COVID-19 has shaken the markets and the economy as a whole, and the role of intermediaries may be changing.
In a roundtable, panelists discussed the general health of the markets and how market participants are recovering from the effects of the COVID-19 economic shock. The SEC staff issued a report on the interconnectedness of the U.S. capital markets and real economy interconnected, the panelists noted, and the effects may not yet be fully realized.
Staff report. The SEC staff’s interconnectedness report, designed to assist policymakers and market participants in understanding and improving market function and the financial system, focuses on the interconnection among the U.S. credit markets and how the actions of stakeholders in one market can affect other markets and the financial system generally. According to the report, interconnections could have contributed to risk during the period of market stress during the COVID-19 global economic shock of March 2020. The report discusses credit markets, builds from a segment-by-segment analysis of the credit life cycle, and makes observations regarding the feedback from interested parties.
The report identifies approximately $54 trillion of credit issued and outstanding in the U.S. financial system at the end of 2019 and broadly traces the flow of approximately $52 trillion through various intermediaries and prior holders to the ultimate holders. This demonstrates that the financial system and the flow of credit involves an interconnected collection of markets, including short-term funding markets, corporate bond markets, leveraged loans and CLO markets, municipal securities markets, and mortgage and other consumer lending markets. Short-term funding stresses were caused by a suddenly elevated demand for liquidity, and market structure and liquidity-driven stresses caused by the demand for intermediation in the context of constrained capital and risk limits also caused issues, the report states.
Ultimate effects. The markets have seen short-term stress and likely will continue to see long-term effects, according to the panelists. It will be crucial to control uncertainty, and regulators and market participants should keep engaging in monitoring activities, given the interconnected components of the markets and the general economy.
According to MetLife Executive Vice President and CIO Steven Goulart, the facilities instituted in response to the COVID-19 market shock restored confidence, but effective liquidity practices will need to be in place when the facilities are removed. Market signals could be affected by changes, and market participants need to return to price discovery, he said. Thomas Wipf of Morgan Stanley agreed, noting that basis points rallied in connection with programs. David Finkelstein, CEO of Annaly Capital Management, noted that bid-offer spreads became wide but urged a view in context of intermediation. Markets worked "reasonably well" given the uncertainty, he said. However, Finkelstein noted, platforms are not a permanent solution to liquidity.
BlackRock Vice Chairman Barbara Novick stated, however, that both individuals and institutions engaged in a "dash for cash" and that this could cause implications for liquidity down the road.
According to North Island Chairman Glenn Hutchins, the interconnectedness of the markets should not surprise anyone. The real question is not if there is interconnectedness but instead how the interconnectedness is structured, he said. The facilities put in place to respond to the COVID-19 market shock must be fine-tuned to respond to this crisis, according to Hutchins. Gary Cohn, formerly of the U.S. National Economic Council, suggested that, if not for the 2008 financial crisis, we would not be talking about a potential positive outcome. The earlier crisis gave legislators and regulators a chance to prepare for future crises, he said. Both Hutchins and Cohn agreed that cooperation and minimizing arbitrage will be crucial in the upcoming times. In the realm of financial interconnectedness, it is important to keep credit flowing, the panelists agreed.
SEC Chairman Jay Clayton stated: "Don’t let the ‘best’ be enemy of the ‘good.’ "A system is only as good as a weakest point," he concluded.
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