Unregulated finance feeds French watchdog vigilance

With a high solvency ratio of 14.7% for six French banks at the end of June 2022, the sector is strong enough to absorb shocks to judge supervisors. However, the increased risk of unregulated financial players, who are freed from the restrictions imposed on banks in terms of solvency and liquidity, should not be ignored. “The observed volatility in financial markets, energy commodities, shares and bonds does not allow us to exclude the risk of a market crash, which we perceive as a vector of systemic risk”, – the Supreme Council for Financial Stability responds. HCSF) on the occasion of publication of its annual report.

“The focus is on the least well-regulated non-bank players, such as hedge funds and family offices, as these funds have excessive leverage that can cause significant liquidity shocks,” adds one within the macroprudential mandate. A case in point is the bankruptcy of the Archegos family office, which in particular troubled Credit Suisse and Nomura. Vincent Mortier, Amundi’s chief investment officer, also warned in a Financial Times column about the dangers of hidden leverage in the financial system. He said the recent turmoil over Britain’s pension funds should act as a “reinforcement shock” to investors and regulators.

Although banks have recovered fairly well from the Covid crisis and have so far resisted the indirect effects of the war in Ukraine, as evidenced by their exceptional results in the first half of the year, they are therefore not immune to this crisis. new shock. “Counterparty risk is an important point of vigilance,” HCSF acknowledges. Banks interact with these unregulated players as counterparties in providing liquidity for repo operations, through commodity futures contracts, as well as access to the derivatives market through member clearing centers.

Measuring the hidden leverage effect in the system remains difficult due to the lack of transparency of non-bank intermediaries. As Vincent Mortier reminds us, “this is more difficult than in 2007 because leverage has shifted from banks to other less regulated parts of the system.”

Limited interaction between cryptocurrencies and traditional finance

HCSF is also concerned about the rise of crypto players who have so far avoided regulation. Even if “interactions with traditional finance are still limited”, HCSF believes that their “improper growth” poses “risks to financial stability”. The latter are “characteristic of these products,” notes HCSF: “very high volatility, leverage effect, non-transparent management and operational risks.”

Although the HCSF does not consider the cryptocurrency ecosystem to be a systemic risk “due to its relatively limited size”, it admits that “the growth of contagion channels due to the lack of reliable data characterizing the sector and the growing interest of institutional actors gives rise to caution”. Currently, these transmission channels between cryptocurrencies and traditional finance are implemented by payment giants through the development of crypto-asset settlement services, but also through “the increasing importance of cryptos in the strategies of some investors such as hedge funds, wealth managers”. and certain asset managers more broadly,” notes HCSF. “The use of crypto-derivatives allows for significant exposure due to a strong leverage effect, a potential source of profit, as well as increased risks,” the official adds.

On the other hand, a “substantial portion” of the underlying reserves of major stablecoins are backed by dollar-denominated commercial paper. “It has been determined that the commercial paper market is partly linked to the demand for stablecoins, and more broadly, the increase in the issuance of these assets may affect more traditional financial instruments,” HCSF reminds.

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