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Market operations have proven resilient
April 2020
S&P/TSX composite index
steps in their own operations —
pulling back from activities that historically have been carried out face to face, either cancel- ling them or implementing work- arounds that don’t involve direct physical contact. For the most part, regulators are continuing their compliance work, but they are conducting exams remotely and holding meetings by phone or teleconference only.
Certain enforcement activ- ity is on hold too. The Ontario Securities Commission (OSC) has suspended live hearings until April 30. In the meantime, some proceedings may continue in writing and by using video or teleconferencing, but live appear- ances before the regulator’s tribu- nal are off for now.
Regulators also are accom- modating dealers regarding compliance procedures that are tough to replicate in a home office, such as voice recording.
On that matter, both the
Investment Industry Regulatory Organization of Canada (IIROC) and the regulatory division of the Bourse de Montréal Inc. provided guidance to firms on meeting their audit trail obligations during the pandemic.
While these deviations from normal procedures are under- standable — and perhaps
unavoidable, given the scale and scope of the pandemic — they do represent relaxed compliance standards that ordinarily exist for a reason.
Whether looser supervisory arrangements will result in additional misconduct probably won’t be evident for some time, but that’s a risk that’s tough to avoid under the circumstances.
There are opportunists try- ing to take advantage of the unusual market conditions. Several securities regulators have warned about an increase in frauds sparked by the Covid-19 outbreak, ranging from pump- and-dump schemes involving companies touting fake treat- ments to false promises of help for frightened investors eager to protect their battered portfolios.
Over the longer term, there also is likely to be fallout from the current turmoil on the regu- latory policy front. Consultations that are already underway at the provincial regulators — such as the OSC’s proposals for limiting trades in deferred sales charge (DSC) mutual funds — are being extended for 45 days to provide more time for meaningful feed- back. These sorts of extensions are likely to spell delay overall.
Sources indicate that other regulatory initiatives — such as the Canadian Securities Administrators’ planned review
of the SRO structure, the SROs’ implementation of the client- focused reforms scheduled to take place over the next couple of years and the MFDA’s continuing education initiative — are likely to be delayed too.
The financial markets have been sent reeling by the unprecedented economic fallout from the Covid-19 outbreak. Yet, despite the sharp spike in vola- tility and the shift toward emer- gency footing for both firms and regulators, market operations have proven remarkably resilient.
Apart from an outage experi- enced by the TMX Group Ltd.’s trading venues on Feb. 27, Canadian markets have weath- ered the effects of the Covid-19 pandemic without interruption. And the TMX’s disruption, which was caused by a surge in mes- sage volume, was cushioned by the fact that other markets remained operational during the disruption.
In the weeks since, the spike in volatility has triggered Canada’s marketwide circuit breakers on several occasions. Those tem- porary trading halts, which are generated by the markets hit- ting downside thresholds, are intended to prevent trading from failing altogether. And despite the fact that heavy selling may have gutted some investors’ port- folios, the markets have remained
functional and relatively orderly. So far, there haven’t been significant spillovers from the extreme volatility in equities mar- kets into other sectors. During past crises, wild market swings often led to difficulties, such as funds struggling to value assets accurately, surging redemptions and liquidity shortages. Given the exceptional market conditions, these risks naturally are concerns, but as Investment Executive went to press, they have yet to material-
ize in any major way.
In addition, so far there are
not worries about excessive short-selling in Canada’s mar- kets. In Europe, several regula- tors have imposed restrictions on shorting particularly hard- hit stocks. So far, these kinds of curbs have been limited to a handful of countries.
As bad as the global financial crisis was in 2008-09, at least no one was banned from going to the office back then. During that crisis, short-selling limits on cer- tain financial-sector stocks were adopted in the U.S. and Europe, with Canadian regulators taking action on interlisted securities as well.
At the time, the decision to ban short-selling was con- troversial, and some followup research concluded that the ban affected market quality nega- tively — exacerbating volatility
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Market-wiide circuit breakers triggered
    and widening spreads. The fact that more pervasive short- selling restrictions haven’t been imposed this time is an encour- aging improvement over the 2008-09 crisis.
Current operational stability is even more impressive, given that much of the investment industry and regulatory authorities are operating in emergency mode — public health authorities have steadily ramped up demands for social distancing and organiza- tions have shifted substantially to remote working arrangements.
All these things are now taking a deserved back seat to the grow- ing global pandemic. Putting aside these kinds of minor casual- ties, investor confidence in mar- ket infrastructure and oversight should be bolstered by the resili- ence shown so far. IE
   Social distancing, while costly for the economy, will save lives
travel and leisure — would be
temporarily disrupted and that weakness would be relatively short-lived. The reality is that vast swaths of the economy are being shuttered, and the financial pain is certain to be much greater than originally expected.
The downside revisions are staggering. In its latest fore- cast, Toronto-based Royal Bank of Canada’s (RBC) economics department now projects a 2.5% decline in Canada’s GDP this year. Less than a month ago, the forecast was for 1.4% growth.
This much grimmer outlook includes a 3% drop in GDP in the first quarter of this year, followed by a whopping 18% decline in the second quarter — with the job- less rate also jumping to 10.7% in Q2 from 6.8% in Q1.
The huge drop in output is the result of widespread social- distancing requirements imposed by governments to stem the spread of the virus. This public health imperative has prompted Ontario and Quebec to lock down “non-essential” busi- nesses, among a variety of other measures (closing schools and banning public events), in an effort to prevent a public health emergency.
“The pressure on the econ- omy will be widespread, with the services sector hit by a severe demand shock as social dis- tancing keeps consumers and workers at home,” states the RBC forecast. “On the goods-produ- cing side of the economy, the disruption of supply chains and
collapse in the energy sector will exert further downward pressure on [economic] growth.”
The increasingly bleak out- look is subject to significant uncertainty — most important, what happens with the pan- demic. The efficacy of social dis- tancing in curbing the infection rates is not known. Therefore, the duration of the govern- ment-mandated shutdowns also is unknown.
Moreover, once the crisis passes and government restric- tions lift, the risk of the virus flaring up again remains. Until either an effective vaccine is developed or infection (and recovery) rates rise high enough to generate “herd immunity,” the prospect of Covid-19’s re-emer- gence remains a genuine threat.
While this is the case with any virus, Covid-19 is more deadly and more transmissible than the ordinary seasonal flu and previ- ous pandemics, such as the H1N1 outbreak in 2009.
A research note from Montreal-based National Bank Financial Inc.’s (NBF) econom- ics department indicates that Covid-19 spreads at about double the rate of these other illnesses. “In that context, unprecedented action taken by governments worldwide to shut down the economy, while painful, is under- standable,” NBF’s note states.
Economists are trying to understand the trade-off between human health and economic growth under the threat of a deadly pandemic.
To that end, on March 18, the Federal Reserve Bank of
Minneapolis published a paper that aims to bridge the gap between economics and the models public health experts are using to guide governments in their decisions to curb ordin- ary human interaction and busi- ness activity.
The Minneapolis Fed paper concludes that infection mod- els indicate that “severe social- distancing measures” probably will have to be maintained for a full year, and possibly as long as 18 months, to avoid severe public health consequences.
Alternatively, if governments abandon social distancing and allow the disease to run its course, the economy still may not fare any better. In that case, gov- ernment-imposed shutdowns wouldn’t be the cause of lost out- put, and extensive death and ill- ness would impose their own large economic costs.
“Which option would have the more severe economic con- sequences is hard to determine,” the Fed paper concludes.
New research into the Spanish flu of 1918-20 found that the eco- nomic and financial conse- quences of that unconstrained outbreak were severe, generating an average 6% decline in GDP, along with significant drops in stock and bond returns, in afflicted countries.
What is clear is that social-dis- tancing efforts to combat the spread of Covid-19, while costly for the economy, will save lives. A new working paper from the U.S. National Bureau of Economic Research, which aimed to inte- grate the standard model of
virus spread with economic decision-making, concluded: “It is optimal to introduce large- scale containment measures that result in a sharp, sustained drop in aggregate output.”
That paper estimated that the “optimal containment policy” will save about 600,000 lives in the U.S.
While the Covid-19 crisis often is framed as a binary decision between health and economic growth, economists are contem- plating other possible approaches.
One option is to impose strict social-distancing requirements initially, loosen those restric- tions once infection rates sub- side and then ratchet them up again when the virus inevitably re-emerges.
The paper from the Minne- apolis Fed examined that sort of approach and found that it will probably delay the virus’s spread, but doesn’t solve the underlying challenge: “The model predicts that once mitigation efforts are relaxed, the disease simply restarts its rapid progression and sweeps through the population in less than 18 months, reaching its peak infection rate about 450 days from now.”
So, while initial efforts to contain the virus may be suc- cessful, dialing down restric- tions is likely to open the door to a new outbreak — requiring governments to reinstate social- distancing restrictions. However, temporarily backing off on social distancing could at least buy some time to invest in addi- tional health-care resources (e.g., manufacturing ventilators and training workers) to cope
with the next outbreak.
At this point, that’s not a scen-
ario the newly gloomy economic forecasts contemplate. Instead, they anticipate that the severe economic consequences of social distancing will be relatively short-lived and that the econ- omy will bounce back quickly once government restrictions are lifted and pent-up demand is released.
For example, RBC’s forecast foresees GDP growth rebounding in the third quarter of 2020, ris- ing by 9.0% and generating 2.9% annual growth in 2021.
Expectations for a rapid rebound are underpinned by the unprecedented efforts that governments and central banks are deploying to help cushion the economic consequences of social distancing. Along with large interest rate cuts and central banks’ efforts to ensure liquid- ity in financial markets, gov- ernments are stepping up with major fiscal measures.
In Canada, so far this includes $85 billion in tax deferrals, $52 billion in direct spending and $65 billion in loans.
In the U.S., policy-makers are launching US$2 trillion worth of support for individuals, compan- ies and local governments.
Globally, these efforts should support an eventual economic recovery. DBRS Morningstar Inc. states that while government measures won’t be able to fully offset the economic effects of the lockdown, they will help underpin “a relatively more robust economic recovery” that will begin later this year. IE
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