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Are We Ready for the Next Financial Crisis

By Adrien Vanderlinden, DTCC Executive Director, Credit & Systemic Risk | March 11, 2019

The Role ISBs Can Play in Mitigating the Risks of Market Fragmentation
Adrien Vanderlinden, DTCC Executive Director, Credit & Systemic Risk

The financial services industry has come a long way in the past ten years, addressing many of the structural weaknesses that were exposed in the wake of the Lehman insolvency. Regulatory measures to strengthen banks’ balance sheets and liquidity buffers, the shift of a considerable portion of OTC derivatives to central clearing and the adoption of LEIs (Legal Entity Identifiers) to enhance transparency are all examples of major efforts that have significantly strengthened the resilience of the global financial system.

However, the nature of the risk threatening global financial markets continues to evolve, and is therefore different from what we faced a decade ago. While we may be better equipped to address the type of crisis we faced after the Lehman collapse, the question remains as to how well the industry is prepared for the next crisis, which could be difficult to predict.

As a result, it is important that we continue to examine and respond to today’s top risks, including macroeconomic issues such as geopolitical uncertainty, market-related risks such as the ramifications of the increase in passive investing, and the potential risks associated with the rise of emerging fintech (financial technology). Arguably, the biggest threat to financial stability could be potential cyber-attacks.

Global Turbulence

2018 was a year marked by heightened volatility and geopolitical worries, partly because of the ongoing tariff war between the US and China, as well as the continued uncertainty surrounding Brexit. Although financial markets tend to recover relatively quickly from geopolitical events that occur in isolation, a succession of shocks could have a more significant impact on market sentiment, investment flows and asset prices.

Global debt has reached an all-time high of USD 184 trillion in nominal terms, the equivalent of 225 percent of GDP in 2017, according to the most recent IMF (International Monetary Fund) data. China, Japan and the United States account for more than half of global debt, exceeding their share of global output. While the rise in public debt largely reflects the impact of, and response to, the most recent financial crisis, it also limits the range of policy options available for responding to the next one.

Given that these trends are likely to remain a source of concern in the near future, the industry must continue to assess how we can reduce the implications of global turmoil for markets and overall financial stability as we move through 2019.

Passive Investing

The general shift from active to passive investing, as illustrated by the popularity of index funds and many ETFs (exchange-traded funds), may also affect financial stability.

The popularity of ETFs continues to grow around the globe, and Asia is no exception. In the Asia Pacific region, ETF assets registered double-digit growth and reached record highs in 2018. According to Bloomberg data, a total of 255 ETFs tracking Chinese equities saw a record USD 7.34 billion of net inflows in October 2018 alone. Hong Kong’s ETF product range is also set to increase, with the SFC (Securities and Futures Committee) consulting on new rules that may see the first listing of active ETFs in 2019.

Although ETFs do not currently pose a major systemic threat, passive investing strategies may increase concentration risk and reinforce market movements, which could intensify market volatility in response to a significant idiosyncratic event. Also, the emerging risks associated with the proliferation and increasingly esoteric nature of some of these products should be watched and managed closely, given their potential to create or exacerbate market disruptions.


The rapid rate of innovation in the financial industry, with ongoing fintech developments such as distributed ledger technology, artificial intelligence and robotics, combined with increased use of the cloud, has given rise to new risk considerations.

The range of fintech applications is vast, so risks should be assessed on a case-by-case basis. Robo-advisory, data analytics and blockchain, for instance, all may have a significant impact on existing business models, operations and infrastructures, and open the financial industry to both opportunities and potential threats. As such, new fintech should be carefully monitored to ensure an appropriate balance between the associated risks and rewards.

Cyber Threats

At the same time, market participants are facing greater threats from cyber-attacks, which are becoming ever more complex and sophisticated, with the potential for far-reaching, systemic impacts. In fact, the motivation of cyber-attackers is shifting from simply achieving financial gains to disrupting critical infrastructures. Cyber threats have become so significant that many believe the occurrence of a successful large-scale cyber-attack has become a matter of ‘when’, rather than ‘if’, and this could potentially trigger the next financial crisis.

As a result, it is essential that firms continue to prioritise their cybersecurity plans and procedures, while placing significant emphasis on resiliency. It is also critically important that we continue to share information on threats and incursions across the industry to limit the effectiveness and impact of cybersecurity incidents.

How is Asia-Pacific addressing these threats?

Authorities in Hong Kong and Singapore are continually advancing regulatory requirements to improve the safety and soundness of financial markets. The MAS (Monetary Authority of Singapore), for instance, has developed a set of security assessment guidelines aimed at strengthening the cyber resilience of the financial sector. Meanwhile the HKMA (Hong Kong Monetary Authority) continues to progress on its Cybersecurity Fortification Initiative, launched in late 2016.

With momentum already established in Asia, the industry has the opportunity to establish a universal set of cybersecurity standards to help businesses make consistent decisions to resume business following an incident, and ensure clear communication with clients, investors and the public. DTCC is also working to counter emerging threats to global financial security, alongside industry peers. For example, our membership in the Cyber Sharing Community, launched by the FSARC (Financial Services Analysis and Resilience Center), is part of the process of identifying, analysing and assessing financial activities, to mitigate the threats of cyber-attacks.

For fintech, financial institutions are also deploying layers of defensive measures to reduce their exposure to attacks and improve their reaction and response. With cooperation between regulators and major corporations, the industry will continue to enhance the operational security of the financial sector in Asia-Pacific.

Overall, progress has been made since the last financial crisis and regulators and market participants are constantly working to reduce potential threats. However, the unpredictability of financial crises, as well as their myriad potential causes and effects, means continued vigilance and caution are crucial.

The key areas of concern, which have evolved since the Lehman collapse, include macroeconomic issues, market-related risks, fintech, and cyber-security threats. In response, firms should remain focused on plans and policies that protect against, and ensure speedy recovery from, these risks.

This article was originally published in Regulation Asia.