WFE against applying prudential rules designed for credit channels to market-based finance

Rick Steves

“It is wrong and counterproductive to take the risk-reward characteristics of one part of the financial system and apply it to another part, whose different profile makes the system safer and sounder.”

The World Federation of Exchanges (WFE) has released a white paper titled “Financing the Future,” shedding light on the critical role of market-based finance in shaping the economic landscape and securing individuals’ financial futures.

The report underscores the importance of fostering long-term investment and calls for public policies that support this objective rather than impeding it. It also emphasizes the distinction between market-based finance and credit channels, urging regulators to recognize and respect these differences in their policies.

Market-Based Finance vs. Credit Channels

The WFE’s white paper highlights the distinct but complementary roles played by market-based finance and credit channels in supporting economic growth. These channels act as twin engines, but current regulatory policies often blur the lines between them, leading to confusion.

A central focus of the report is to differentiate short-term risks inherent in market-based finance from concerns about systemic stability typically associated with the credit world.

The paper challenges the practice of applying prudential rules designed for credit and banking channels to market-based finance, arguing that such rules are unnecessary and potentially detrimental in most cases.

While credit channels can give rise to systemic risks necessitating measures like capital rules, market-based finance rarely faces such challenges. Misapplying inappropriate regulations has already led to adverse outcomes, as exemplified by the LDI crisis of 2022, jeopardizing collective investment schemes that offer long-term returns to the majority of investors.

Policy Support for Market-Based Finance

Share markets have demonstrated their resilience over time, including during recent turbulent periods such as the COVID-19 pandemic. In 2020, these markets continued to facilitate new issuances and trading in company stakes, even as the economy underwent significant transformations.

Market-based finance encompasses various instruments, including bonds, which provide investors with additional options while mitigating some of the opacity associated with credit markets, and derivatives, offering flexibility to fine-tune risk profiles across chosen horizons. However, shares remain pivotal in financing the future.

Nandini Sukumar, CEO at the WFE, said: “Both credit markets and share markets have a place in the financial system and are needed for different financing requirements. To enable share markets to deliver their potential in funding future growth opportunities (including net zero transition), the appropriate policy support is required.”

Richard Metcalfe, Head of Regulatory Affairs at the WFE, said: “The WFE believes that a clear and coherent risk-reward analysis should lie at the heart of public policy towards all forms of finance. It is wrong and counterproductive to take the risk-reward characteristics of one part of the financial system and apply it to another part, whose different profile makes the system safer and sounder.”

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