The Plenary discussed, as part of its regular risk assessment, market developments and vulnerabilities in the global financial system. The Plenary continues to see 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.
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.
IOSCO updated the Plenary on its work to develop consistent leverage measures for investment funds, as part of its work to operationalise 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.
Full press release
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