COVID-19 versus 2008: worse, different – or better prepared?

More than a decade after the Lehman’s default precipitated the 2008 crash, can systems built then help to mitigate pandemic impact now?

Sionic Partner Christian Lee is a world-leading expert in clearing, risk and financial market infrastructure. In 2008 he was working at the centre of the global financial crisis – leading the default process for the most complex aspects of the Lehman’s default.  His work then and since 2008 changed the regulatory landscape, immunised the market from even more dramatic losses and helped create some of the most important infrastructure in place to mitigate and manage risk today. His latest opinion piece below explores key comparisons and contrasts with the dramatic impact of Coronavirus COVID-19 on markets and economies worldwide.  

As signalled by the dramatic declines in equity indices, it is apparent that the world faces its biggest peacetime slump in modern times. Forecasts predict that the world economy is likely to shrink by at least 4% this year with the US declining by 5% and Germany and Spain by up to 8%, and Italy down by an incredible 11%. Forecasts for the UK are somewhere in the range between the US and Germany.

Much of Sionic’s work over the past decade has focused on the financial reforms following the financial crisis of 2008, and it is interesting to compare the current situation with that event.

On the positive side, many of the reforms put in place after the 2008 crisis appear to be ‘working’.

  • Banks are far better capitalised and, so far, there is no sign of any of the major international banks being in trouble, at least not quite yet. Additionally, with the mandate of clearing for OTC derivatives, the large majority of derivatives trading is now inter-mediated by Central Counterparties (CCPs) thus reducing the systemic risk from a failure of one institution.
  • The CCPs themselves have significantly upgraded their risk management capabilities and have been preparing for just such a crisis we are now facing. It is quite possible that there will be some smaller financial institutions failing and this is when the tried and tested CCP default management processes will be initiated. Even should a major bank be in trouble, such an event should be localised with the avoidance of a knock-on impact to other market participants; this is precisely what the G20 intended when they mandated the clearing of derivatives in 2019.

Nevertheless, there are still some stark issues facing the financial services industry.

  • In 2008 it was the banks that required bailing out and this has a knock-on impact to the “real” economy. This time it is almost the full spectrum of business that is receiving government support. There will, however, be casualties and this will inevitably put stress and strain on the financial system, hence the possibility of a number of default scenarios.
  • The CCPs themselves have a delicate balance to maintain in order to avoid exacerbating a serious situation. Whilst it will be tempting to increase margin levels and haircuts on collateral significantly, this needs to be tempered by the impact that it might have on banks’ liquidity. As was the case in 2008 it was poor liquidity that resulted in banks requiring government support.
  • Additionally, any decision to declare a default needs to be taken very carefully as these events can rapidly result in an escalation of matters.
  • In conclusion, financial services including infrastructure is on the whole “safer”, but these will be challenging times whilst we ride out the current storm.

Learn more about Christian Lee and Sionic Managing Partner Stephen Loosley‘s role in the Lehman Brothers default process here.

Download Sionic Managing Partner Xavier Pujos‘ briefing on Coronavirus: impact on markets and business.

Hear more from Christian Lee speaking about risk and the 2008 crisis in this short video.