Trust And Financial Markets: Global Challenges And Reflections On Asian Markets

The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.

TRUST AND FINANCIAL MARKETS Global challenges and reflections on Asian markets

February 2019 Rob Patalano Senior Financial Expert Committee on Financial Markets

Contents

1. Overview – Trust in Markets 2. Financial markets and debt in the post-crisis era 3. Asian financial markets*

*Based on the working paper on Asian financial markets, written by Caroline Roulet, Directorate of Financial and Enterprise Affairs, OECD.

2

Framework - Trust in Markets Efficient, open, stable, sound

Functioning of markets and market-based finance

Financial innovations

Efficacy of policy

Transparency, confidence, integrity

• TRUST that markets will effectively and efficiently intermediate between investors and issuers.

• TRUST that innovations can foster economic/other benefits (speed, choice, safety, cost efficiencies, etc.).

• TRUST in policies to safeguard against macrofinancial vulnerabilities that could erode financial sector resilience.

Contribute to sustainable and inclusive growth

Financial returns commensurate with risks

New products, greater choices, more inclusion

Public Trust

Does not pose a burden to taxpayers

Sustainable growth aligns with societal interests

3

Highly accommodative monetary policies • While global liquidity has been abundant due to central bank asset purchasing programs, very low interest rates have reduced fixed income yields to historically low levels. • As policies have contributed to portfolio rebalancing toward risk assets by design, “Exit” will have consequences. Central bank balance sheets – key source of bond demand Bank of England

18

Bank of Japan

European Central Bank System

Very low rates contribute to a mispricing of debt

Federal Reserve

USD tn

16 14 12 10

8 6 4 2

0 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016 2016 2017 2017 2018 2018 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3

Source: Refinitiv Federal Reserve

European Central Bank System

Bank of Japan

Bank of England

Source: Refinitiv

4

Abundant debt amid benign credit conditions • Sovereign and corporate debt have risen to historically high levels, as low interest costs accommodated higher indebtedness without raising viability concerns. Global increase of sovereign and corporate debt Non-financial corporations

Households and NPISHs

• In advanced and emerging market economies, credit conditions have remained benign for an extended period (until recently). Global corporate credit default rates

General government

USD tn (2017 prices) 250 200

150 100 50

0

83 37 23

23

102 97

96

39

37

38

108

41

29

28

28

32

34

31

30

35

125 46

136 49

145

161 166

127 46

56

65

67

176 181 183

198 204 191 193 188 182 182

82

86

48

53

54

60

63

64

70

70

71

75

77

76

75

75

52

51

51

52

49

47

59

61

64

64

63

60

38

42

40

46

51

50

52

41

45

41

43

45

49

55

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: BIS Non-financial corporations

Households and NPISHs

General government

Source: S&P Global Rating

5

Outlook: debt markets • Sovereign debt markets will face large refinancings – up to 40% of outstandings – by 2020. • Rising debt costs could strain public deficits in some countries.

• Corporate debt markets refinancing hurdles.

45

G7

Euro area - 16 members

Somewhat elevated corporate debt levels

Emerging OECD

% of of total marketable debt in 2017

S&P 500

STOXX 600

Japan

Emerging Asia

% of EBITDA 5.5

40

5

35

4.5

30

4

25

3.5

20

3

15 10

2.5

5

2

0

similar

• High leverage could threaten viability of lower-rated corporates amid rising yields and weaker earnings.

High refinancing risks in sovereign debt markets OECD

face

2018

Source: OECD

2019

2020

1.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: Refinitiv, financial institutions are excluded. 6

Outlook: Market-based finance • While “toxic” assets have declined, the rise of asset managers raises questions about heavy redemptions and market spillovers, amplifying credit concerns. Growth of Asset Management

Source: Investment Company Institute

• Growing concerns over the rise of leveraged loan market (>$1.1 trillion), now largely without covenant protections, and the similar rise of CLOs, which hold 60% of leveraged loans. Growth of CLOs

Source: SIFMA European CLO data includes CDOs

7

Outlook: Fintech developments •

A range of fintech developments bring promise of greater efficiency (cost, speed), financial inclusion, and greater trust through blockchain.

•

However, risks associated with crypto-assets, if not addressed, could cause consumers/investors to disengage.

•

Moreover, in the future, could they affect and disrupt channels of monetary policy transmission? SME Initial Coin Offerings

Crypto-assets are prone to high volatility Other cryptocurrencies

Bitcoin

USD, bn 800

Bitcoin Ripple Ethereum Bitcoin Cash EOS Stellar Litecoin Tether Bitcoin SV TRON Cardano Monero Dash NEM Ethereum Classic NEO ZCash WAVES Dogecoin Bitcoin Gold Decred Lisk Digibyte Verge MaidSafeCoin PIVX Bitcoin Private Gas Vertcoin

700

600

500

400

300

200

100

0 Apr-13

Apr-14

Apr-15

Apr-16

Apr-17

Apr-18

67.50 15.14 14.58 2.87 2.43 2.26 1.91 1.90 1.56 1.33 1.12 0.81 0.70 0.62 0.57 0.53 0.33 0.31 0.28 0.24 0.17 0.16 0.12 0.11 0.06 0.06 0.04 0.02 0.01 0

5

10

15

20

As of 31st Dec 2018 (USD, bn)

Source: Refinitiv, Coinmetrics, OECD calculations

Source: OECD

8

Asian financial systems: structural shifts • The structure of the financial system in Asia is generally shifting from banks to non-banks, driven by investment funds and also insurance companies. Structure of financial system is shifting toward non-banks…

Source: FSB, OECD national accounts data, staff calculations

• Relative shift from money market funds to openended funds have been particularly strong in US and Japan.

… as investment funds continue to grow

Source: OECD

9

Risks from rising Asian corporate debt and leverage •

Corporate debt issuance has been strong in Asia, led by China.

•

The growth in investment funds helped to absorb this issuance, but with increased liquidity risks. China leads the growth of Asian corporate debt issuance

Source: AsianBondsOnline, OECD calculations.

•

Rising corporate leverage, particularly in China and other emerging Asian countries, raises viability concerns in a higher-rate environment.

Elevated corporate leverage in China and emerging Asia

Source: Refinitiv; note that financials are excluded.

10

Asian Markets: Shadow banking in China • China’s shadow banking, including wealth management products, entrusted loans, peer-to-peer lending, have grown considerably recent years. China wealth management products grow

Source: Bloomberg Intelligence

• Growing losses and failures in the banking and shadow banking in China raise concerns over spillovers to the real economy.

…while losses have begun to rise

Source: WDZJ.com, OECD calculations

11

Policy Challenges and Trust • Sovereign and corporate debt  credit and liquidity risks – Have macroprudential tools worked?

• Market-based finance – Asset managers and liquidity transformation  run risk – CLOs  Deteriorating underwriting and correlated losses

• FinTech – Need for appropriate policies regarding consumer and investor protection, competition, etc. before financial stability risks arise.

12

Q&A