The ongoing fallout from the Ukraine war and the crypto crash are creating a greater risk to financial stability, the Financial Stability Board of international regulators has warned.
In a letter to G20 finance ministers and central bankers, Klaas Knot, chairman of the FSB, warned of spillover effects due to volatility in commodity markets.
“The volatility in commodity markets following Russia’s invasion of Ukraine has highlighted the risk of financial stress in these markets, through large margin calls, undetected leverage and concentrated exposures,” he wrote.
At a news conference, Knot told reporters that the volatility has highlighted the complex links between commodities and the rest of the financial system, adding that for the most part markets have handled it well.
“Markets weathered the significant volatility in commodity prices in February and March 2022 without any major disruptions, perhaps a small exception for the London Metal Exchange nickel market,” he said.
A combination of the three factors mentioned by Knot contributed to a spike in the price of nickel, which led to a brief squeeze. The LME canceled about $4 billion in trades and the episode is now subject to two lawsuits and a regulatory review by the Financial Conduct Authority and the Bank of England.
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Watchdogs including the European Securities and Markets Authority, the International Organization of Securities Commissions and the International Monetary Fund have also noted that nickel’s debacle was a sign of underlying problems in the asset class .
Knot said the stress in the commodity market is not over, and as volatility continues, it becomes more difficult to predict market conditions. There may be liquidity issues in commodities and beyond.
“It calls for ongoing monitoring and in-depth investigation into the behavior of commodity traders. This is an example of something on the FSB’s work programme,” Knot said.
His letter also warned of the stability risks created by crypto assets, particularly the failures of stablecoins and their position as a key asset.
“The failure of one market player can not only impose huge losses on investors and threaten market confidence. It could also quickly transmit risks to other parts of the cryptoasset ecosystem and spread to important parts of traditional finance, such as the short-term funding markets,” his letter said.
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Regulation of cryptoassets is still nascent. So far, only the EU has outlined what the regulation of digital assets will look like.
The FSB recommends that any regulation should follow a “same activity, same regulation” approach.
Knot told reporters: “It is clear that we must continue our work to address the risks in this ecosystem. An effective regulatory framework must ensure that crypto-asset activities that pose similar risks to traditional financial activities are subject to the same regulatory outcomes in order to create the necessary conditions for safe innovation”.
The Bank for International Settlements and IOSCO also released a report on July 13 arguing that stablecoins should be subject to the same international standards governing payments, clearing and settlement.
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