Liquidity, data quality, and benchmarks

The week on, February 12–18, 2016


AUTOCALLABLES tied to sliding Chinese stocks have not produced big dealer losses – so far

DATA QUALITY issues have made swap data collection useless

BENCHMARK rule proposals from EU ambiguous, critics claim


COMMENTARY: Preparing for drought

Few people now doubt the critical role of liquidity in financial stability, both at the institution and the market level. Measures designed to tackle these risks remain controversial, though.

Some asset managers would like to end the promise of daily liquidity that is associated with mutual funds in the US and Ucits funds in Europe – but it's an option that is too sensitive to be seriously debated, according to the chief risk officer at one European buy-side firm: "In the conversations between the industry and the regulator, it's a no-go area, because no-one wants to talk about it: neither the regulator nor the industry, because it's a scary scenario."

Others are keen on the idea of imposing liquidity costs on exiting investors – a regulatory proposal that has won support from key buy-side firms, such as BlackRock, but will require an industry-wide overhaul.

Another intriguing alternative might be to slap a health warning on funds that are more likely to suffer during bouts of illiquidity – or to put it more politely, to introduce a liquidity rating system. Some firms say this would increase transparency for investors, and may even forestall prescriptive regulation; others worry investors might rely too heavily on these assessments and balk at the practical challenges.

Liquidity risk is inherently difficult to model, one of our columnists noted this week, as it depends heavily on market conditions and sentiment: risk managers need to be alert to perceptions of their firms as well as the status of their counterparties. (Another problem is the relatively short time series of liquidity data available – one that some researchers now believe could be addressed by bootstrapping multiple synthetic data series from historical records.)

Recent research, meanwhile, exonerates one regulatory change from causing a liquidity shortfall in post-crisis US bond markets: the crisis itself led banks to shed corporate debt holdings, Canadian researchers Francesco Trebbi and Kairong Xiao argue.

Around 20% of outstanding Korean autocallables linked to the HSCEI will knock in at between 7,500 and 7,000, according to analysis by Societe Generale Corporate & Investment Banking. The key pain point was originally thought to be around 8,000 – a level breached in January – but losses so far have been muted.

"The abnormally high level of bondholdings in 2007 seems the result of a pre-crisis run-up of risk-taking, as shown by a series of breaks towards greater holding amounts between 2002 and 2007. In this light, the dramatic reduction during the crisis appears actually more a 'getting back to normal'... Using the pre-crisis level as a baseline to calculate the change of inventory is somewhat misleading" – Canadian academics Francesco Trebbi and Kairong Xiao


Emerging market benchmarks under threat from EU law
Heightened regulatory scrutiny discourages banks from participating in third-country benchmarks

Firms fail to unlock benefits of key risk indicators
Risk culture and data problems have besieged KRI programmes, say the authors of a new book

Conduct risk: a useful way to carve through chaos?
Conduct risk is a hazy idea, whose success will depend on its effectiveness in managing risk

Putting a price on long-term life insurance business
Allianz's Thomas Wilson re-examines how firms measure the value of capital-intensive products

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