Covid-19: why volatility stress-testing must extend beyond the banks

Covid-19: why volatility stress-testing must extend beyond the banks

Joseph Cordahi

Product Strategy Director at NeoXam

Views 442

Covid-19: why volatility stress-testing must extend beyond the banks

21.05.2020 03:00 pm

Stress-testing has become a common tool of regulators and central banks to assess the readiness of banks to deal with sudden volatility in global markets. With Wall Street suffering its worst day since the 1980’s in March, and Covid-driven volatility set to grip the global economy for the months to come, banks will be expected to run stress tests to examine their resilience. However, why should this be limited to banks? To ensure the best levels of preparedness for future volatility, stress testing needs to be expanded to other market participants.

Being the focus of regulation since the 2008 financial crisis, banks are well acquainted with stress testing and what is required of them by Basel III. Seen as systemically important to the economy, banks have historically, and still to this day bear the brunt of regulatory scrutiny.

The global economy, however, has shifted since 2008 and whether regulators were right or wrong to solely focus on banks then, they would certainly be wrong to do so now. Large institutional investment firms hold huge systemic importance to the global economic system, with some of the world’s biggest asset managers falling into the ‘too big to fail’ category.

There has been a greater focus on asset managers in recent years, both in terms of regulation and wider industry discussion. The FCA has already brought in new rules for some types of open-ended funds investing in illiquid assets such as property, with the aim of giving investors clearer warnings about the risks involved.

However, despite a number of players across the industry beginning to enact measures along the same lines of stress-testing for banks, there is yet to be a standardised process across the industry for voluntary stress testing of funds.

The greatest call for a standardised process came last year from the then governor of the Bank Of England who wanted an industry-wide stress test because he claimed that more than half of funds have a “structural mismatch” between the frequency with which they offer redemptions, and the time it would take them to sell.

With a new governor and the world being in the midst of a crisis, the timeline for any new regulation has been cast into doubt. Regardless of this, asset managers should not wait, but should act now and begin voluntary stress testing measures. This will not only equip them for regulation down the line but will give them a competitive edge, which given the current climate, is crucial.

To accurately stress test, asset managers need to have an accurate and timely view of portfolio transactions, trading positions, corporate actions, as well as pricing to support investment. The best way to do this is through a centralised Investment Book of Records (IBOR), which provides a ‘single version of the truth’ that captures positions, valuations and exposures based upon all the investment data of a financial institution.

With global market volatility showing no signs of abating anytime soon, asset managers need to start looking towards stress testing, not only to better cope with the volatility but to set them apart from their competition. With regulations imminent, asset managers should get ahead of the curve and start stress testing now.

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