Retail participation in capital markets soars

Can markets balance the interests of society and economy, or do official institutions need to step in?

Individuals combining the power of social networks with platforms that facilitate access to capital markets presented a new challenge to the financial sector at the start of 2021. These platforms have served to inform, educate and include, but may pose a challenge for those interested in protecting the interests of both the end investor and maintaining stable financial markets.

At a panel hosted by OMFIF and CME Group in March, experts from across the financial sector discussed how technology has opened the markets to new participants and explored the key priorities in balancing the interests of society and economy. The panellists looked at why retail participation has soared during the pandemic, the need for financial literacy and the potential risks this poses to security.

Erik Norland, senior economist, CME Group, observed that the economic drivers behind increased retail participation in financial markets through providers like Robinhood and moomoo are connected to the combination of quantitative easing by central banks and low interest rates. Increased household liquidity is another factor, as consumers have not been spending in the same way over the last year.

Much as e-commerce, food delivery and streaming services have thrived during the pandemic, many people have had more time on their hands to invest. Credit Suisse estimates that retail traders accounted for up to a third of all US stock trading. This has been despite conventional budget strains for many – one in four home renters in the US are behind on their rent.

The panellists viewed greater democratisation of the markets as a positive trend, particularly as recent rallies have shown the robustness of the market structure in managing associated volatility and mispricing. Protections such as clearing to ensure trade fulfilment are important in mitigating mispricing risks, and last-mile access providers like Virtu have provided transparent pricing and liquidity.

Jessica Morrison, CEO and head of execution services APAC, Virtu Financial, recognised this transparency of information as a critical protection. Accurate data underpins sound decision-making, and this has become ever more important, particularly in the context of Asian markets where volatility of 40% to 60% in a single day is not unusual.

Where this volatility exists, liquidity is paramount. Being able to leave the market is just as important as being able to enter it. Derivatives have done much to add liquidity to the markets, and the increase of cleared listed derivatives provides participants with a ready mechanism to manage their risk. The question is whether these tools are fully understood and what drives an investment decision for investors.

This was echoed in a report by the Financial Conduct Authority, who warned that financially vulnerable younger investors have been engaging in high-risk investing offered by gamified investment apps.

Michael Duignan, senior director of enforcement at the Securities and Futures Commission, Hong Kong, pointed out that investors of all ilk source their trade ideas from the networks around them. In some cases, individuals such as John McAfee, Roaring Kitty and Elon Musk have offered trade ideas or recommended products that have then seen higher than average levels of interest. It is difficult to say whether this evidences the wisdom of a crowd or the existence of a greater fool. The panel agreed that financial literacy was of paramount importance for market participants, particularly as more volatile and illiquid products become accessible.

Cryptocurrency is one example of such a product. Ruenvadee Suwanmongkol, secretary-general of the Thai Securities and Commission Exchange, shared the Thai experience of engaging with market participants interested in this emerging asset class. Thailand has seven licensed digital exchanges where more than half a million investors have deposited funds directly with the exchanges to transact. This ensures that they have the funds to lose, and that they are able to leave the market as well.

In consultation with these participants, however, it became clear that there was a resistance to conventional practices such as financial literacy tests and know-your-customer controls. If the peer-to-peer nature of cryptocurrencies means that requirements could be easily sidestepped, how then might regulators support appropriate access to these products? India has proposed banning cryptocurrencies, but this approach may not be tenable in all markets, and access may not always be preventable.

The panel explored the potential for adapting practices in the Asia Pacific region when designing potential security checks, such as reduced settlement cycles to bridge domestic investment to institutional flows. However, peer-to-peer exchange of assets presents an undeniable risk to the effectiveness of capital controls and protections against terrorism financing and money laundering. The challenge that will be faced by exchanges, custodians and banks in the future is likely to be proving the legitimacy of token ownership when onboarding clients.

The markets are still coming to grips with the new forces of retail participation at scale and peer-to-peer unbacked products. Effective market stability mechanisms such as clearing and the development of a robust derivatives market to support liquidity are needed to ensure markets operate efficiently.

Financial education and accurate data that supports transparency and accountability are key priorities for enabling sound investment decision-making by retail and professional investors alike. It is not the role of supervisors to interfere with access to markets, nor to provide a floor on trading losses, no matter how much investors may wish this to be the case. Buyers should beware.

Tamara Singh is Head of Asia Pacific, OMFIF.

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