The State of the Capital Markets in 2022

And the Outlook for 2023

Recently, SIFMA held our year-end State of the Industry Briefing. Jim Reynolds, Chair of SIFMA’s Board of Directors and Chairman and CEO of Loop Capital Markets, and Kenneth E. Bentsen, Jr., president and CEO of SIFMA, discussed key trends in the capital markets as well as an overview of SIFMA’s priorities on behalf of our members in the year ahead.

The following highlights excerpts from their conversation. 

2020-2021: The Golden Years for Capital Markets 

The post-COVID period produced golden years for capital markets.

In equities, initial public offerings exploded: issuance was up +75% from 2020 versus 2019, and then another +80% from 2021 versus 2020. IPOs totaled $85.4 billion in 2020 and $153.6 billion in 2021, +86% and +234% to the three-year pre-COVID average of $46.0 billion.

Corporate bond issuance was $2.3 trillion in 2020 and $2.0 trillion in 2021, +53% and +32% to the three-year pre-COVID average, $1.5 trillion.

2022: What a Difference a Year Makes 

In 2022, we saw a significant reversal, with some capital markets businesses down around 90%.  

For example, IPOs retreated $8.3 billion YTD (through October), versus $130.3 billion for the same time period last year, -94.0%.

Total IPO Deals: Annual

SPACs have all but disappeared at $12.9 billion YTD (through October) versus $140.4 billion for the same time period last year, -91%. 

Total Spac Deals

Similarly, corporate bond issuance has dropped to pre-pandemic levels. 

Corporate Bonds Issuance

Markets are in significant transition away from a 0% interest rate environment, as the Fed continues to raise interest rates. This in turn causes a revaluation of financial assets, and, with the end game uncertain, market participants are asking what the intrinsic value of many assets should be. As such, markets have been on a downward trend on average throughout the year. As of the end of October, the S&P 500 was down 19% from the start of the year. And October closed down another 3% from the prior month.

2023: Where do we go from here? 

The story is really going to be inflation and the Fed.  

Many economists and market participants expect the U.S. to enter a recession next year – a mild one – and the debate continues as to whether or not this is appropriately baked into markets. After peaking at 4.2130, the 10-year Treasury has been hovering below 4% recently. It appears a continued increase to around 5% is baked into markets. Market participants expect the Fed to continue hiking rates, albeit at a slower pace than prior with the consensus that they will slow the level by only raising 50 bps at the December meeting. 

While people can argue whether or not the U.S. is in recession – the technical argument of two quarters of negative GDP growth versus difficulty of calling a recession when the labor market remains strong – one area that perhaps already feels like a recession is in financial assets highly impacted by increasing rates, i.e. stocks.

The Policy Landscape 

In the United States, the U.S. Securities and Exchange Commission (SEC) is pursuing a wide-ranging and ambitious agenda to significantly change existing market rules and practices over a short period of time across a variety of interrelated markets. To date the Commission has proposed 26 major new rules and is on track to meet its projection of issuing more than 50 new rule proposals over the course of next two years. While some of these rules address explicit Congressional mandates, others do not warrant immediate consideration at the expense of other priorities. Although the industry supports several of the proposals or their intent, we believe many are not good policy.

Importantly, we continue to be concerned that the Commission is trying to do too much, too quickly and while not completing other important pending rulemakings. Financial economists, legal scholars, and capital markets participants have identified flaws in many new rule proposals that, if not addressed, could have a range of negative effects on investors, issuers, and market operations. Further, commentors including SIFMA have expressed concern that the potential cumulative and interactive effects of these proposals are not fully understood and have not been subject to sufficient cost-benefit analysis.

Rather than proposing dozens of new rules in short time frame without clear explanation of the market failure needed to be addressed, the SEC should focus its resources on the most time-sensitive priorities such as T+1 and data privacy rules for the Consolidated Audit Trail, and conduct more robust economic analysis that accounts for cumulative and overlapping effects. These steps are essential for the SEC to accomplish its important mission.

Fixed Income Market Structure

Fixed income markets are an integral component to economic growth, providing efficient, long- term and cost-effective funding. How market liquidity can be maintained, including for corporate bonds, municipal bonds, mortgage-backed securities, and Treasury securities, is the subject of significant study and debate.

Key issues currently facing the fixed income markets include the application of Rule 15c2-11 to the fixed income markets (relief was recently extended into 2025), investing in infrastructure through municipal finance, and amendments to Regulation ATS as they relate to government securities.

The U.S. Treasury market is a bedrock of the global financial system. U.S. Treasuries are debt instruments issued by the U.S. government to finance its activities. Owing to the United States’ creditworthiness and status as the world’s leading economy, the U.S. Treasury market has been described as the “biggest, deepest and most essential bond market on the planet.” U.S. Treasuries also often serve as benchmarks for other fixed-income securities and hedging positions; as a result, U.S. Treasury yields have an impact on the rates that consumers, businesses, and governments across the globe pay to borrow money. In addition, the U.S. Treasury repurchase agreement or “repo” market is a key transmission mechanism for U.S. monetary policy, and vital to the liquidity of the cash Treasury market.

Recent suggestions to enhance the resiliency of the Treasury market include:

  1. Greater use of centralized clearing and “all-to-all” trading platforms;
  2. Uniform regulation and oversight of market participants;
  3. Expanded access to the Federal Reserve’s recently created standing repurchase (“repo” facility (“SRF”);
  4. Changes to banking regulation (such as reform of the SLR requirement); and
  5. Improved data and disclosure by market participants.

Some of the reforms appear able to add more straightforwardly to market making capacity; for example, modifications to the Supplemental Leverage Ratio (SLR) and GSIB surcharge could be relatively straightforward and result in more capacity at significant market participants. On the other hand, mandating broad central clearing in the cash market, while delivering some benefits, could raise costs and limit participation by some.

“Based upon research commissioned by SIFMA, in terms of data transparency, the work we have done underscores the need for the regulators to be judicious in their approach to data disclosure in order to avoid upending what is really the fundamental primary market in how the government funds itself.”

Kenneth E. Bentsen, Jr.

The goals of any reforms in the Treasury market should be to enhance the liquidity and resiliency in the market and to increase the market-making capacity of market participants in order to meet the growing demand for, and supply of, Treasury securities. These twin goals must be top-of-mind as policymakers and market participants assess the costs and benefits of any reforms. 

 

 

Equity Market Structure Reform 

“We are concerned with some of the ideas that are being discussed which could we think could have sever negative consequences for investors who are really enjoying the best ease of access, the lowest cost of trading, the best execution that they’ve ever had, particularly retail investors… We really believe the SEC needs to be extremely careful in its approach here to not put forth a solution in search of a problem that really could have negative consequences for retail investors in particular.” 

Kenneth E. Bentsen, Jr. 

The evolution of equity market structure – including capital formation, market data and self-regulatory organization (SRO) structure – is a key priority for issuers and investors alike. As the SEC considers significant changes to equity and options market structure, we ask: why overhaul a successful system and risk unintended consequences instead of improving upon it?

Efficient and resilient market structure is key to sustaining investor confidence and participation in the equity markets. It is imperative that we enhance market efficiency, liquidity and competitiveness to maintain our standing on the global financial stage.

 

Market Innovation & Digital Assets 

“Regulators have an urgent role to play here…  In particular, the need to impose investor protection rules similar to that our members operate under in the securities world and to build off the existing regulatory framework that applies to securities, commodities and bank products.”  

Kenneth E. Bentsen, Jr.

U.S. capital markets have continued to innovate as technology has allowed for profound evolutions in market infrastructure, changing at times the very nature of American financial markets.

Financial services firms are embracing the cloud and Distributed Ledger Technology (DLT) to transform the capital market ecosystem and infrastructure. In wealth management, new capabilities are anticipating customer expectations and better serving clients as they demand a more personal, immediate experience while the financial industry remains committed to ensuring protecting the data of the clients we serve at every turn. And, as the industry moves toward further shortening the settlement cycle, e-delivery will only become more necessary, and we are engaging with the SEC to make it easier for market participants to make this transition. Perhaps the most discussed area of development, however, is digital assets.

We are at a pivotal point in the development of digital assets markets and products, including blockchain-based securities, stablecoins and cryptoassets. There is an urgent need for policymakers to provide regulatory clarity to the digital asset markets. The existing regulatory frameworks which govern regulated financial institutions such as broker-dealers, banks and asset managers are focused on ensuring investor protection, safety and soundness, and risk management, and extending them, with modifications where appropriate, to digital asset markets will help protect investors.

SIFMA has called on policymakers and regulators pursue key guiding principles as they make policy in this area. These include putting investor protections at the forefront of any policy action; adopting a “technology neutral” approach that follows the “same risk, same activity, same regulatory outcome” principle; distinguishing between different types of digital assets, and between digital assets and the use of blockchain technology to facilitate “traditional” asset transactions; and applying, with appropriate modifications, existing and well understood regulatory frameworks to digital assets. As described, existing securities regulation, such as the SEC’s Customer Protection Rule, offers a robust framework for investor protection which can be applied to digital asset markets.

 

Prudential Regulation of Capital Markets 

“These [Basel III rules] are really the final leg of the post-financial crisis capital and liquidity rules applying to banking institutions… These rules can have a very severe, a very profound impact on the trading books or capital markets activities of bank-affiliated broker-dealers… [Regulators] should be careful to not be overly punitive with respect to trading book activities of bank-affiliated broker-dealers.”

Kenneth E. Bentsen, Jr.

Prudential regulation requires financial firms to control risks, hold adequate capital and liquidity, and have in place workable recovery and resolution plans.

It is essential that our prudential regulatory regime accounts for the vital role the capital markets play in providing credit and financing the real economy, particularly as regulators consider the implementation of elements of the Basel III capital proposal, including the Fundamental Review of the Trading Book (FRTB) and Credit Valuation Adjustment (CVA). Those rules should be implemented in a manner that does not penalize banks’ capital markets activities, which in turn could reduce liquidity in vital corporate and other funding markets, thereby hurting growth in the real economy.

U.S. prudential rules generally impose significantly higher capital and liquidity costs on banking entities with significant capital markets operations. This has increased costs to financial firms and the economy as a whole and reduced market depth for a wide variety of corporations and other end-users, particularly during periods of economic stress. This has also had another effect: transforming U.S. banking regulators into a supervisor of the capital markets at times superseding the oversight role traditionally played by the SEC and CFTC. This has created distortions in the capital and liquidity requirements between market and prudential regulators as well as lessened the efficiencies by increasing costs to end users. It is thus crucial to align and allow for mutual recognition, to the extent possible, the capital and liquidity standards set out by the U.S. banking regulators and the market regulators.

 

Shortened Settlement Cycle 

“We are setting a target date, which we think is the appropriate target date of transition, of Labor Day 2024. We think that gives ample time for the industry to conduct testing… We’re eager for the SEC to act and give clarity.” 

Kenneth E. Bentsen, Jr.

Enhancing our securities settlement process is critical to the continued resiliency of our markets and market operations.

In the U.S., the standard settlement cycle for equities and other products is T+2 (two business days after the trade). Following the industry’s successful work to transition from T+3 to T+2 in 2017, SIFMA, the Investment Company Institute (ICI), and The Depository Trust & Clearing Corporation (DTCC) are now collaborating to accelerate the U.S. securities settlement cycle from T+2 to T+1, which should be completed in the third quarter of 2024, pending regulatory support.

Why this massive undertaking? T+1 settlement cycle will mitigate settlement risk well beyond what was achieved under T+2. In addition, a move to T+1 will increase settlement efficiencies and improve the use of capital, especially in periods of high volatility.

Taking 24 hours out of the settlement cycle will require a myriad of significant changes. The list of impacted areas is long: global settlements, documentation, corporate actions, securities issuance, and coordination for mutual fund portfolio securities and investor shares. Some areas—allocations, affirmation and disaffirmation processes, clearinghouse process timelines, and securities lending—will require fundamental changes. Other areas that will require significant change include prime brokerage, delivery of investor documentation, foreign currency exchange (FX), global movement of securities and currency, batch cycle timing, and exchange-traded fund (ETF) creation and redemption. It will also be imperative to analyze current settlements to identify the reasons behind settlement errors and fails and ensure that the error and fail rates do not increase under a newly compressed timeline.

To assist market participants in the move to T+1, SIFMA, the Investment Company Institute (ICI), and The Depository Trust & Clearing Corporation (DTCC), together with Deloitte LLP (Deloitte), have published The T+1 Securities Settlement Industry Implementation Playbook. This guide outlines a detailed approach to identifying the implementation activities, timelines, dependencies, and risk impacts that market participants should consider as they prepare for the transition to T+1 settlement.

 

 

e-Delivery 

“It will be physically impossible to meet the requirements of getting confirms to clients in a T+1 environment by physical delivery. We’re going to need some form of this we believe as part of the transition to T+1 and we think we should go further.”

Kenneth E. Bentsen, Jr.

An issue very much related to shortening the settlement cycle is e-delivery. In September 2020, SIFMA and SIFMA AMG along with several other financial services trades outlined how and why the SEC should amend relevant investor communications rules to permit firms to shift the default delivery method from postal delivery to e-delivery. A recent survey commissioned by SIFMA and conducted by YouGov shows that a large majority of retail investors, regardless of income or age, want e-delivery for its environmental benefits, speed, and convenience.

The SEC will need to modernize its rules to make e-delivery the default mechanism for transmitting investor communications and disclosures in a T+1 environment. The logical and natural next step is for the SEC to review its rules on the delivery of investor communications and foster an e-delivery framework suitable for the 21st century.

 

Retirement & Savings 

Helping Americans grow savings for a secure retirement is among the most important roles of the U.S. capital markets. Individuals of all income levels can start investing, invest for the long term, and have access to work with a professional financial advisor who serves as a critical link in helping investors meet their goals.

Changing demographics, including increasing longevity, underscore the need for a robust private retirement system. Policymakers must continue to address the challenge of encouraging and facilitating saving and investing for retirement across our society.

Today, U.S. workers are increasingly relying on individually funded retirement plans, such as 401k’s and IRA’s. Defined contribution plans account for $7.4 trillion in assets, growing at a 7% compound annual growth rate over the last decade. Both through their employers and individually, Americans today are largely responsible for building their retirement accounts themselves. Over 56% of total retirement assets are individually funded through defined contribution retirement plans and IRAs. Because individual savers play a greater role in the decision-making regarding their investments, access to a financial advisor is even more important today to help individuals prepare for their future.

SIFMA is committed to increasing retirement security for all Americans and has identified three primary pillars to reach this goal:

  1. Expanding access to plans,
  2. Increasing participation and decreasing leakage,
  3. Enhancing education.

SIFMA supports legislation including the Securing a Strong Retirement Act of 2021 (SECURE Act 2.0) and the Retirement Security and Savings Act of 2021, comparable bills which represent important steps toward enhancing the private retirement system and increasing retirement savings. Both include provisions to incentivize small businesses to offer retirement plans, thereby expanding small business savings; enable older Americans to save more and hold on to their savings longer; and allow matching contributions for student loan payments.

With efforts such as these, we can boost participation in retirement savings, enable Americans to save more, promote financial literacy and support a strong retail investor culture.  

 

Fostering Diversity, Equity & Inclusion  

“There’s never been a time where global investment banks, corporate funds, private hedge funds, and regulators are as serious about diversity as they are right now… The access and real desire of firms to have diverse candidates is absolutely there and is absolutely a commitment.”  

Jim Reynolds  

Diversity, equity and inclusion is an issue of utmost importance for the financial services industry and society at large. Our industry leaders, together with regulators and corporate stakeholders, play a pivotal role in shaping organizational culture to achieve a more inclusive and effective workforce that reflects those we serve.

SIFMA advocates for a diverse, equitable and inclusive financial industry. Together with our members, we strive to provide firms across the financial services industry with the resources needed to achieve, expand and promote workforce, client, and supplier diversity and inclusion. Through a six-pillar approach, SIFMA’s Diversity & Inclusion Advisory Council assists member firms in developing their diversity initiatives to increase inclusion in the workplace and in their efforts to market to diverse customers.

For more than 20 years, the Council has conducted a benchmark survey and encourages more of our member firms to participate. While clearly an ongoing commitment for the industry, having conversations and working towards a more diverse, equitable, and inclusive future is imperative.

SIFMA’s benchmark survey provides participants with critical insights for firms to take action. On the whole, our 2022 survey found significant progress made in hiring women and people of color and efforts to build inclusive cultures, such as executive sponsorship and employee resource groups. The levers the industry needs to address now? Promoting female employees to executive ranks and retention of ethnically diverse talent.

By building a diverse talent pipeline, we can foster diversity, equity and inclusion in the financial services industry. The SIFMA Invest! program and virtual platform offers students enrolled at Historically Black Colleges and Universities (HBCUs) and Minority Serving Institutions (MSIs) a myriad of educational, industry research and career development opportunities to pursue a career in financial services. At a glance, SIFMA Invest! provides:

  • A job board of internship and entry-level opportunities provided by SIFMA’s member firms;
  • A resume bank searchable by recruiters from SIFMA’s member firms;
  • Educational resources about the capital markets and careers in financial services; and
  • Opportunities for students to study for and take the FINRA Securities Industry Essentials (SIE) exam.

 

Outlook 2023

 

For more on our insights into the markets, the industry’s viewpoints on critical policy issues and several helpful resources, download SIFMA’s 2023 Outlook.

Jim Reynolds is Chair of the 2022-2023 SIFMA Board of Directors and Chairman & Chief Executive Officer, Loop Capital Markets LLC 

Kenneth E. Bentsen, Jr. is President and CEO of SIFMA.