13 Dec 2021

Risk from Open-ended Bond Funds, BIS warning

The Cassandra of the markets is not heard, until it is too late. Maybe the BIS is overly-cautious but given the enormous growth in all types of investments the risks arising from a sudden turn in market sentiment are quite substantial. The bear markets of the Seventies could be digested in an orderly basis, apart from serious settlement problems that stemmed from the large rise in transaction volumes. But markets took the massive declines in their stride and nobody ever even thought that the financial system was at risk.

Now - as with the Covid Virus - panic is always in the air if there is the slightest risk of a substantial drop in asset prices. But while this may be overdone there is one risk that is neglected in my view: are margin levels throughout the financial system really able to cope well with a sudden sell-off of, let's say, 20-25 percent? It did happen in 1987 and fortunately that 'blip' got reversed more or less instantly. But now - when volumes are a multiple of those in 1987 - how would the system cope? The desaster that hit Credit Suisse and others when margin was insufficient earlier this year could be played out on a much much larger scale!

BIS Quarterly