Oliver Bodmer, Product Management Director, SIX, writes that for what seems like forever now, sanctions have been treated as a highly specialised concern.
Something for compliance people, legal beagles and watch dogs to concern themselves with while investors got on with the business of allocating capital.
But during these times of daily geopolitical unpredictability, that view is now precariously outdated. The cold hard reality confronting investors, exchanges, custodians and market operators is that sanctions have become a market risk in their own right.
At this year’s ACI Sanctions Conference in Washington, you would be hard pressed to find someone discussing sanctions as a box-ticking exercise. Instead, every man and his dog was talking about market resilience, operational stability and the ability of financial systems to function under growing global pressures.
This fundamentally different way of viewing sanctions is of paramount importance because whenever a company or individual is sanctioned, entire investment portfolios are now affected. Not only do securities can become nigh on impossible to trade, but investment products can also suddenly contain exposures that investors did not realise existed. Consequently, market participants can find themselves trying to manage risks that emerge not from their clients, but from the instruments and structures sitting inside their portfolios. This is the reality of the impact of sanctions in this day and age – they actually have the power to alter market behaviour itself.
Take the securities as a prime case in point, This international market involves a highly complicated relationship better ownership, exposure and interconnected financial products. An ETF, for example, may not be sanctioned. Nor the fund manager who issued it. Yet an underlying holding, indirect exposure or linked instrument may suddenly fall within a sanctions regime. Complicating matters further is the divergence in regulatory approaches. The US, for example, permits the trading of ETFs containing sanctioned Russian securities provided those holdings remain below a 50 per cent threshold, while regulators in the EU, UK and Switzerland take a stricter stance. This creates practical challenges for global markets, particularly given that many ETF issuers are US based. The challenge is that these risks are often hidden until they are not.
Traditional approaches built around knowing your customer of course remain imperative, But they are no longer enough on their own. Markets today require a much deeper understanding of how securities, funds and financial products connect with one another. The risk increasingly lies in the relationships beneath the surface.
That reality creates a new responsibility for market participants. Too often, sanctions are still viewed through the narrow lens of policy documents and compliance manuals. But a policy does not keep a market functioning during periods of geopolitical disruption. Understanding the implications and responding to unexpected policy news breaks with confidence is what’s really important.
Markets ultimately depend on trust, and investors need confidence that risks can be understood and managed. Regulators also need confidence that rules are being applied consistently. As for market operators, well they need to be 100 per cent confident their systems can cope with sudden change.
Achieving all this requires accurate data, transparent processes and most importantly, crystal clear accountability. In addition, it needs firms to test their systems rather than simply document them. And it puts the onus on leadership teams to recognise that sanctions are no longer a peripheral issue delegated to specialists. They are now a core part of risk management.
The good news is that financial institutions are no strangers to transition. Cyber risk, operational resilience and financial crime prevention all moved from esoteric concerns to the top of boardroom meeting agendas. Sanctions are following an all too familiar path. Wherever we like it or not, sanctions have become part of the daily grind of capital markets. The sooner we recognise that reality, the better equipped the industry will be to remain stable, transparent and trusted come the next unforeseen political event.
