samchain/econo-pairs-v1 huggingface dataset:
I want first to review why that historical performance has been so sluggish, before turning to look at how things are changing, and fast, under the influences of shifting public policy and consumer behaviour, and the physical realities of a changing planet. I will focus mainly on developments in private financial markets, but will also touch on some of the ways that we in the UK public sector can contribute, as market participants in our own right. Why markets have struggled to price climate risk: externalities, horizons and opacity Given the sheer scale of the climate challenge, it is at first glance surprising that financial markets have struggled to reflect it in asset pricing. The reasons for that failure are threefold. First, it is in the nature of climate change that many of the costs of failing to address it, and the opportunities for positive change, fall to society as a whole, rather than specific individuals or companies. The freedom to emit unlimited amounts of carbon is one example. Markets are notoriously poor at pricing such ‘externalities’. Not all climate risks are externalities, of course. Investor activism can bring consequences to bear on firms viewed to be responsible for climate harm.8 And climate-related natural disasters – already three times more frequent than 40 years ago – fall on real individuals and real companies.

First, because a central bank cannot create wealth above and beyond the income derived from its own investments, and therefore cannot finance old age pensions. Second, there are still people who believe that, in the event of an economic slump, the central bank will bring about a sustained improvement in economic performance. It is an illusion to believe that, in the long term, jobs can be created through monetary stimulation. Over a longer period monetary policy is neutral. The third and final reason relates to the fact that it is possible that the response to the demographic challenges of the future might affect the equilibrium real interest rate of our economy – a variable that always enters into our assessments of a given situation.
In this regard, Asia’s needs are likely to be different from those in the advanced economies. Economies in rapid transition need responsive banking and capital markets. Bankers need to appreciate the changing needs of the economy, build new capabilities and develop new products and services, to support the needs of companies, large and small, in both mature and new industries. The financial industry needs to build up capabilities to understand the requirements of new industries in the technology and services arena, and to efficiently fund long term infrastructure needs. To sustain Asia’s growth  BIS Review 51/2010  1  trajectory, we need to further develop and deepen national financial systems and regional financial integration. MAS is studying several ideas in these areas, and we look forward to working with our counterparts in the region and with the industry to advance this. 8. Let me now share the measures that MAS is taking to respond to the challenges from the international reform agenda and the evolving new financial landscape. Our measures are based on three key pillars. Sensible rules 9. The first pillar is establishing sensible rules. MAS seeks to establish sound rules of a high standard that allows well-managed risk taking and innovation, and which emphasises the stable and sustainable development of the financial services sector. The effectiveness of a regulatory framework is not determined by whether it is stringent enough to prevent any kind of shortcoming or failure of any firm.

The draft standard on risk management for new bond issuances sets out principles to mitigate risks around selection and formation of reference rates. The FMSB’s Statements of Good Practice, such as for surveillance of FX markets, provide more detailed guidance and worked examples to help set expectations. The FMSB is also scanning the horizon for future misconduct risks, including through its innovative behavioural cluster analysis. Rightly, given rapid changes in underlying market structure, this process has prioritised work on vulnerabilities arising from fast automated markets. Will These Standards and Codes Make a Difference? We know from history that codes are of little use if nobody reads, follows or enforces them. Why should the FMSB’s efforts be expected to help reverse the tide of ethical drift? Indeed, given the long history of misconduct, aren’t such efforts akin to King Canute rebuking the waves? 8  I’m more optimistic that the tide will turn because the FMSB is part of a much broader effort by UK authorities and market participants. Together, we have created a comprehensive and mutually reinforcing set of measures that strengthen the hard and soft market infrastructure. The resulting incentives give FMSB standards moral force and practical consequence. First, in the FMSB’s core work, the best in the market are taking responsibility for identifying and codifying best practice, in a way that complements and reinforces existing regulation. The FMSB now convenes senior participants from fifty global issuers, underwriters, asset managers, exchanges, custodians and investment banks.
Preventing Financial Problems The market disturbances of the past 18 months have focused a great deal of attention on the need for greater transparency and for increased attention to corporate governance, legal and accounting matters, without diminishing the traditional supervisory focus on credit, liquidity and capital. Recent events suggest that we are seeing new ways in which the links between credit and liquidity are increased in the financial system. Wider credit spreads in virtually all actively traded financial markets, accompanied by declines in liquidity in many markets, signal us that credit concerns are rising in the financial system. We, as supervisors, must interpret and respond to those signals, often in shorter time frames than we are comfortable with, and often in concert with a high level of market volatility. One anomaly is that these issues arise in the face of apparently genuine improvements in liquidity in the high-yield bond, syndicated loan, and emerging markets that we have seen at various times since the early 1990s. Four questions about the current developments appear to offer well-defined avenues which supervisors can pursue. First, are current market conditions signaling a loss of confidence in prior credit judgments, perhaps in response to the growing awareness of how capital markets instruments, especially derivatives, can transform the risk profile of customers and counterparties?

•  Our banks also undertake regular stress tests on their own and those coordinated by MAS. •  We have subjected the banks’ balance sheets to a combination of stresses – including a sharp rise in interest rates, a decline in property prices, and a rise in unemployment rate. They have enough capital to see them through. It is the household sector that we are concerned about. •  At the aggregate level, household balance sheets are resilient. Cash and deposits exceed household debt. •  But the health of the balance sheet is not uniform across all households. Many households could have over-extended themselves, fuelled by low interest rates and stretched loan tenures. •  The vast majority of mortgage loans are on floating-rate packages, which means that households will face higher monthly repayments when interest rates normalise. •  An estimated 5 to 10% of borrowers have probably over-leveraged on their property purchases, i.e. they have total debt service payments at more than 60% of their income. •  If mortgage rates were to rise by 3 percentage points, the proportion of borrowers at risk could reach 10 to 15%. •  In particular, lower income households and those with smaller saving pools may find this a strain. Those with longer tenure loans will also be adversely affected. So, when interest rates rise, long before any bank gets into trouble, some households will. Banks must therefore practice responsible lending, and consider the ability of borrowers to service their debt in a sustainable manner.
And that gets to both the nature of interactions between insurance and banking on the one hand and to the environment in which we all operate - the areas of accounting, regulation, payment and settlement and law, the broad infrastructure if you will - on the other. In simpler days, it hadn’t occurred to most people that the world of insurance could be relevant to the issue of overall financial stability. The worlds of insurance and banking were relatively distant from each other as were the worlds of securities and banking. Separate silos, if you will. But today insurance companies are an important factor in mitigating risks which earlier would have been contained within the banking world. I’m talking about risks like debtor default. And now, there is increasing overlap and interaction with banks and capital markets. A personal anecdote might help to make that point; and also highlight my view that the breaking down of the silos is a pretty recent phenomenon. I well remember a time in the 1970s. As an investment banker, I used to handle capital market deals in the early days of the eurobond market. I began to observe that, even though I couldn’t articulate what was going on with precision, there were areas of the insurance industry which seemed to be taking similar types of risk as banks, but charging a wholly different price. I remember talking to my friends in the insurance broking industry about it. One or two of them are here in the audience!

First of all, was it true? Secondly, if it was, why? And thirdly, if indeed there was an arbitrage opportunity then how could we unlock its value? I remember feelings of frustration. Somehow we couldn’t quite see how to reconcile some of the essential differences, including regulatory and accounting distinctions. To say nothing of the language or jargon used in the two sectors. Well, the rapid growth of the derivatives industry during the late 1980s changed all that! All sorts of new instruments for exploiting arbitrage opportunities like the one I described came into being. The different aspects of risk were unpicked and recombined. Those developments depended partly on new information technology. And, together with securitisation the functional divide was crossed. That evolution provided colossal commercial opportunities and enhanced general economic value. I recall this because it’s a good example of how technical advances, some rocket science and market forces have changed the fortunes and capabilities of two great industries. And today, even though we don’t have full integration we certainly have greatly increased interdependence and linkages. Just take the involvement of the insurance industry in credit risk transfer as an example. And just as with a lot of interdependencies you get network effects with undoubted economic benefits on the one hand, but potential vulnerabilities on the other. Maybe I can start by making a few observations on the vulnerabilities - increased risk to firms or the overall financial system - that were less significant until the interconnections appeared.
What often then emerges is a “popular narrative”. These narratives have been found to be an important driver of collective behaviour in financial markets and the economy.6 Behavioural biases at times of existential risk, spreading contagiously, can result in pessimistic popular narratives detached from reality. At times of stress, a global game of Chinese Whispers can generate unduly negative expectations. 4  See Haldane (2015) See Gigerenzer (2004) 6 See Akerlof and Shiller (2009) 5  7  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  7  I think the prevailing popular economic narrative, among businesses and households currently, is unduly negative. It has emphasized recession and risk over recovery and resilience. It has resulted in good economic news (of which there has been plenty) being discounted too readily, and fearfulness about the future being accentuated. Let me give a few simple examples. Chart 5 plots a simple Google search of the relative incidence of two words – “recession” and “recovery”; it is an economic pessimism ratio. Before the Covid crisis, the pessimism ratio was steady. As the crisis struck there was a predictable and sizable spike upwards, by a factor of roughly 8. Since then the ratio has fallen somewhat, as we might expect as the economy has moved from recession to recovery. The dynamics of this sentiment indicator are nonetheless revealing. The drift down in the ratio has been very gradual. It remained elevated well after economic recovery had commenced and recession ceased.

The MPC’s minutes also explained that the Bank would be taking forward operational work to assess the feasibility of implementing negative interest rates, should this be required in future. Commencing that operational work underlines the MPC’s commitment to having negative rates as a potential tool in the monetary policy toolbox. Some commentators have interpreted the start of this work as conveying a signal about the likelihood of the MPC introducing negative rates in the near-term. The minutes contained no such signal. The operational work necessary to assess the feasibility of negative rates is likely to take a number of months. After that work is complete, judgements on negative rates will depend on the economic outlook at the time and in particular on whether that necessitates further monetary stimulus. If that condition was satisfied, any decision on negative rates would then depend on whether the balance of costs and benefits from using this tool was positive and whether this cost/benefit balance favoured negative rates over other monetary tools. All three of these conditions would need to be satisfied before negative rates became a reality. At present, none of those conditions is in my view satisfied. Conclusions The economy faces uncertainties that are extraordinarily large and risks that are skewed to the downside. In this environment, caution is natural and understandable. It is important policymakers are vigilant to these risks and uncertainties and responsive to them with their policy actions.
But I think that it is important already to agree on the principles even if they will be designed in detail by standard-setters. There are important principles that would create confidence in the financial system, like subjecting all financial actors of systemic importance to appropriate regulation and/or oversight as needed. FT: Is there a difference between the continentals the UK/UK on counter-cyclical provisioning by banks? CN: There are two different avenues that could be complementary. They are being studied in a subgroup of the Financial Stability Forum and in the Basel committee on banking supervision. One has to do with the banking book, or classical loans, and is more or less the dynamic provisioning that the Spanish created. That could answer the national pro-cyclical effect of provisions, that is when you increase provisions in the down-turn, and reduce provisions in the upturn, quite normally, because that’s what happens when you measure risk at a particular moment. But what the Spanish have done is to take the whole cycle, so that you are obliged to build up certain provisions in the upturn and you can use them in the downturn and that reduces and eventually eliminates the pro-cyclical effects of the credit cycle. The second concept is that for the trading book.

We are discussing regulation of the financial system but it doesn’t mean that we need an over regulated system – certainly not. We have to strike a balance, but it is clear in Europe, that we hope we will have a system that will be more regulated, or at least better regulated, without holes in the system. But we are living in a global world and we need to have consistent rules around the world. FT: But Europe also needs to have its own internal dynamism, to encourage innovation. That was part of the problem of the economic model before the crisis. If you create more regulation, doesn’t that make the problem worse? CN: I think it does not prevent innovation if the rules are well designed. The lesson that we should take from the crisis is that if we let something an innovation – like hedge funds, or securitisation – develop freely and continue not to regulate it or exert any surveillance even if it grows to such an important level that it is systemic, then the risk is enormous. We should be able to detect when a systemic risk is becoming too big in the system and then act. BIS Review 29/2009  5
Following discussion at FSB, that gap in the analysis is now being addressed by the IOSCO leadership. Post-trade infrastructure: CCPs as risk managers The other big area of reform is, of course, around central counterparties. Clearing more OTC products; being more resilient; revisiting criteria for access to CCPs, and so on. You don’t need me to rehearse all of that for you. But I would note that this is not just about derivatives markets. LCH’s move to clear repos in Spanish government bonds helped that market stay open during some dark days. And I do want to make one very important general point about the role of CCPs and their management. CCPs simplify the complex web of counterparty exposures through multilateral netting – precisely what the US authorities contemplated trying to achieve ad hoc towards the end of a weekend when Lehman was unravelling. They act as a central market authority for valuing positions and setting minimum margin levels. Having centralised risk upon themselves, they redistribute it to their clearing members through a clear waterfall. They are, in effect, systemic risk managers. They absolutely must think of themselves as that. Their job is not just to deliver ever greater operational and capital efficiency for their clearing members. Too many senior executives at CCPs I have met over the past decade or so have seemed to fall into that trap – a trap encouraged by some being for-profit organisations.

That will create an incentive to price risk. We also need to be alive to artificial but potent incentives to take too much risk. What I have in mind here, for example, are the regimes or practices under which long-term asset managers (life companies and pension funds) end up targeting or even guaranteeing high nominal returns or, a separable issue, investing as herds. For example, it is said that public sector pension funds in the USA aim to achieve returns of around 8%.22 This kind of thing, which I would guess has global effects, distorts the appetite for risk in our capital markets, especially when current and expected policy rates are low. We need to get to the bottom of whether this materially fuels the Search for Yield, which is being talked about again by market participants in ways that remind me of 2003/04, when the markets reignited astonishingly quickly after the dotcom and telco debt blood bath. Separately, we need to have a richer understanding of the effects of relative-return performance measures on the dynamics of crucial debt and equity markets. These seem like badly neglected issues, of little interest to microregulators of fund managers or securities markets but, possibly of profound system-wide significance. My objective today is no more than to call for research on this. 21  See FSB (2011) “Shadow Banking: Scoping the Issues.
The Spanish economy The weakening of the international economy and the loss of buoyancy in the European economy contributed in 2001 to prolonging the gradual slowdown in activity in Spain in train since the previous year, when the first symptoms of the previous lengthy expansionary phase having run its course were discerned. Consumption and investment in construction were the main underpinnings of growth in our economy, while productive investment and exports were the chief components dampening it. That said, GDP increased by 2.8% in 2001, clearly above the figure of 1.5% posted in the euro area. The maintenance of high job creation rates during 2001, set against the slowing trend marked by general developments in the economy, and the favourable financial conditions in place contributed to sustaining household income and helped underpin consumer spending and residential investment. However, the declining course of investment in capital goods steepened in the face of heightening uncertainty, worsening expectations and slowing final demand, which the generous financial conditions were unable to offset. The effects on activity were reinforced by the fall in the growth rate of exports as from the early months of 2001.

Issues around misaligned incentives and an over-emphasis on short term performance which encouraged reckless risk-taking, in addition to the lack of transparency, and the pervasive conflict of interests have long been the focus of public attention especially in relation to companies with dispersed shareholding structures. These same issues however, are far more serious when they involve the financial institutions given the significant externalities inflicted on society following the failure of such financial institutions. Banks in particular are especially vulnerable to the consequences of governance failures given the critical importance of public confidence to their very survival. Since the crisis, substantial work on several fronts have been devoted to strengthening the resilience of financial institutions. New capital and liquidity standards have been a key focus of the global regulatory reforms and the work to transpose these global standards into national regulations are now well underway in many countries, including in Malaysia. While this will deliver significantly improved frameworks for risk-taking by financial institutions, they remain, at best, poor substitutes for good governance. Evidence of this can be drawn from the contrast between institutions that operated under the same regulatory framework, but that experienced very different outcomes during and after the crisis. The comparisons are revealing. Of significance has been the observation – including in the most recent cases of massive bank losses – that behaviour and culture had a more significant part in the recent governance failures.