On a day that will undoubtedly represent the high-water mark for international financial regulatory reform, a panel of leading minds gathered in Davos to assess where we’ve been, where we are going, and the challenges facing markets and policymakers.
Looking back at the regulatory response to the financial crisis of 2007-08, the panelists – including Larry Summers, Barbara Novick and Greg Medcraft - surmised that global markets are safer, but not entirely safe. Medcraft, the current the chairman of the Australian Securities and Investments Commission and former chairman of International Organization of Securities Commissions, said progress was made because of one key lessons global regulators learned.
“The crisis was a wake-up call for regulators,” Medcraft explained. “It showed we needed to cooperate a lot more. We needed to be a lot more proactive and look at emerging risk.”
Increased collaboration among global regulators was a hallmark of the response to the financial crisis, but what no one on the Davos panel mentioned was the effect new personnel would have on that collaboration. The UK and the US are now led by regimes that are leery of - or openly despise – international treaties and organizations. To think those regimes would embrace the collaborative spirit Medcraft describes is naïve.
The panel did accept that not all aspects of regulatory reform have been implemented perfectly. Italy’s handling of Banca Monte dei Paschi di Siena exemplifies how Too-Big-To-Fail is still a problem and how the resolution powers policymakers hoped to devise are not yet functional.
In one of the lighter moments of the discussion, Summers - who looked like he either had a very late night last night or was exhausted from a long week in Davos - likened such bank bailouts to kidnappings.
“You want to solve the problem by paying ransom, but you don’t want to set terrible precedents,” said the former US Treasury Secretary.
People are worried about bond liquidity (hat tip to Matt Levine)
On the question of whether regulations implemented in response to the financial crisis have harmed bond market liquidity, Novick didn’t hesitate:
“There has been all sorts of talk about whether these bank rules have reduced liquidity. I will simply point out that in the last week we have seen record earnings from a number of broker-dealers; all of which refer to their very strong trading after the election - bond trading in particular. So I think the scenario where bonds were going to stop trading, that there was no market liquidity, etcetera, etcetera because of all these bank regulation, we’re seeing that is just not accurate. … The downside scenario of increasing resiliency has just not materialized.”
It would be one thing if those comments came from Sen. Elizabeth Warren or some other left-wing policymaker, but it is pretty fascinating that those words came from Novick, a vice chairman of BlackRock.
Medcraft added that the key to developing sustainable, liquid markets is focusing on why bonds are being originated in the first place.
“You have to think about what investors need, not what issuers need. Pre-crisis, we were too focused on what issuers wanted,” Medcraft said.
What Risks Lie Ahead?
Novick suggested – and the rest of the panel agreed – that three of the greatest risks facing global markets included:
- Market plumbing – The regulatory response to the financial crisis mandated more activities be conducted via central counterparties. While that means risk is more transparent, it also means it is more concentrated.
- Pension funds – There is a worldwide crisis coming in terms of pension underfunding. Novick stressed that it won’t just be a matter of defined-benefit plans being forced to reduce benefits, but rather not being able to pay for any benefits at all.
- Cybersecurity – As markets and market participants become more and more technically advanced, cybersecurity will remain a challenge. Medcraft noted how the interconnectedness of markets that proved so ruinous during the financial crisis also looms as a threat should a major cyber event occur.
What Does Trump Means for Global Financial Regulation?
Fragmentation. Fragmentation. Fragmentation.
Trump’s lack of love for international regulatory collaboration stands to fracture global financial rules. As evidenced by the pause the Basel Committee opted to take defining how banks measure risk, global regulators are uncertain what a team from the Trump administration will bring to such negotiations – if Trump decides to send a team at all.
Medcraft said nationalistic approaches to global rule-making is a recipe for disaster.
“If you don’t have globally coordinated markets that stops the flow of capital. That’s not good for anybody.”
Summers suggested a better approach would be to place a heavier emphasis on market values, rather than accounting values. He also expressed concern for President Trump's lack of nuance.
“Policymaking by tweet is likely to be a substantial danger to economic performance over time,” Summers said.
The unofficial theme of this week in Davos has been how the concept of globalization is on trial. What the Davos panel today failed to state explicitly is how the US and the UK are likely to embrace fragmentation. Fragmentation has negative connotations for those who still believe in the promise of globalization. But for those seeking to play by their own rules, fragmentation is the goal.