BIS: New Rules, Supervision Needed for Bond Funds, DeFi Growth

Stricter rules and more oversight are needed to curb the risk of bond funds throwing market stability and the runaway growth of decentralized finance (DeFi), the Bank for International Settlements (BIS) said in its December Quarterly Review.

The financial watchdog that serves central banks worldwide said that March 2020 showed that intervention was necessary after bond funds were forced to sell assets “on an elevated scale” at the time. The sudden rush to exit added fuel to the coronavirus fire across mixed-income markets that could only be doused by central bank interventions, per the report.

“The turmoil raised questions about whether bond funds’ own lines of defense can prevent the potential amplification of risks during periods of stress,” the BIS said in the report.

The position of the BIS complements proposals by the IMF, Financial Stability Board and the International Organization of Securities Commissions, according to reports.

See also: BIS Official Urges Central Banks to Adopt Digital Currency

Investors can generally withdraw money from bond funds with little advance notice, but the BIS said that could change, with a longer time period for withdrawals to safeguard anyone trying to sell illiquid assets in a market spiraling downward.

Analysis by the BIS shows that bond fund managers overvalued their portfolios and how much they could raise in one day. One suggestion is to transfer bonds in-kind instead of cash to clients making withdrawals from fixed income funds.

Read more: BIS GM Raises Caution on Big Tech’s Move Into Finance

Another concern the BIS targeted was the fast and unsupervised growth of DeFi, which could be a threat to financial stability, according to the report, due to the lack of a central authority and its reliance on algorithms over humans to handle transactions.

“If DeFi were to become widespread, its vulnerabilities might undermine financial stability,” the report indicated. “There is a ‘decentralization illusion’ in DeFi since the need for governance makes some level of centralization inevitable and structural aspects of the system lead to a concentration of power.”