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Financial Markets during COVID-19
By​ Riya Mathur and Anushka Bansal, 5/12/2020

The Italian Conundrum

As the spread of the Coronavirus disease takes on pandemic proportions, there are grave concerns in Italy regarding the Italian national health system’s capacity to effectively respond to the needs of patients who are infected and require intensive care. The Italian government has moved determinedly with containment measures. In March, a nation-wide lockdown was announced in Italy, which spanned four weeks. Non-essential productive activities, educational institutions, public gatherings, travel, were all restricted during this time.

According to the Italian research institute, Ref  Ricerche, Italy’s economy could contract by as much as 3% in the first half of 2020 following the outbreak of COVID-19. The yield spread between Italian and German government bonds has “widened considerably, raising fears of another crisis for Italian banks, as many of them hold substantial amounts of government bonds.” In the face of this crisis, the collateral managers are grappling with the current credit environment. Moreover, “even when the COVID-19 crisis starts to abate, demand could take a while to pick up, while it will also be difficult to encourage concerned investors to buy Italian bonds.”

In the face of real and financial stress, governments maintain critical roles. While cutting interest rates is a possible response for central banks, the shock is not only a demand management problem but a multifaceted crisis that will require monetary, fiscal and health policy responses. On March 17, the Italian government adopted a €25 billion (1.4 percent of GDP) “Cura Italia” emergency package. This package includes funds to enhance civil protection, strengthen the Italian health care system, support the income of laid-off workers, and other measures to support businesses.

Initially, as the credit conditions had just begun to deteriorate, investors in European CLOs who were looking to sell CLO liabilities found it difficult to find buyers with a number of bids-wanted-in-competition (BWICs) failing to result in sales. (DLA PIPER) This was a result of social distancing efforts as more and more traders chose to work from home. In the current economic climate, the collateral managers are facing a number of challenges such as “deteriorating credit conditions, questionable liquidity, potential workouts, and restructurings.”

The spread of COVID-19 has had a significant impact on the global financial markets. The economic repercussions of the pandemic are expected to be felt for many more months, and maybe even years. No individual country is immune to the economic and political challenges caused by the pandemic, and there are intelligible concerns about the health of the global economy. In these times of crisis, relief plans, such as the one introduced in the United States, have started to lift financial markets around the world, but investors remain cautious and look set to wait for the outbreak to be controlled before once again investing in stocks.
The Indian Financial Situation

As India grapples with the Coronavirus pandemic, the nation’s financial markets continue to show great volatility amid concerns of prolonged disrupted activity. The VIX, India’s Volatility Index has seen its most drastic swings ever since the financial crisis of 2008. As the index measures investor perception of the financial market for the next thirty days, a persistently high VIX is a cause of serious worry, with the stocks of major companies taking massive hits. 

The Sensex saw its fastest and largest crashes during the spread of the Coronavirus pandemic, coupled with an overwhelming outflow of foreign investment of over Rs. 25 crore. Valuations of major stocks including blue chip behemoths and government organisations fell, with some plunging more than 50%. Moreover, as is customary during a crisis, interest rates and bond yields in the country have been falling ever since. Federation of Indian Chambers of Commerce and Industry (FCCI) recently reported a disruption in the operations of as many as 53% of Indian companies, with almost 80% of India Inc. witnessing a steep decline in its cash flows. With interrupted activity, there is now immense pressure on the Indian banking sector to maintain adequate flow of funds while struggling with a liquidity crunch itself. Even as India stands at a risk of higher inflation by making plenty of cash available, experts believe the issue should not be top priority for a country with such a prominent unorganised sector. Small traders and businessmen run the risk of bankruptcy and being wiped out altogether.
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The Economic Times
As an integral instrument of most financial markets, even CLOs are expected to be impacted. Collateral Loan Obligations or CLOs are a type of structured debt. When talking about CLOs, the major difference between these and other bank securitisations is the formation of a ‘pool’ of loans or other financial assets held by that particular bank. The objective for taking out a CLO, apart from the usual agenda of liquidity, also goes on to include reducing risk, balance sheet adjustments, enhanced asset management and capital benefits. This is so because grouping together a variety of loans works to build a more diversified portfolio. Furthermore, what separated CLOs from corporate bonds is the fact almost all of them work on floating interest rates, which translates to comparatively higher yields if interest rates go up.

CLOs have been hailed for their great performances in the past and have thus become a popular tool for most banks nowadays. However on the flip side, CLOs have also been associated with high leverage risk and skewed estimates which tend to undermine the true risk factor for large banks, making regulation extremely difficult. Given the chances of a financial meltdown following the Coronavirus, growing dependence on CLOs in the Indian financial sector too faces great risk today. The possibility of an economic collapse has led prices of loans which are generally included in CLOs to plunge. With increased volatility, there is greater chance of assets becoming riskier, i.e. borrowers defaulting with greater probability and companies seeing their earnings shrink. Market watchers predict a return of around 60 cent for every dollar invested, as Bloomberg reported recently.
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However, efficient asset management might not affect CLO returns greatly due to the inherent hedging functions of a diversified portfolio. Nonetheless, given the scale of the adverse impacts of the virus on the economy, the effect of a slowdown would depend on the operational flexibility of companies and how robust their financial investments are.
International Youth Politics Forum, Est. 2019

All arguments made and viewpoints expressed within this website and/or its nominal entities do not necessarily reflect the views of the writers or the Forum as a whole.

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