Covid liquidity, block trades and Fed op risk

The week on, August 1-7, 2020

7 days montage 070820

Preparation paid off for funds during Covid liquidity crunch

Buy-side risk survey: asset managers weathered the liquidity crisis in March

CFTC block trade plan gets cold shoulder

Industry divided over swaps reform proposal, and advisory committee doubts reform is needed

Fed’s approach to stressing op risk frustrates banks

Regulator’s stress-test results overshoot banks’ numbers, threatening capital plans


COMMENTARY: Beyond redemption

Liquidity is the lifeblood of any market. For funds, liquidity risk mostly arises when a manager cannot raise enough cash through asset sales to support its short-term obligations.

Even in relatively normal times, the risk is clear and present. Last year, the £3.5 billion ($4.6 billion) Woodford Equity Income Fund, packed with illiquid assets, was suspended to avoid fire sales after it was flooded with redemption requests. From real estate to money market funds, liquidity mismatches can be exposed after just a few days of sustained outflows as meeting a large number of redemptions could take some investment vehicles to their breaking point.

A recent survey of buy-side firms shows that 75% of respondents run regular liquidity stress tests. No doubt, the practice helped asset managers and hedge funds cope with the Covid crisis in March and the welter of redemptions it caused. Still, a significant minority of firms (13%) found themselves forced out of positions in order to meet margin calls. Time to exit positions was considered the most significant test of liquidity risk.

And, according to the survey, it was within credit portfolios that investors reported the biggest strain compared with other asset classes, with 54% of respondents saying that during March their ability to transact did not meet their expectation of liquidity.

The reasons for illiquidity in some instruments, such as bonds, have been well-known for some time, of course. Regulations introduced after the 2008 financial crisis mean dealer balance sheets are constrained and the Volcker rule generally prohibits banks from taking on proprietary risk.

Asset manager AllianceBernstein tells that in less unusual times a credit fund manager might bankroll redemptions with cash. But in a stressed market, selling other assets in the fund “pro rata” makes more sense. That means a fund can retain the same risk and liquidity profiles, although it requires the manager to make hard choices about the fund’s assets.

To tackle the issue of liquidity risk, other industry participants have sought to put technology to work to better predict fund outflows. Regulators on both sides of the Atlantic, meanwhile, have come up with rules on liquidity stress-testing. 

The requirement to model redemptions, contained in the European version, had been criticised by the funds industry, but in the light of the Covid crisis more funds now appreciate the utility of the new rules, which come into force on September 30.



The price difference between longer-dated interest rate swaps benchmarked to the secured overnight financing rate (SOFR) and the effective federal funds rate (EFFR) has tripled since mid-June. At 30-year maturities, the SOFR-EFFR basis jumped from two basis points on June 15 to a high of 7.8bp on July 21, according to Bloomberg data.



“[The rule] does prompt people to roll their eyes, because it takes a lot of time. They’re aware they are disclosing information that pretty much no-one will look at, bar potentially the broker community, because [brokers] have an incentive to see where they stand in the pecking order” – Adam Jacobs-Dean, from the Alternative Investment Management Association, on Europe’s RTS 28 reports that require regulated investors to disclose annually their five most-used counterparties across cash and derivatives instruments.

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