By Waleed Saeed Al Awadhi, Chief Operating Officer, Dubai Financial Services Authority (DFSA), United Arab Emirates; and Steffen Kern, Chief Economist and Head, Risk Analysis, European Securities and Markets Authority, Paris

COVID-19 hit financial markets at a time when the global market environment was fragile already, given buoyant market valuations, heterogenous growth prospects in many economies, trade disputes, and a plethora of political and geostrategic challenges. The forecasting and assessment of such event risks, as well as the crisis management needed to handle them, are not new disciplines in financial markets, but the pandemic certainly presented a fresh impetus.

The initial COVID-19 wave put financial markets under massive strain, steering risk managers and policy-makers towards a variety of additional vulnerabilities to consider, including liquidity

and cyclicality risks. The onset of the pandemic caused equity markets to lose over a third in value and created liquidity constraints in a variety of investment-grade and high-yield bond markets, leading to massive contractions in issuance activities and drastic hits in the portfolios of investors around the world.

To draw conclusions, a number of issues need to be investigated, and market and portfolio liquidity and their interplay need to be better understood. Today, asset managers play an increasingly important role in global markets, with investment funds alone managing around $55 trillion across the globe. How open-ended funds, money market funds or unit-linked insurance structures exposed to assets with fragile liquidity can prevent such stress is a question of growing interest. Similarly, sharp drops in asset prices can put clients and clearing members in derivatives markets under stress, particularly banks and other financial institutions.

Through its effect on collateral values and subsequent margin calls, volatility can be amplified in these markets and liquidity reduced.

Since this initial impact, markets have largely recovered – and in some countries exceeded – these losses, up to the point that from a systemic perspective, concerns have been rising that financial markets are in the process of decoupling from economic realities. The IMF is expecting the sharpest global recession since the Great Depression with a massive contraction of global GDP and double-digit dips in key economies, a slower -than-expected recovery, and a higher-than-usual degree of uncertainty over future economic performance.

This uncertain economic outlook points to the longer-term implications the pandemic is set to bring, and these may be more far-reaching than the initial market reaction. Public health restrictions, changes in consumer behaviour and the economic contraction are weakening companies across various sectors, bearing the risk of a widespread deterioration of corporate credit quality. Knock-on effects on the banking system and debt markets could follow suit. With more than $4 trillion in fiscal support to counter the crisis impact committed by governments around the world, public debt levels are rising at a record pace. And against the background of persistent ultra-low interest rates, corporate debt funding is set to remain easy, bearing the risk of growing corporate indebtedness over time.

Against the risks, markets and policy-makers alike look into the long-term effects of the pandemic. The impact of a potential large wave of “fallen angels”, the resilience of bank balance sheets and the effects of a possible rise in non-performing loans, as well as the level and sustainability of public and corporate debt levels are central questions currently under close scrutiny by analysts and risk managers. Last but not least, the evolving role of central banks is of growing interest: with the pandemic, many monetary authorities have added “market buyers of last resort” to their portfolio of roles of “lender of last resort” and guardians of their currencies.

Going forward, strong cooperation on the resulting policy issues will be beneficial. For information sharing, risk assessment and policy alike, the case for collaboration in the COVID-19 age is more compelling than ever. In light of the unprecedented nature of the root cause of the crisis, the learning curve is equally steep for governments, central banks and regulators alike.

Progressive disruption in regulation – at a global scale

The COVID-19 pandemic has had a devastating de-globalizing impact on economic and social infrastructures around the world, disrupting supply chains and derailing demand. However, for sectors such as financial and regulatory technology, it has opened up a wide range of opportunities fueled by digitization and Industry 4.0 acceleration, through the adoption of new technologies, including internet of things, blockchain and artificial intelligence.

The financial technology industry is proving to be particularly resilient, as people turn to digital services fueling progressive disruption. This has required regulators to be increasingly agile in their adoption of technologies to reduce the regulatory burden on companies and economies alike. As governments around the world mandated social distancing guidelines, this disruption was significantly accelerated. The dynamics of some of these advancements, specifically, remote work, moved from optional to necessary, as required quarantines globally demanded that companies facilitate ways for their employees to work remotely. VPN (virtual private network) capabilities, cloud- based infrastructures and videoconferencing capabilities have been essential to business continuity.

With such a sudden shift in resource allocation, regulatory bodies have focused on more oversight and limiting additional regulatory requirements. One of the key principles to success has been “same risk, same regulation”. Simply put, money laundering, fraud, embezzlement, etc., continue to be crimes, regardless of the way that they are conducted. Therefore, the rules in the market must be technology-neutral and the real focus is how these regulations are policed.

As institutions pivot their operating models, cloud- based solutions have enabled IT departments to rapidly deploy required services, ensuring data confidentiality and continued operations. Automation in repeatable tasks and pattern recognition in large data sets have allowed companies to reassign their limited resources towards creating higher value. Regulators do this by creating and hosting platforms to identify pattern or trigger-based threats for the companies that they are regulating. These initiatives foster information-sharing communities, mitigate risk and limit impact.

Enhanced control and supervision of the financial ecosystem are only possible with the support of innovative solutions and regulatory cooperation from bodies across the world. The Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO), etc., have all been effectively cooperating from day one of the pandemic, which has contributed to market stability and strength. The environment for regulators has become more complex, and authorities now have the opportunity to bring their effectiveness to the next level.