New York City, December 5, 2013 - The IIF's Market Monitoring Group released the following statement today after their quarterly meeting in New York.

1. Some regulatory reforms may weigh on market liquidity, efficient funding provision:The overall direction of the regulatory reform agenda-and the important goal of financial stability-is fully supported by the international financial community, and there is a strong commitment to working with the official sector to achieve desired outcomes. With full implementation of many regulations still to be completed, and changes in market practices still in flux, the cumulative impact is yet to be seen. MMG members noted that some regulatory changes aimed at stability may be (and in some cases already are) impacting the efficiency of capital markets in ways that could work against the broader policy goal of supporting stronger economic growth-and could potentially contribute to new systemic risks. The following are areas of particular concern:


1. OTC derivative reforms will provide more transparency and stability but may have negative consequences for end users and the system more broadly.The industry broadly supports the development of central clearing, while stressing that OTC derivatives continue to serve important and legitimate needs. Raising the relative cost of non-standardized, non-centrally cleared derivatives contracts could expose firms to more volatility and negatively impact their business decisions. Creating significant incentives for the system to move from non-standardized to standardized derivatives contracts could reduce the efficiency of risk management for end users, particularly as some contracts are not well suited for standardization and central clearing. This could lead to large pools of unhedged risks. Moreover, central clearing for derivatives creates a significant concentration risk, raising concerns about risk management and emergency liquidity provision for central counterparties. The magnitude of the relative costs of non-standardized contracts should be reconsidered. In addition, there should be a more prudent assessment of the scope of acceptable securities suitable for central clearing.


2. Requiring more collateral constrains financial transactions that support economic activity:For banks, additional requirements to provide collateral coincide with a trend towards more secured forms of bank funding (in turn adding to bank balance sheet encumbrance). Regulatory requirements such as the Liquidity Coverage Ratio requiring banks to hold more high-quality liquid assets on balance sheets, and derivatives reforms requiring posting of high-quality collateral are leading to a significant increase in demand for collateral in the system. A system highly dependent on collateral may create a false sense of security in normal circumstances, but can be vulnerable to liquidity crunches or other disruption in times of stress.


3. A decline in secondary market liquidity hinders efficient capital market activity and adds to volatility:Increased requirements for capital, liquidity and leverage ratios have incentivized banks to reduce their market making or dealing activities in a range of markets. As part of this trend, many banks have reduced their risk appetite for market making. This has caused secondary market liquidity for various securities to suffer. Less-liquid secondary markets are subject to much higher volatility under stressed market conditions, as evidenced in this past summer's market developments.


4. Less funding for long-term investment:Current regulatory reforms, while broadly embraced by the global financial services industry, may decrease the willingness and ability of financial institutions-including non-bank financial institutions-to invest in long-term assets. For example, both Basel III and Solvency II discourage banks and insurers from holding long-term assets, potentially affecting their ability to provide long-term funding. The ability of other long-term investors to fill this gap is still being assessed. Regulatory measures that impede the provision of long-term finance run directly counter to official sector initiatives designed to ensure financing for infrastructure and other long-term investment.


2. Rising corporate debt levels in certain sectors pose risks for pockets of weaker firms and more fragile economies.While large international firms with stronger profitability and balance sheets are much less vulnerable, the increase in corporate debt is worrying in more fragile segments of the corporate world-those with weaker balance sheets and/or profitability. Specifically, these include corporate borrowers in the periphery of the Euro Area, high-yield corporate issuers, and many firms in emerging market countries. Additionally, emerging market corporate borrowing in foreign currencies has been on the rise and should be monitored-the potential combination of higher foreign debt, rising global rates and weaker emerging market currencies could be very damaging.

The IIF's Market Monitoring Group (MMG) is an independent forum of private-sector leaders in international finance and experienced market practitioners. The purpose of the MMG is to consider and identify potential systemic risks and alert market participants and policymakers to these risks. The MMG is co-chaired by Jacques de Larosière, Chairman of Eurofi, former Managing Director of the International Monetary Fund and former Governor of the Banque de France, and by David A. Dodge, Senior Advisor of Bennett Jones, LLP and former Governor of the Bank of Canada.

The Institute of International Finance (IIF) is a global association of more than 470 financial institutions. Its mission is to support the financial industry in the prudent management of risks, including sovereign risk; the development of sound industry practices and standards; and the advocacy of regulatory, financial and economic policies that are in the broad interests of its members and global financial stability. Within its membership the IIF counts leading global banks, insurers, pension funds, asset managers and sovereign wealth funds, as well as leading law firms and consultancies. More information about the Institute of International Finance is available at www.iif.com.