility of underling volumes have highlighted vulnerabilities arising from the limitations of estimate-based benchmarks such as LIBOR. This realization in turn led to recognition that alternative approaches would be beneficial. The reputational risk from alleged manipulation and penalties where it was detected also made financial institutions less willing to provide estimate-based submissions to the benchmarks.

In some jurisdictions this episode prompted a regulatory response. For example, the EU and United Kingdom introduced requirements for benchmark administrators to be authorized and implement procedures to avoid or manage potential conflicts of interest. The regulations allowed for certain benchmarks widely used in financial markets to be deemed “critical.” They gave supervisory authorities powers to compel administrators to continue producing or ensure orderly cessation or transition of such critical benchmarks, and to compel regulated financial institutions to make submissions to them for a specified time. The regulations have since been amended, with the United Kingdom introducing powers for the regulator to require changes to critical benchmarks in certain circumstances, and the United States and EU introducing (LIBOR-specific, in the case of the United States) legislative measures to enable replacement rates to be specified in certain circumstances.

It then became clear that an orderly transition to alternative rates with different characteristics would be needed, with the end of 2021 identified as a target date. Efforts were set in train internationally to design and encourage an orderly transition to alternative reference rates and, in 2017, the UK Financial Conduct Authority announced that it did not plan to require panel banks to continue submitting to the LIBOR administrator beyond the end of 2021. Alternative reference rates were identified, generally based on compounded risk-free or near risk-free rates in overnight transactions. These rates have the advantage of being grounded in transactions rather than estimates, but do not as such replicate the different forward-looking term structures available under the current reference rates.

The potential for significant market disruption arising from the cessation of the LIBOR benchmark warrants consideration. Benchmark transition is a good test of the extent to which regulatory and supervisory regimes are capable of taking a forward-looking approach to identify and mitigate harm without having established rules or precedent to rely on. In the case of LIBOR, the UK regulations and proactive supervisory effort enabled the authorities to support a managed and orderly transition. Issues arising during the LIBOR transition are likely to be pertinent in other jurisdictions where LIBOR or similar rates have been relied on, particularly given that US dollar LIBOR is due to continue until 2023, or where other benchmarks are widely referenced in financial instruments. There may also be a need to consider whether the transition of benchmarks can be managed effectively where they are administered from jurisdictions in which neither systemically important benchmarks nor their administrators are regulated and assess future challenges in relation to other benchmarks in light of the findings.⁴³

Preparing for the cessation of LIBOR and other similar benchmarks meant designing alternative reference rates, putting in place the infrastructure to support trading in instruments referencing the new rates, and working out how to deal with “legacy” references to LIBOR. Once the new rates were settled on, action was needed by market participants to design contracts and instruments referencing them, taking into account their different characteristics, to ensure that services such as clearing were available for them, and to build sufficient liquidity in markets referencing the new rates to enable them to function once the old rates cease to be available. In parallel, extensive work was undertaken, particularly under the auspices of the International Swaps and Derivatives Association, to put in place “fall-back” arrangements for existing contracts referencing LIBOR and other rates once those rates were discontinued or declared unrepresentative of the underlying market. In the United States, reflecting the significance of US dollar LIBOR, there was a concerted policy effort to design alternatives and remove obstacles to their adoption, but less of a focus on supervisory tools as a means of assessing and mitigating risks arising from the readiness of infrastructure providers and market intermediaries for the transition.

Most LIBOR settings ceased at the end of 2021, but with significant new issuance referencing US dollar LIBOR continuing through 2021, continued effort may be needed to secure an orderly transition when US dollar LIBOR ends in 2023. In March 2021, the UK authorities and the benchmark administrator confirmed that LIBOR would end or cease to be representative in all currencies other than US dollars on December 31, 2021, but that some US dollar settings would continue until June 30, 2023. Nevertheless, the FSB noted in July 2021 that activity in US dollar LIBOR-based derivatives had grown since 2017 and that the US securitization issuance remained primarily LIBOR based. It underlined the importance of accelerating transition and efforts to address remaining “tough legacy” contracts and indicated it would report again in mid-2022.⁴⁴

C. Climate Transition and “Green” Finance

A key emerging issue for securities and derivatives markets in the years ahead will be the risks from and response to climate change and the associated development of “green” finance.^45,46 Efforts are underway to increase the coherence and robustness of international standards for the classification of activities, the disclosure of material information related to climate change and energy and ecological transition and classification of securities and investments as “green.” Supervisors will increasingly be expected to ensure that institutions not only address climate risks but also respond to and accurately disclose their approach to climate transition policy in ways that do not give rise to “greenwashing” of activities and financial instruments, despite imperfect data. This will bring challenges for regulatory and supervisory authorities, financial institutions, and other corporate issuers through what is likely to be a constant evolution in international standards.

Climate change and transition policy add extra dimensions to the timely and accurate disclosure of material information by issuers on which securities markets depend. It is a longstanding feature of public securities markets that an initial offer of securities must include the disclosure of material risks and other information relevant to investors’ decisions, supplemented by ongoing disclosure requirements. Issuers, investors, and regulators are grappling with how climate change and energy and ecological transition need to inform and feature in such disclosures.⁴⁷ The need to do so is illustrated by the fact that an issuer’s assets may experience a significant loss of value, or even become a valueless “stranded asset,” as a result of either climate change itself (for example, if a particular form of agriculture were no longer viable in a given location) or energy and ecological transition (for example, if a jurisdiction were to remove subsidy from or prohibit coal mining).⁴⁸

Jurisdictions will need to determine how to give effect to evolving international climate disclosure standards, how to ensure that financial statements appropriately reflect climate risks and impacts, and that audits appropriately reflect the climate dimension. Various initiatives have sought to codify what constitutes adequate disclosure, and efforts are also underway under the auspices of the newly-formed International Sustainability Standards Board to bring enhanced consistency to standards and pave the way for enhanced integration with international accounting standards.^49,50 Adoption of the existing standards has to date been largely voluntary and implementation of variable quality.⁵¹ However, some jurisdictions are now making the use of such disclosure frameworks compulsory for at least some categories of issuer.⁵² Compulsion can enhance coverage, potentially raise standards and remove some of the competitive distortions which may arise where disclosures are voluntary and made without reference to a common standard. However, where compulsion is limited to entities that are publicly owned, this could introduce other distortions in competition between publicly- and privately-owned entities and even potentially incentivize private ownership structures. Consideration will also need to be given to whether the scope of audits and audit standards are sufficient to ensure that climate-related disclosures are accurate and appropriately reflected in financial statements. The challenge of verifying the accuracy of disclosures related to climate-related risk and impact is significant, given uncertainty regarding the effects of climate change, the difficulties of providing assurances on forward-looking risks and the lack of data. Attention should also be devoted to risks stemming from a fragmentation of market practices and policy developments on climate information architecture, as alignment or at least interoperability of national approaches is vital to the effectiveness of these measures.

Asset managers including operators of collective investment schemes will face challenges in ensuring that portfolios are consistent with mandates and that asset valuations are realistic once climate-related factors are considered. Climate change and transition policy can reduce the value of certain assets (such as those related to fossil fuel extraction) and make the valuation of assets and liabilities challenging. This brings the risk of shocks to the value of funds and portfolios which would impact not only asset managers and their clients but potentially also banks that extend credit lines to them. Jurisdictions will need to reflect on whether their current regulatory and supervisory approaches address these challenges⁵³ and whether the scope, underlying rationale and methodology of stress-testing practices needs to be enlarged to adequately cover climate-related scenarios.

As existing futures and derivatives markets grow and new instruments emerge, jurisdictions may need to review the scope of their regulatory perimeter and consider whether operational resilience in these markets is sufficient to deal with extreme events. For example, there may be an expanded market for futures and other derivatives of water, climate variables, emission allowances, or other carbon pricing mechanisms. Jurisdictions will need to ensure that their regulatory perimeter encompasses the appropriate range of such instruments, which may not previously have been caught where scope was limited, for example, to futures and other derivatives where the underlying investment was a security or other financial instrument. Climate-related physical or policy shocks could trigger extreme movements in these markets, testing the operational resilience of infrastructure providers in particular. The potential for extreme and unexpected movements in commodity derivative markets, though not in this case climate-driven, was underlined by the period during the coronavirus pandemic in which some oil derivatives had negative prices due to storage and other capacity constraints.

Investor interest in green finance is growing and, in some jurisdictions, actively encouraged to support the Paris Agreement climate goals, but the risk of greenwashing is high and could have significant consequences. Public policy, investor preference and reputational risk are all driving interest in investments which contribute to or are at least consistent with meeting Paris climate goals and development of associated products and services, from “climate-friendly” collective investment schemes to sustainability benchmarks. For financial institutions this creates opportunities for differentiation and new product niches which are potentially beneficial for investors and may contribute to public policy goals. However, without a consistent way to determine which activities, assets and products are compatible with which climate-related objectives, a reliable way to verify whether claims are delivered in practice, and appropriate disclosures to investors to inform decision-making, it is hard to be confident that investor preferences or public policy goals are met. This could have potential financial stability consequences in scenarios where, for example, significant pension funds invest in assets which transpire not to be compatible with the claimed climate-related objectives and may consequently need to be written-down or written-off.

Regulatory and supervisory authorities will face challenges in identifying and applying appropriate standards while supporting infrastructure is put in place and evolves as new scientific evidence emerges. While various standards exist for green or “climate-bond” issuances, and for catalogues of projects or taxonomies of activities and their environmental objectives, authorities will need to act before there is any definitive international standard or full “interoperability” of existing standards.⁵⁴ While particular challenges arise where claims of climate-related benefits are made, to deliver public policy goals, supervisory authorities may need to consider the much broader canvas of the climate-related characteristics of other investments which make no such claims, as well as disclosures by a broad range of corporate issuers and other financial market participants. Determining the standards applicable and ensuring they are consistent with available scientific evidence and supervising their use by financial institutions is likely to require specific expertise that may not be readily available within authorities and exacerbate resource challenges by further increasing pressure to spread available resource more thinly.

D. Debt Markets and Other Emerging Issues

The market stress that began in core funding markets in March 2020 was stabilized through a swift and significant policy response, but this involved material risk and the potential of engendering moral hazard. In emerging market economies, the shock manifested as a shortage of US-dollar cash, so central bank responses focused on more traditional monetary policy responses or measures to provide dollar liquidity. In some advanced economies (AE), central banks additionally purchased risk assets, including commercial paper, asset-backed securities and corporate bonds, sometimes through purchases of high-yield bond exchange-traded funds. Some AE central banks also introduced targeted liquidity facilities for specific entities such as dealers or MMFs, while others also changed dealer leverage rules, allowed use of bank buffers to support lending, or temporarily modified the leverage ratio. To facilitate access to US dollars in cash, several central banks introduced or extended the frequency and tenor of existing swap lines, and the Federal Reserve also introduced a temporary repo facility to allow foreign monetary authorities to enter repurchase agreements directly with the Federal Reserve. While effective, these measures increased G7 central bank assets by USD7 trillion in the eight months from February 2020, compared to about USD3 trillion in the year following the collapse of Lehman Brothers in 2008. They could potentially lead to moral hazard if market participants do not fully internalize their liquidity risks in expectation of central bank intervention. The intervention and the risks associated with it have prompted consideration of how the need for such a backstop could be reduced in future.

Analysis of causes and amplifiers of this stress episode shows the continuing relevance of fund liquidity management and interconnectedness, the adequacy of CCPs’ margin requirements and operational resilience. Analysis by international standard setters⁵⁵ underlines the importance of robust and continuous risks and vulnerabilities assessments, including stress testing of MMFs and bond funds, particularly high yield and emerging market funds; consideration of the adequacy of liquidity management tools for open-ended funds; analysis of the interconnectedness between NBFIs and banks; adequacy of CCP margin models, including anti-procyclicality measures; and operational resilience of both infrastructure and liquidity providers.

In addition, more explicit consideration of the tailoring of regulatory frameworks to debt markets and the ability of dealers and other participants to respond to liquidity shocks may be warranted. It may be beneficial to explicitly consider whether jurisdictions’ regulatory regimes are well-calibrated to the specificities of their debt markets, including their liquidity profiles, both in relation to traditional execution channels and the smaller but growing segment traded electronically, and to consider whether such regimes need to be modulated in times of stress. Consideration may need to be given to whether and how dealers and other market participants take account of the implications of significant margin calls in stress scenarios, their liquidity preparedness, and the adequacy of data available to regulators about the NBFI sector on this topic. The transparency, predictability and anti-procyclicality of CCP margin requirements and the appropriateness of margin models for non-centrally-cleared transactions may be beneficially reviewed, as could the interaction between margin calls and redemption pressures on MMFs. The effectiveness of the mechanics of settlement and the management of settlement fails under stressed market conditions could be given fresh consideration. Finally, it may be useful to ensure that interactions between spot and futures and other derivatives markets are explicitly considered to identify and mitigate avoidable dislocations or transmission of shocks.

More generally, business model changes that can lead to changes in the behavior of market participants, the resilience of bond markets, and the adequacy of audit standards and oversight warrant closer attention in the period ahead. Turbulence in US markets connected to “meme” stocks following the transition of intermediary business models to commission-free dealing, with revenue gained from payment for order flow, suggests that changing intermediary business models can create or expose wider vulnerabilities in securities markets, for example in relation to margining practices and settlement times and processes.⁵⁶ Turbulence in key bond markets during the coronavirus pandemic has also prompted reflection on whether additional policy measures are necessary to ensure market resilience.⁵⁷ In addition, high-profile corporate frauds and failures have raised the question of whether audits are being conducted to sufficiently robust standards and whether enhanced oversight is required,⁵⁸ a question that will also be increasingly relevant to audits of nonfinancial information given the climate change and broader ESG agenda.

Focus may also need to be placed on the extent and terms of issuer participation in public markets. As various commentators have noted, capital raising through public markets appears to be less attractive than in the past, with fewer listings and more de-listings occurring in many jurisdictions, notwithstanding the increase in initial offerings seen in some jurisdictions and sectors in 2020–21.⁵⁹ If this decline continues, equity trading may become even further concentrated in a few stocks at a time when valuations may be subject to change as the impact of climate change and transition become increasingly material and given other significant policy changes being contemplated, for example, in relation to the regulation of “bigtech” firms or significant changes to international corporate taxation regimes. These changes in turn will bring further challenges in ensuring that corporate disclosures are appropriate and sufficient to support investor decision making.