The World Federation of Exchanges (WFE) has issued a Guidance Note, aimed at policy questions arising from any resurgence of market volatility.
In particular, the WFE’s Guidance focuses on how exchanges create fair and orderly markets; and why, when navigating times of economic uncertainty, it is better and safer to maintain continuous visibility of asset prices and risk premia rather than suppressing markets. Understanding these issues is key to avoiding harmful public policy in relation to all three regulatory imperatives: investor protection, market integrity and systemic risk.
It is well known that markets are an unending, multilateral debate about prospects for companies and countries and about how other market participants will position themselves. This year’s pandemic introduced extraordinary economic uncertainty and, in such circumstances, the strangest outcome would have been for volatility to go down. Even in normal times, the ‘equilibrium price’ is inherently transient and markets would be failing the public if they did not reflect the ever-changing balance of opinion or the arrival of new information.
What central, public, regulated marketplaces provide is the only trustworthy, authoritative way to allow price consensus to update in real time, providing policy makers as well as investors and issuers with valuable information. This is particularly true when the price moves are extreme. Intermediary market makers help this process, maintaining their own viability by exploiting the highly granular data licensed to them by exchanges. In other words, the system is built to process inevitable changes in price.
As part of the generally high trading volumes in 2020, in addition to the investment institutions that manage pensions and other savings, there has been a marked increase in retail participation in some countries, in both securities and derivatives. This has made it especially important to have a fair, transparent price-formation process, which in turn supports investor protection. Continuous operation, with some flexibility for pauses when price moves exceed typical ranges, also has other advantages. It reduces the risk of market prices moving in a sharply discontinuous manner, which could trigger systemic stress. And central markets also provide a safe, reliable channel through which new offerings can come to market, allowing the economy to continue to evolve while reducing levels of indebtedness and leverage. In June 2020, companies raised over $31 billion through IPOs – one of the highest monthly amounts observed in recent years.
A key part of the role of exchanges is their operational resilience. (The same is true of CCPs.) Resilience means minimising disruption and, where this cannot be avoided, ensuring that service is only restored in a manner that is safe and controlled, thereby preserving the interests and integrity of the whole market ecosystem. Resilience also means recognising that the nature of threats is constantly evolving, and that the focus must therefore be not just on textbook scenarios (useful though they can be) but on the processes and ability to respond in an adaptive fashion.
The WFE is currently working on a number of other issues related to this year’s market activity, including: the role of CCPs in adjusting to changed levels of volatility; the structure of volatility control mechanisms (notably circuit breakers); and the importance of supporting issuers of securities in times of uncertain economic outlook.
Nandini Sukumar, Chief Executive Officer, the WFE said: “The concept of fair & orderly markets goes to the heart of public markets and the willingness to constantly improve them is part of the pledge exchanges make. It goes hand in hand with ensuring the integrity of markets. The quickest way to severely damage public confidence in markets is to leave participants uncertain as to when authorities might shut them without warning. Similarly, bans on short sales deprive participants of information, making trading less orderly, not more. At a time when the banking channel is facing unusually challenging conditions, such moves would not just be sub-optimal for the economies that the markets serve. They would be outright counterproductive. We are publishing this Guidance Note so that no one need be in any doubt as to the issues at stake.”
