The New Normal -- COVID-19 Perspectives

If you’ve been working in and around financial markets long enough, you’ve seen your fair share of volatility and downturns like the one we are experiencing now. In times like this, it is natural to look back and make comparisons against other times of stress to assess how markets reacted and what the fallout was after the crisis.

Even though my grey hair may say something different, I wasn’t alive at the time of the crash of 1929, and I was just a kid in middle school during the 1987 crash. I was, however, alive and well (with less grey hair) working as a collateral manager in retail brokerage during the dot com and 9/11 crashes, and was front and center at a very large quant asset manager during the 2008 recession.

The economic events during the first decade of the 21st century made it clear that the automation in the movement of collateral, especially in the OTC market, needed a seismic change. Past economic market crashes are still debated today, but we know they were due to several factors, including run away leverage, a run on the banks, and a lack of bank capital to absorb shocks. What we are seeing today is not a run on the banks, but a run on the economy.

These are scary times, and we are clearly in uncharted waters. As uncertain as things seem, we have been given a gift, the gift of history and experience. Setting aside just for a moment the health toll this is taking on us as a society, we have lived through worse economic experiences than the one we are experiencing today. To put it into perspective, the crash of 1929 saw an 89% decline in stock prices. During the crisis in 2008, the Dow experienced a 49% decline. So far, the COVID-19 crisis has seen around a 35% decline in the Dow during the period of February to the end of March.

We may have seen the bottom of the market, but most experts say we’re not out of the woods just yet. History has generally shown that after a crisis comes change and, most of the time, change for the better. In 2008, change in the financial markets came in the form of improvements in risk mitigation, the organization of resources, and the automation of legacy processes. According to a recent op-ed published in The Wall Street Journal by CFTC Chairman Heath Tarbert, even during this time of high volatility in equity and commodity markets, the OTC derivative market has acted like a shock absorber to these market swings. Tarbert attributes the reforms and actions that came after the crash in 2008.

Looking back at 2008 and the lessons learned during that time, we witnessed several gaps in how business was conducted, especially in the OTC derivatives market. Before the emergence of MarginSphere®*, for instance, OTC margin calls were manual and often at times missed in a sea of e-mails. Due to the lessons learned from the crisis of 2008, that has thankfully all changed for the better. Many firms have moved from a manual, risk-prone process into a full straight through process, reducing huge amounts of operational risk and cost to business.

With great market stress comes high volatility, and with volatility comes large spikes in the exchange of collateral. AcadiaSoft has recently seen spikes as high as 2.5 times the normal margin and collateral messaging volumes. We have been able to support these volumes, ensuring that firms are managing and settling collateral with their counterparties and satisfying their regulatory and contractual obligations in a timely manner. In addition, firms exchanging regulatory Initial Margin using ISDA SIMM™ have not seen any cliff effects and for all intents and purposes the model is working as intended.

Risk mitigation reforms, working as they should to ensure the viability of a very important marketplace, are the bulwark of financial reforms that have been put in place for just such an event. In short, we are in an unprecedented period of market stress, and many of the reforms and changes in infrastructure and technology that emerged from the last market shock in 2008 have been serving us well so far.

We know we are moving towards a new normal. When the COVID-19 crisis passes, and it will, AcadiaSoft and our many industry partners will remain equipped with the tools necessary to meet the demands that volatile markets can throw at us. We are seeing that play out in real time today. The reforms, technology, and experience we have in place today will serve our markets and our clients well into the future. Perhaps the next question may be what great lessons will we learn from this crisis, will it be an economic one or a humanitarian one or both? Only time will tell.

*MarginSphere is an automated margin call service used by over 1350 firms globally, processing nearly one million margin calls per month