Three distinguished think-tanks led three call for papers for the conference.Bruegel
, headed by Guntram Wolf, and with Alexander Lehmann at the head of the call, will be looking at sustainable finance trends and challenges.CIRSF
, headed by Luís Morais, and with José Gonzaga Rosa leading the call, will dive into the digitalization of the international financial system.CEPS
, headed by Karel Lannoo, and with Apostolos Thomadakis heading the call, will explore the functioning of capital markets in Europe and around the world.
Meet the authors and abstracts of the six selected articles: Sustainability in rulemaking and in practice (by Bruegel)
Chair: Alex Lehmann, Bruegel and Frankfurt School of Finance Sustainable investing in times of crisis: evidence from bond holdings and the COVID-19 pandemic
Serena Fatica and Roberto Panzica, European Commission Joint Research Centre
Using data on institutional investors’ bond holdings, we investigate the resilience of green bonds to the COVID-19 shock in a difference-in-differences framework. We find that during the COVID outbreak green bonds experience lower sales, on average, while in normal times no significant differences emerge compared with conventional bonds. The result is robust across different investor classes and is not driven by those that have a longer-term investment horizon. Furthermore, we find that sustainability-oriented funds sell less of green bonds than their peers without sustainability concerns. We also document that the ownership of green fixed income securities is more concentrated than that of comparable conventional bonds, and that concentration has increased in the first quarter of 2020.
Discussant: Sara Lovisolo
, Head of Group ESG - Euronext Group
Measuring Sustainability: a survey of the ‘big 4’ ESG data providers’ methodologies
Marco Dell’Erba, University of Zürich and Michele Doronzo, Swiss Re Asset Management
Sustainability has become a prominent topic in financial regulation and corporate law, with multiple entities (market actors, corporations, central banks, and securities authorities) playing a role in the shift toward a new economic and financial paradigm. Consistent with the growing relevance of sustainability, Environmental Social Governance (ESG) indicators and ESG data providers are becoming increasingly influential in the economic and financial landscape. The lack of standardization at the level of ESG indicators and the multiple methodologies that the different ESG data providers have elaborated raise doubts and concerns. These problems share some similarities with some of the issues that emerged in the credit rating industry. After providing a brief background analysis of credit ratings, credit rating agencies and their regulation, this article identifies some key features of ESG ratings, in comparison to credit ratings. Furthermore, it provides a review of the most popular ESG data providers and related investable indices, with an analysis of their key performance statistics. In light of these results, this article advances some policy options to improve transparency, standardization, and alignment with climate change policies to ensure a full implementation of sustainable practices within the financial industry.
Discussant: Robert Patalano, Acting Head - Financial Markets Division, OECD Digitalizing investment finance (by CIRSF)
Chair: Luís Morais, CIRSF Machine Learning, Market Manipulation, and Collusion on Capital Markets: Why the 'Black Box' Matters
Wolf-Georg Ringe, H. Siegfried Stiehl and Alessio Azzutti, University of Hamburg
This paper offers a novel perspective on the implications of increasingly autonomous and “black box” algorithms, within the ramification of algorithmic trading, for the integrity of capital markets. Artificial intelligence (AI) and particularly its subfield of machine learning (ML) methods have gained immense popularity among the great public and achieved tremendous success in many real-life applications by leading to vast efficiency gains. In the financial trading domain, ML can augment human capabilities in both price prediction, dynamic portfolio optimization, and other financial decision-making tasks. However, thanks to constant progress in the ML technology, the prospect of increasingly capable and autonomous agents to delegate operational tasks and even decision-making is now beyond mere imagination, thus opening up the possibility for approximating (truly) autonomous trading agents anytime soon. Given these spectacular developments, this paper argues that such autonomous algorithmic traders may involve significant risks to market integrity, independent from their human experts, thanks to self-learning capabilities offered by state-of-the-art and innovative ML methods. Using the proprietary trading industry as a case study, we explore emerging threats to the application of established market abuse laws in the event of algorithmic market abuse, by taking an interdisciplinary stance between financial regulation, law & economics, and computational finance. Specifically, our analysis focuses on two emerging market abuse risks by autonomous algorithms: market manipulation and “tacit” collusion. We explore their likelihood to arise on global capital markets and evaluate related social harm as forms of market failures. With these new risks in mind, this paper questions the adequacy of existing regulatory frameworks and enforcement mechanisms, as well as current legal rules on the governance of algorithmic trading, to cope with increasingly autonomous and ubiquitous algorithmic trading systems. It shows how the “black box” nature of specific ML-powered algorithmic trading strategies can subvert existing market abuse laws, which are based upon traditional liability concepts and tests (such as “intent” and “causation”). In concluding, by addressing the shortcomings of the present legal framework, we develop a number of guiding principles to assist legal and policy reform in the spirit of promoting and safeguarding market integrity and safety. Does EU Regulation adequately address the tension between CCPs shareholders’ and members’ incentives?
Anastasia Sotiropoulou , University of Orleans
The current EU regulatory regime on CCPs falls short in addressing the misalignment of incentives between CCPs’ shareholders and clearing members. On the one hand, clearing members, albeit without ownership in the CCP, bear risks first. They are the ones that, according to the 2012 EMIR regulation, contribute to the mutual guaranty fund used to absorb the potential default of at least the two members to which the CCP has the largest exposure. Furthermore, in case the guaranty fund is exhausted, the CCP has the legal right to ask the non-defaulted members for additional cash injections. Despite bearing these risks, clearing members do not enjoy substantial governance rights: they merely participate in the risk committee of the CCP, whose role is, however, only advisory. On the other hand, shareholders are owners of the CCP and, as such, enjoy governance rights. Although they appoint the members of the board which sets the risk profile of the CCP, they do not bear final losses first, as in ordinary corporations. Not only do they not have substantial skin in the game when a clearing member defaults on its obligations, but they also, in case the CCP enters resolution, bear losses only after the clearing members. And if, by exception to this principle, the resolution authorities decide that shareholders should bear losses first, shareholders are entitled to compensation claims for violation of the “no creditor worse off principle”, set out by the 2021 CCP Recovery and Resolution Regulation. It is however obvious that when the owners of a firm are not the ones bearing the risks, the firm is prone to moral hazard and excessive risk-taking. This can make the firm riskier, a riskiness that is further exacerbated when the firm is systemically important. The choice of the incentive structure of a CCP is therefore an important element when designing clearing structures: CCPs’ owners should ensure adequate control over the risk management of the CCP and clearing participants should continue to trust CCPs and to centrally clear their transactions. Hence, the objective of this draft paper is to discuss a number of ways to improve the incentive setting and incentive structure of CCPs.
Discussants: Alberto Tapia Hermida, Complutense University of Madrid and Pierre-Henri Conac, University of Luxembourg Which direction for capital markets in the EU and around the world? (by CEPS-ECMI)
Chair: Apostolos Thomadakis, ECMI-CEPS Strategic Complementarity among Investors With Overlapping Portfolios
Christof Stahel, Investment Company Institute
Academics and regulators posit that mutual funds that engage in significant liquidity transformation can be systemically risky because investors, driven by strategic complementarity, compete for a common fund liquidity pool and are redeemed at the fund’s net-asset-value, which leads to run-like behavior. We analyze the class of investors in separately managed accounts for the period from 2000 to 2021, because, unlike mutual fund investors, these investors directly own the assets in their portfolio. Hence, the common liquidity pool and net-asset-value redemption channel present in mutual funds has been turned off for these investors. The results estimating standard flow-performance models show concave flow-performance relationships for separately managed account strategies that invest in less liquid assets. We further present evidence that the sensitivity of outflows to bad past performance increases during periods of market illiquidity and for strategy portfolios that are more illiquidity. We also find that strategic complementarity is less important for large investors, who more likely internalize the negative externality generated by their decisions to sell.
Discussant: Marie Brière , Head of Investor Research Center - Amundi; Senior Affiliate Researcher - Université Libre de BruxellesRegulation, financial crises, and liberalization traps
Francesco Marchionne, Indiana University, Beniamino Pisicoli, University of Rome Tor Vergata and Michele Fratianni, Indiana University.
The paper first develops a theoretical model showing a concave impact of regulation on the probability of a crisis, and then tests this relationship by applying a non-linear Probit model to annual data from 138 countries over the period 1996-2017. Our key inference is that the probability of a financial crisis fits an inverted U-shaped curve: it rises as regulation stringency moves from low to medium levels and falls from medium to high levels. Countries located in the intermediate level of regulatory stringency face more financial instability than either loosely or severely regulated countries. The latter two groups of countries are caught in a “liberalization trap” and a “regulation trap,” respectively. Institutional quality interacts significantly with the regulatory environment, implying trade-offs between regulatory stringency and institutional quality.
Discussant: Eva Schliephake, Assistant Professor - Católica Lisbon School of Business & Economics
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