Financial markets

Financial Market Trends No.96, Volume 2009/1 - July 2009


Please find below an overview and selected links for each of the articles published in No. 96, Volume 2009/1:

Dealing with the Financial Crisis and Thinking about the Exit Strategy

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This article looks at the stages of crisis management and some of the different degrees of transparency on losses and risks in the US and Europe. It also compares alternative approaches to dealing with impaired assets used in the USA and Europe. Exposure to off-balance losses remains a key issue. Europe, surprisingly, has been and remains the major issuer of collateralised synthetic obligations that have been so prominent in the crisis. The capital needs of banks over the next few years is examined, and great uncertainties remain due to the unknown extent to which off-balance sheet vehicles will need to be consolidated. Finally, the requirements of longer-run reform are outlined.

The Turmoil and the Financial Industry

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The situation in financial markets deteriorated over the past year, but government actions have helped to avert an even bigger crisis. While some signs of recovery are on the horizon, the banking sectors in many countries are not yet on solid footing. Recent government programmes that deal with banks’ ‘toxic assets’ are welcome in this regard. But further reaching financial sector reforms such as those recently endorsed by the G20 leaders and proposed in Europe and the United States are necessary in order to establish a sound financial system.

Corporate Governance Lessons from the Financial Crisis

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This report analyses the impact of failures and weaknesses in corporate governance on the financial crisis, including risk management systems and executive salaries. It concludes that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies. Accounting standards and regulatory requirements have also proved insufficient in some areas. Last but not least, remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests. The article also suggests that the importance of qualified board oversight and robust risk management is not limited to financial institutions. The remuneration of boards and senior management also remains a highly controversial issue in many OECD countries. The current turmoil suggests a need for the OECD to re-examine the adequacy of its corporate governance principles in these key areas.

Expanded Government Guarantees for Financial Institutions: Selected Issues

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Government provision of a safety net for financial institutions has been a key element of the policy response to the current crisis. In the process, existing guarantees have been expanded and new ones introduced, including, in particular, in relation to bank liabilities. Among other things, such guarantees create costs that arise as a result of potential distortions of incentives and competition. To limit such distortions it is important to specify risk-based premiums for additional government-provided guarantees, and to the extent that guarantees are priced appropriately potential distortions also should be limited. The evidence however has been mixed in this regard. The present article discusses pricing and some other selected issues related to the recent expansion of guarantees for bank liabilities.

Private Pensions and Policy Responses to the Financial and Economic Crisis

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This article discusses responses to current financial and economic crisis by regulators, supervisors and policy makers in the area of private pensions. These responses are examined in the light of international guidelines, best practices and recommendations to improve the design of private pensions. Policy makers are reminded that private pensions continue to play an important role in a balanced pension system, with security coming from diversity of provision.

Retirement Saving and the Payout Phase: how to get there and how to get the most out of it

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In the wake of a dramatic financial crisis and with the first waves of baby boomers approaching retirement we hardly need to think about how best to arrive at the pension funds’ payout phase. This paper argues that there is an urgent need to raise retirement saving, to reduce defined contribution plan members’ exposure to investment risks and to provide the financial industry with cheap and safe payout instruments. These challenges are also likely to call for a more active government role.

Evaluating Risk Sharing in Private Pension Plans

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The principal purpose of this article is to analyse the trade-off between the (un)certainty in contributions on the one hand and benefits on the other that is embedded in different pension arrangements. The article employs the funding ratio (ratio of assets to liabilities) and the replacement rate (ratio of benefits to salaries) as key criteria for evaluating the risk sharing characteristics of a private pension plan from the perspective of the plan member. The stochastic simulations performed show that hybrid plans (those in between traditional DB and individual DC) appear to be more efficient and sustainable forms of risk sharing than either of the other two. Of the three main hybrid plans analysed, conditional indexation plans appear to have the greatest potential as sustainable forms of risk sharing.

OECD Sovereign Borrowing Outlook 2009

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Many OECD governments are facing unprecedented challenges in the markets for bonds and bills, as a result of the explosive growth in their borrowing needs. Amidst an unusually uncertain economic outlook, the gross borrowing needs of OECD governments are expected to reach almost USD 12 trillion in 2009. The key policy issue is how to raise smoothly new funds at low cost, while also managing a rapidly growing debt stock.
For the time being, several factors are offsetting the trend towards higher yields. But the risk is that when the recovery gains traction and risk aversion falls, yields will start to rise.  There are already signs that issuance conditions are becoming tougher with reports of weaker demand at some recent government bond auctions. Thus far, these less successful auctions can best be interpreted as “single market events” and not as unambiguous evidence of systemic market absorption problems. Also from this perspective lowering OECD sovereign ratings is not obvious. 
The future could become more challenging, given that rising issuance is occurring in tandem with increasing overall debt levels. Also contingent debt is on the rise. In response, sovereign debt managers have begun to plan or implement credible medium-term exit strategies to avoid future “crowding out” and issuance problems.
Although fund raising strategies have become more flexible and somewhat more opportunistic, OECD debt managers remain committed to maintaining a transparent debt management framework so as to minimise medium-term borrowing costs. The other key challenge, roll-over risk as a result of the increasing use of short-term instruments, is being addressed by OECD debt managers by rebalancing the profile of their issuance programmes by incorporating more long-term instruments.

New Challenges in the Use of Government Debt Issuance Procedures, Techniques and Policies in OECD Markets

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Government debt issuance procedures and policies differ across OECD jurisdictions, in particular in terms of technical standards for selling techniques, primary dealer systems and other primary market arrangements.
However, the increased integration of global financial markets (including the jump in the integration of European government debt markets since the introduction of the Euro) has been an important catalyst in the standardisation of the structure and types of instruments as well as the convergence of general procedures and policies for the issuance of government debt. In many OECD countries, the ongoing credit and economic crises have prompted a review of existing issuance procedures and policies.
This article provides (a) a survey of the general characteristics of government debt issuance procedures and related primary dealer (PD) arrangements in the OECD area; and (b) an evaluation of the challenges and changes generated by the impact of the turmoil in global financial markets on issuance procedures and policies.

The Role of Stock Exchanges in Corporate Governance

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Historically, the main direct contribution of exchanges to corporate governance has been listing and disclosure standards and monitoring compliance. Stock exchanges have established themselves as promoters of corporate governance recommendations for listed companies. Demutualisation and the subsequent self-listing of exchanges have spurred debate on the role of exchanges. Regulators have been concerned about conflicts of interest between exchanges' for-profit activities and their regulatory responsibilities. The conversion of exchanges to listed companies is thought to have intensified competition. And, the sharper competition has forced the question of whether there is a risk of a regulatory “race to the bottom”.
Recently, the rise of alternative trading systems (ATS), first in the United States and then in Europe, have had a profound impact. Their existence has induced exchanges to cut fees and in some cases launch their own off-exchange trading platforms. The effect of ATSs on corporate governance is not clear. Two practical concerns voiced so far are, first, that trading fragmentation may reduce the transparency of the markets for corporate control and adverse consequences for price discovery. Secondly, exchanges are uneasy about the prospect of having to continue performing their traditional regulatory and other corporate-governance enhancing functions amid a shrinking revenue base.


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