In an FSB plenary discussion on risks and vulnerabilities to the global financial system, a major concern identified a broad-based snap-back in long-term interest rates as a risk. After a decade of very low interest rates, financial institutions and markets in advanced and emerging market economies may not be sufficiently prepared for potential adverse economic and financial risks from market developments. A tightening of financial conditions could stem from surprises in economic growth, inflation, expectations of monetary and fiscal policies, or geopolitical events.
The plenary specifically explored the possible consequences such a snap-back could have, focusing on the following areas:
- High sovereign, corporate and household debt levels in many parts of the world could expose the financial system to market losses, rising credit defaults and increased rollover risk. A reduction in investors’ risk appetite could contribute to higher financing costs among some corporate and household borrowers.
- Sharply rising yields could trigger swings in cross-border capital flows, which could spill over to local equity, bond and foreign exchange markets. Recent episodes of portfolio rebalancing by institutional investors have already contributed to capital outflows from some emerging market economies and related exchange rate fluctuations.
Plenary members noted the considerable progress made over the last decade in strengthening the resilience of the financial system, but stressed the importance of monitoring financial markets during the transition away from a very low interest rate environment.
The Plenary discussed the results of a systemic stress assessment that examined the potential impact of portfolio rebalancing behaviours by asset managers and institutional investors on liquidity in fixed-income markets. Outcomes from an institutional investor survey in some countries and a model-based simulation suggest that, while fixed-income liquidity may appear resilient under normal market conditions, correlated portfolio rebalancing away from higher-yielding fixed-income assets could in some circumstances amplify market stress during a market shock. The work is being conducted as part of the FSB’s vulnerabilities work, in order to better understand the potential consequences of market stress.
Other topics included:
Transforming shadow banking into resilient market-based finance: IOSCO updated the Plenary on its work to develop consistent leverage measures for investment funds, as part of its work to operationalize the FSB policy recommendations on structural vulnerabilities from asset management activities. IOSCO plans to publish the consultative document on funds’ leverage measures in the autumn.
Crypto-assets: The G20 Finance Ministers and Central Bank Governors asked the FSB to update the G20 at its July meeting on its work and that of the standard-setting bodies (SSBs) together with a report from the Financial Action Task Force. The Plenary discussed progress on crypto-assets deliverables. While the FSB assesses that crypto-assets do not pose a risk to global financial stability at this time, they raise a host of issues around consumer and investor protection, as well as their use to shield illicit activity, money laundering and terrorist financing.
The plenary agreed on a framework to monitor potential emerging financial stability risks of crypto-assets. Members also received an update on the ongoing work by the Basel Committee on Banking Supervision, Committee on Payments and Market Infrastructures and International Organization of Securities Commissions (IOSCO) on their work on crypto-assets, including monitoring bank exposures, work on applications of the underlying technologies and use in payments, and considering issues stemming from initial coin offerings and crypto-asset exchanges that could impact investor or consumer protection.
The FSB will publish a summary of its work and that of the SSBs on crypto-assets ahead of the July meeting of G20 Finance Ministers and Central Bank Governors.
Cyber resilience: Members discussed the macrofinancial implications of operational and cyber risks and current challenges for supervisors in overseeing cyber risk management in internationally active financial institutions. The Plenary approved for publication in July a consultation paper on the common cyber lexicon the FSB has developed. The cyber lexicon is intended to support the FSB, SSBs, authorities and private sector participants in addressing cyber security issues and enhancing cyber resilience in the financial sector.
Evaluation of the effects of reforms: The FSB discussed preliminary results from two ongoing evaluations of the effects of reforms: on the financing of infrastructure investment, and on the incentives to centrally clear over-the-counter derivatives. The objective of these evaluations is to assess whether reforms are operating as intended, and to identify and deliver adjustments where appropriate, without compromising on either the original objectives of the reforms or the agreed level of resilience. Public consultations on both evaluations will be issued in the next two months. The final reports will be delivered to the G20 Leaders’ Summit and published in November.
Two other evaluations agreed upon by the FSB will be launched in the coming months. These are an evaluation of the effects of reforms on the financing of small and medium-sized enterprises, which will be delivered under the Japanese G20 Presidency; and an evaluation of the effects of policies to address too-big-to-fail, which will be completed in 2020.
Firm-level data collection framework: The Plenary discussed a draft framework for FSB collection and handling of firm-level non-public data. The FSB collects such data as part of its work to assess vulnerabilities, develop policies, monitor implementation and evaluate the effects of reforms, when data are not available from other sources. The Plenary has agreed to develop a framework that sets out robust processes for the collection and handling of such data in order to protect the confidentiality of the data.