Predictable volatility

Speaker: Nikhil Rathi, Chief Executive
Event: FCA International Capital Markets Conference 2024, London
Delivered: 8 October 2024
Note: This is a drafted speech and may differ from the delivered version

Highlights

• We are living in an era of predictable volatility but we must now expect to face this predictable volatility – as a constant.
• The UK has a chance to lead how capital markets can drive economic growth and development.
• We need to nurture liquidity, shift regulation and a new mindset towards risk.
• No single entity has all the answers and it will take action from us all.

I spent much of my youth playing tennis. Quite seriously, in fact. Not on the gentle, breezeless lawns of Wimbledon or Queen’s. But on the rugged courts of Barrow-in-Furness, in Cumbria. The wind was exhausting, the rain bone-shatteringly cold. Some courts were too hard, some too soft. They made you slip - or stick. And every rival, waiting across the net, was different.

The American novelist, David Foster Wallace, said playing tennis is 'like playing chess on the run.' He was right.

Victory isn’t decided by your speed, power, or reflexes alone. It’s as much about the mind. You think ahead – and make split-second decisions. You learn from the opponent – you adapt. You never stay still. Because if you do…you lose.

Every match needed a different strategy. But one thing was always predictable: the unpredictability of the game itself. The same is true of the financial world.

During my career I’ve seen just how volatile markets can be. I worked in government through terror attacks, wars, and oil spikes. I led the Treasury’s Financial Stability Unit during the 2008 crash. I was at the London Stock Exchange during Brexit, and the pandemic. And over time, I’ve seen the frequency of incidents go up. Between 1994 and 2007, the most-watched volatility index – the VIX – recorded 9 major market shocks[1]. During the crash, it topped 80. And in the pandemic, it reached 82[2].

Since joining the FCA, I’ve seen the nickel episode, the LDI crisis, the failures of Credit Suisse and Silicon Valley Bank…and an explosion of conflict in the Middle East. Long term challenges are accelerating too. Climate change, demographic shifts. And volatility isn’t in just a single asset class.

Today a small blip can ripple across equities, fixed income, FX, commodities…or more recently, crypto. All more and more connected. And things that used to be one-in-10-year events now happen every month. In short: the weather is worse. The grounds keep changing. And the opponents are tougher. 

Why?

But why are we seeing this sharp rise in volatility and resulting risk? 

Beyond familiar geopolitical concerns, I want to mention a few reasons. The first is technology. As early as 2009, algorithms accounted for up to 60% of trading in major US exchanges[3]. What used to take 10 to 50 traders, now happens on one computer. And a single glitch can run haywire through global infrastructure.

Look at CrowdStrike – how could anyone have imagined that one bit of patching of cyber software could bring down US airlines, GP surgeries in Britain, and payment systems across Europe…all brought to a halt by a technical bug?

Then there’s market concentration. Just 10 firms represent nearly 50% of the FTSE 100’s value[4]. In the US, 7 companies generated over half of the S&P 500’s 26.3% return last year (source: ibid). And the value of Nvidia alone can move as much as half of Ireland’s GDP in a single day.

It’s not just the number, but the type of players we’re looking at. 

Investment management is increasingly centralised in the largest firms. The biggest principal traders now hold sway alongside banks in sovereign debt markets. A few providers control most of the world’s data. And they increasingly partner, including through equity stakes, with a handful of Big Tech names…that dominate the cloud, and now AI services too.

This heavier reliance on fewer firms means disruption – from earnings, regulation, or geopolitics – can trip the global market.

Tougher liquidity conditions add to this fragility. Today’s more fragmented system - exchanges, private markets, ETFs, derivatives - works in normal times, but becomes harder to trade when volatility strikes. Take the Archegos crisis, 3 years ago. Hidden leverage in a fragmented system led to $10 billion in losses.

And the increased interconnectedness of financial systems means events in one country can have profound effects elsewhere – and fast. 

Think back 2 months, to 5 August – it happened to be my birthday and I was heading off with my family for our summer holidays. A disappointing set of US payroll numbers came out. Recession fears hit the market, with speculation of emergency rate cuts. Japan’s Nikkei 225 index fell 12% – its largest single day fall since Black Monday in 1987. It seemed like an unwinding in foreign exchange and interest rate markets of the yen carry trade. And the VIX index rose over 60, becoming dislocated from underlying volatility. Fortunately, my holiday was saved – by a well-timed statement from the Bank of Japan…and investors seeing value in the market.

Prices recovered. Infrastructure held up. We were able to enjoy our trip.

But did we get lucky?

Volatility per se is not the issue and should not be conflated with systemic risk. But excessive moves, especially intraday, due to runaway volatility that dislocate prices from fundamentals are the central concern. We’re still piecing together exactly what happened to understand if there are new systemic risks needing deeper examination. And even outside exceptional events – passive investment strategies, including through index funds, fuel this interconnectedness…while herding behaviour creates sharper price swings. 

Optimism and ambition

All these factors compound one another. As regulators and market participants, we must now expect to face this predictable volatility – as a constant. But I am an optimist.

Our careers have been defined by some of the biggest crises the financial world has ever seen. But we’ve also seen how people have solved those crises. Or even prevented them. It’s what I love about this job, and the financial system. How it self-corrects. How it innovates. 

And capital markets have a crucial role to play. They drive economic growth and development. Especially here – with the UK so often setting the benchmark.  Our deep capital and liquidity pools, built over centuries…support raising finance, hedging risk, trading debt, currency, interest rate markets, commodities, insurance and reinsurance. Binding finance and technology. And now, in this era of ‘predictable volatility’... the UK once again has the chance to lead.

But it will take action – from us as regulators, and from all of you, as market participants.

So let me suggest a few things. 

Solutions

First, we have to nurture liquidity. Liquidity keeps us agile. Too often, rules designed for large, global banks – with heavier capital burdens – limit smaller firms’ ability to contribute liquidity. The old approach - ‘same business = same risk = same treatment’ – no longer fits today’s financial landscape.

At the FCA we’re exploring how adjustments could encourage wholesale trading and improve market liquidity…and may in turn reduce barriers to entry for specialised trading firms that don’t hold retail deposits. 

Just look at the way non-bank traders are now capturing flows across US equities. A massive shift, in the space of just a few years. 

We know custom rules can work – as in our Investment Firm Prudential Regime. And can free up capital, and new entrants. Tailored regulation for these specialised firms sparks growth and competitiveness, while protecting market integrity. 

Second, we need a shift from reactive, to proactive regulation...and a system guided by good outcomes, not just rules for the sake of it. The goal of regulation shouldn’t just be to step in when things go wrong, or respond to a crisis. We want to deliberately create an environment that helps firms compete, and grow.

So the FCA tracks a wide range of metrics – authorisations, operational efficiency, and the regulatory burden on firms. And our central role in the transition from LIBOR to risk-free rates, like SONIA and SOFR, is a testament to what proactivity and collaboration can achieve. The end of Libor at the start of this month closed the final chapter in one of the biggest transitions in financial history. $400 trillion dollars of LIBOR-linked risk was eliminated. And almost every financial institution was involved – in a multi-year, global effort. More than 16,000 legal entities, from 99 countries. That’s a level of international cooperation rarely seen.

Third, we need a new mindset towards risk. UK markets stay relevant because we are always open to reform. And I am proud that the FCA has so often been at the heart of progress.

We export perhaps more regulatory data than any other securities regulator. And the UK is like a microcosm for the entire system – all global events are felt in our markets.   

Right now, we are challenging longstanding principles to seize the opportunities in this age of predictable volatility.

Be that with far-reaching reforms of listing rules, incentivising pension funds to take greater risk, or radical proposals for prospectuses – so companies can raise 75% of existing share capital without one, and adjusting liability so investors get the forward-looking information they want.

The fourth thing we can do, is to invest in infrastructure – and get better at piloting and adopting tech. Cybersecurity is critical. This year, 50% of UK businesses experienced cyberattacks, up from 39% in 2022[5].

And innovation isn’t just about protection – it’s central to growth, and leaps in productivity. The move to T+1 is a great example. It’s already been adopted by the US, Canada, India and others. We’re looking at the timetable here, to introduce a consolidated tape for fixed income markets. And these processes don’t just offer security – they create new market opportunities, particularly in volatile periods. 

Faster settlements. More transparent markets. Freer capital.

Tokenisation can further enhance liquidity, and open up new forms of investment. 

And on AI – rather than rushing to new rules, we are looking to rely on our existing frameworks, embracing progress, without compromising on security or fairness.

Finally, we need deep market engagement.

No single entity has all the answers. And we want to hear from all corners of the market, big and small, public and private, and all of you, in this room, to understand the root causes of shocks, and how we can manage them.

Later we’ll hear from the Chancellor, Rachel Reeves.

And today’s agenda brings together financial giants, savvy disruptors, and experts shaping the future of our markets.

It’s precisely this diversity that makes today’s conversations so valuable. And I would like to thank every participant.

Conclusion 

These days I’m a long way from the tennis courts of Barrow-in-Furness. But that feeling – that unpredictability – feels just as relevant in this job.

Martina Navratilova said, ‘it’s not how you play when you’re playing well that matters’. 

She had in mind how you play in all weathers. This is the mindset we need in today’s predictably volatile landscape.

We can’t control the weather, but we can prepare for it.

And together, excel at playing chess on the run.