Regulators warn on rise of boom-era debt

October 15, 2013 5:27 pm

Regulators warn on rise of boom-era debt

By Sam Fleming and Philip Stafford

Global securities regulators have warned that the types of debt security that played a central role in the global financial crisis are again growing in popularity among investors. The International Organisation of Securities Commissions (Iosco) said on Tuesday that investors chasing higher yields were placing more money into leveraged investment products that could be vulnerable to a sharp change in financial market conditions.The findings were part of Iosco’s first annual report highlighting the main risks to global securities markets. They come amid growing concerns about the implications of the current protracted period of ultra-low interest rates.

It cited resurgence in the issuance of so-calledcollateralised debt obligations, securities that were at the epicentre of the boom and bust that hit the global financial system half a decade ago. It warned of the risk of large-scale capital flows from emerging markets and dangers related to clearing houses and derivatives.

“Investors have selectively returned to certain types of leveraged investment products,” Iosco found. “While these instruments may offer higher income in the near term, they are more vulnerable to significant revaluations when credit risk increases.”

The report found the value of CDOs had risen from $6bn in 2010 to an estimated $35bn in 2013, amid rising demand for other structured retail products with leverage, such as real estate investment trusts.

“If normalisation of interest rates occurs, this could have adverse impact on the value of these products similar to what has been experienced in the financial crisis, where the value of leveraged products was decimated,” the report, called the Risk Outlook, said.

The body also reiterated a call about its rising concerns over the impact of cyber crime on securities markets. More than half the world’s securities exchanges have fought off cyber attacks in the past year, according to a survey it conducted with the World Federation of Exchanges. Some 59 per cent of the 46 bourses surveyed said there were sanction regimes in place in their own legal jurisdiction to combat cybercrime.

“Cybercrime is perhaps the most significant issue – the next ‘black swan’ event in markets,” said Greg Medcraft, chairman of the Iosco board.

If normalisation of interest rates occurs, this could have adverse impact on the value of these products similar to what has been experienced in the financial crisis, where the value of leveraged products was decimated

– International Organisation of Securities Commissions’ ‘Risk Outlook’ report

The report cited potential systemic risks arising from the global push to move more over-the-counter derivatives through clearing houses. A clearing house stands between two parties in a deal, ensuring the trade is completed in the event of a default.

Separately, Iosco also called for greater transparency by clearing houses for a range of margin requirements and default resources.

It suggested tighter quarterly disclosure for standards on total value of default resources, initial margin rates on individual contracts and the size of “haircut” that would be made to collateral eligible as initial margin. The call was made in conjunction with the Bank for International Settlements as part of a public consultation.