In late February, roughly 48 hours before fears of the COVID-19 pandemic began shutting down conferences across the entire globe, 8,200 members of the structured finance community gathered (with washed hands) at the Aria Hotel in Las Vegas for the Structured Finance Association (SFA)’s annual conference. This year’s event was the largest in the organization’s history and, as such, was the single-largest capital markets conference ever.
News was made, and positive, forward-looking plans were developed. With such a dramatic backdrop, it clearly makes sense to gather a few key takeaways, especially as COVID-19 begins to thrust the global financial markets into a tailspin of confusion and fear. It very well may be that this exogenous incident triggers the first global recession since the financial crisis of 2008. If so, it’s very fortunate that leaders of the financial services industry were able to gather in one place before such an event is a fait accompli.
Here, then, are the main components of the 2020 “Vegas consensus”:
The next downturn will come from outside the financial system, but the system will still be tested. Of course, we weren’t hoping that a flu-like viral pandemic would prove us right so quickly. But, if that happens, this will be the first test of the myriad protections put in place immediately following the crisis of 2008. Put another way, we just might find out how the Fed stress tests, the Financial Stability Oversight Counsel, Fannie and Freddie’s credit-risk transfer trades, the new capitalization rates for banks, the new credit enhancement levels in structured transactions, central clearing of derivatives, new rules for mortgage insurers … and on and on … actually function when a downturn comes. It’s been so long since a recession, there was almost a palpable mood of anticipation.
Bottom line: we might be about to see how our global financial system with lots of new safety features will fare in a big storm. No one (and I mean no one) wants to go through this. But we all believe the financial system has gotten itself ready.
Finance needs – and is willing – to embrace diversity. The structured finance industry knows that it has a lot of work to do to make sure our industry reflects the diversity of American demographics. As a way to start, this year’s conference featured a dozen keynote speakers, and they were all women and people of color. Zero white males. And that’s in structured finance! The conference featured, among others, the co-founders of the news service the theSkimm, former British Prime Minister Theresa May, comedian and television host W. Kamau Bell, Arizona Sen. Kyrsten Sinema, strategist and political commentator Ana Navarro, and strategist, author and Fox News contributor Donna Brazile.
In a recent op-ed, I postulated that diversity in the c-suites of Wall Street will be critical to serving all American communities more effectively and avoiding the group-think that leads to financial crises. I repeated this at our conference. The initial reviews were better than even we had anticipated. Now, of course, I want to see us walk the walk.
The SEC wants to discuss credit rating agencies, but the markets are skeptical of major change. Dating all the way back to Dodd-Frank, efforts such as the so-called Franken Amendment would have forced the SEC to select the credit rating agency on all newly issued bond deals. The argument was that having issuers pay for a rating could lead to inflated bond grades. Congress rejected this heavy-handed approach.
Instead, it created a process where agencies could weigh in on bonds rated by a different rating agency, called 17g5 in industry parlance. Thus far, very few such 17g5 “unsolicited ratings” have been issued. The SEC is wants to know if this needs fixing.
What our conference made clear is that while 17g5 hasn’t worked, there are no patently obvious market structure changes we should undertake. The entire market – issuers, investors, and rating agencies – believe that degradation of rating standards would be bad. A few people at the conference think that additional transparency requirements for structured deals might help prevent this.
But there was very little appetite on the behalf of issuers or investors to make wholesale alterations to the entire model. So, we can continue to look at how bonds get rated and what those ratings mean, but there was much more concern about disruption from regulatory action than worry about what the market relies on today.
Finally, ESG is going to be huge. ESG investing – or, investing that is certified as meeting certain criteria in three categories: environmental, social, and governance – has come on the scene in fixed income in a big way. Large asset managers now have ESG-compliant exchange-traded funds.
Rating agencies are building and enhancing their ESG certification processes. Issuers of bonds are seeking the ESG seal of good housekeeping. And, most importantly, millennial and Gen Z investors are flocking to these funds in droves. That of course means the demand is growing. If our conference is any indication, market participants are desperate to keep up.
ESG investing in the United States is driven by investor demand and preferences, not regulations. The market is responding, and that is what makes this particularly exciting. SFA has hosted several ESG symposiums or roundtables, and without fail, there’s one main takeaway: we need a bigger table. SFA is playing a leading role in the convening of market players on this topic. We just can’t seem to find a large enough room.
Everyone is worried about Libor. Libor (the London Inter-bank Offered Rate), the benchmark used to set many other rates around the world, ends in January 2021. The Federal Reserve has created a replacement rate – SOFR (Secured Overnight Financing Rate). But everyone worries the transition will be rocky. Rocky for consumers, banks, investors … everyone. We are working tirelessly to find solutions, but this one is thorny. That really kind of captures it all at this stage. Stay tuned, because it’s going to be a busy year, and there’s a lot at stake.
So … SFVegas2020 is in the books, and there’s your briefing. Plenty to worry about, plenty to be excited about, and certainly plenty of work to do.
Bright serves as CEO of the Structured Finance Association, where he oversees the vision, strategy, convening, and advocacy work of the association and its thousands of members in the securitization industry. Prior to joining the SFA, he was the EVP and chief operating officer of the Government National Mortgage Association, or Ginnie Mae. As COO he managed all operations for Ginnie Mae’s $2.0 trillion portfolio of mortgage-backed securities.