As we look ahead to 2016, there are a number of industry experts making informed predictions and forecasts for the year ahead. The truth is that some of these will happen and others will not – nobody really knows what the future holds and therein lies the excitement for the next 12 months. But there is one group – financial regulators – who particularly in the current financial climate command a greater influence over what can and will happen in the near future. Financial regulators need to understand the emerging global trends and recognise how these may or may not pan out in the financial landscape.
With this in mind a speech at the beginning of December 2015 by Commissioner J. Christopher Giancarlo (“Chris”) from the CFTC (Commodity Futures Trading Commission) caught my eye over the Christmas period. It was part of a lecture series on international finance given at Harvard Law School.
Financial Regulators Need to look Forwards, not Backwards
Normally a speech by a financial regulator is hardly compelling reading, but i must admit this speech was different. Chris talks about how old regulation is preoccupying both financial regulators and participants which in turn means they are not able to look “assess and prepare for the next financial crisis – a crisis that will certainly be unlike the last one“.
Next Chris gives a pretty cool analogy of how existing financial regulation is forcing the industry to look backwards, rather than forwards. Chris draws similarities between financial regulators in a high speed car with an oversized rear-view mirror – that is past regulation, such as Dodd Frank. The rear-view mirror, or past regulation overwhelms the windscreen through complex rules, requirements and new demands, such that we’re unable “to see the oncoming traffic and looming dangers ahead“.
6 Global Trends Transforming Finance
Okay, Chris indicates that these 6 developments reflect his own views and not those of the CFTC
1. Cyber Threats
Chris very distinctly explains how “cyber risk is the number one threat to 21st century financial markets“, citing:
- The warning in 2012 from the then U.S. Defense Secretary Leon Panetta of a potential “cyber Pearl Harbour”
- The US Department of Defence who have described cyberspace as a new domain in warfare, just as important as any other (land, sea, air) military operation
- Financial markets are new battlefields, which can bring about trading volatility and market collapse
- The vulnerability of global financial markets – even if a country is not the prime target, the consequences of a attack are likely to have global repercussions
2. Disruptive Technology
Chris speaks about a “new phase in human history….[where]…digital technologies are rapidly changing the very nature of human identity, work leisure and society“. This change, according to Chris, will happen most abruptly in 3 main areas:
- Automated Electronic Trading
- Automated trading makes up 70% of futures markets and with developments in technology – which will bring about lower transaction costs, increases in the speed and efficiency of transactions and trader productivity – will surely increase
- These opportunities bring with them new risks, reliance on computer modelling and algorithms which in many cases replace the human element from the process
- Chris describes the current “closed ledger” financial system as “inefficient and unstable”, and the opportunity of distributed ledgers to “revolutionise modern financial ecosystems“
- Chris references the Bank of England who labelled blockchain as the “first attempt at an internet of finance” – explaining how blockchain could decentralise record keeping in the same way that the internet has decentralised data
- Financial Cartography
- Here Chris talks about developing interactive financial network maps that enable analysts to examine and forecast weaknesses and vulnerabilities that maybe emerging
3. Government Intervention
Chris highlights how globally Central Banks have played a dominant role in financial affairs since the financial crash in 2008. Referring mostly to the US Federal Reserve, but also sharing similar experiences at the Peoples Bank of China (PBOC), Bank of Japan and the European Central Bank (ECB), the need for financial stability and price setting by the central banks creates market liquidity and price integrity risks.
The role of central banks needs to be better understood across a multitude of financial markets.
4. Market Illiquidity
Chris emphasizes the importance of market liquidity for global economic growth, and outlines how the “liquidity characteristics have been fundamentally changed in many asset classes and markets“. The decline of trading liquidity, high levels of volatility and capital-constraining regulation are some of the mentioned concerns. Worryingly, there is widespread recognition of the shortfall but the no solution in sight – therein lies the problem and the opportunity!
5. Market Concentration
The threat posed by consolidation in the financial services industry is highlighted. Chris explains how financial services are increasingly being offered by fewer and fewer institutions, and how some large banks are either reducing services or increasing costs of certain products which ultimately excludes certain customers. Regulatory costs also contributed to consolidation.
The point Chris is trying to make is that a thriving economy needs financial institutions to provide a broad range of products and services to a diverse range of customers. Diversity in the economy needs to be acknowledged and encouraged to enable widespread economic growth.
Chris illustrates how the financial crisis in 2008 has reversed the globalisation in financial services that had taken place up to that point in time. He goes on to talk about his analysis of swaps trading – it gets kind of technical. Anyway, Chris likens the breaking up of the global financial markets results to the natural world, proposing that this leads to “a greater number of smaller ecosystems, isolated from each other by a matrix of dissimilar habitats, leading inexorably to broad ecosystem decay“.
The Call to Financial Regulators
“We must stop fighting the last crisis” argues Chris, acknowledging that regulation such as Dodd Frank is not the answer to the challenges that the financial services industry faces today. Lastly, to the financial regulators Chris says stop looking back through the rear-view mirror and look forward at the road ahead.
Happy New Year folks!