Vítor Constâncio of ECB on Macro-Prudential Tools for Non-Bank Sector

According to the ECB Vice-President, the two key systemic risks arise from the increasing size and growth of the euro area investment fund sector and the procyclical nature of margin and haircut-setting practices of market participants. The procyclical nature of margin and haircut-setting practices of market participants and liquidity risk propagation in collateralized securities financing and derivatives transactions is a concern for financial stability. This is because such practices stimulate the build-up of excessive leverage and funding risk in good times, while amplifying funding stress and deleveraging in bad times. Mr. Constâncio highlighted that, although the macro-prudential stress tests were developed originally for assessing banking system resilience, they have recently been extended to cover a wider range of non-bank financial institutions such as insurance companies (conducted by EIOPA), central counterparties (conducted by ESMA), and asset managers. He believes that the stress testing tools for non-banks are still in a fledgling state and suggested ways to improve them. The suggested enhancements include significantly improved data availability, existing non-bank stress test approaches need to better account for interactions between agents, and specificities of non-bank financial institutions must be considered carefully when designing such stress testing tools.

The ECB Vice-President then moved on to discuss the state of play regarding the implementation and progress on the macro-prudential instruments that authorities would need if systemic risks materialize. On the global level, the 2017 FSB policy recommendations on asset management structural vulnerabilities are expected to reduce liquidity mismatches in open-ended funds. In the area of liquidity mismatch, the recommendations address the potential use of system-wide stress testing by authorities. Leverage recommendations focus on the measurement and monitoring of leverage within investment funds, including data for synthetic leverage calculation. On the European level, ongoing work of the Expert Group on Investment Funds develops recommendations that are addressed to funds and asset managers. Given that the investment fund sector is growing relative to the financial system as a whole, the ESRB is analyzing systemic risks posed by liquidity mismatch and leverage in the types of investment funds exposed to these risks. He also offered a preview of the results of a study, which will be presented in an ECB occasional paper to be published soon. The study shows that, for a large sample of European Alternative Investment Funds, the open-ended leveraged funds experience greater investor outflows after bad performance than unleveraged funds. Also, ESRB published a comprehensive report on the macro-prudential use of margins and haircuts this year. The report describes in detail the mechanics of how these tools would affect leverage and procyclicality and it acknowledges a number of implementation challenges and calls for further empirical and conceptual analysis.

Mr. Constâncio concluded that, despite the progress made, more work needs to be done: on the "operationalization" of tools and on further improving data or interaction with the policy and research community to enhance stress-testing models. He encouraged authorities, including EC, ESRB, and ESMA, to continue to contribute toward this goal.

Related Link: Speech

Keywords: Europe, EU, Banking, Securities, Insurance, Macro-Prudential Tools, Stress Testing, Systemic Risk, Asset Management, ECB