Liquidity
The second major worry within the credit markets is liquidity.
One of the unintended consequences of the changes to bank regulation in the wake of the financial crisis was a growing reluctance and, in many cases, an inability on the part of the investment banks to hold large tranches of credit with a view to making a market in them later. As a result the buy-side of the market is now much larger than the sell-side, which makes it more difficult for funds to trade in significant size.
The Financial Conduct Authority is also aware of the challenges this lack of liquidity poses. In a note out on Monday, updating the market on the work it has been doing in conjunction with the Bank of England into the risks posed to markets by fixed income funds, the FCA said: “Current market conditions make it particularly timely to reassess liquidity management.
After engaging with a number of large management fims to get a better understanding of how they manage liquidity, the regulator highlighted three areas of focus for firms:
- Tools, processes and underlying assumptions – these require continuous re-assessment and updating to ensure they remain suitable for market conditions.
- Operational preparedness – a high degree of reassurance that tools, particularly extraordinary measures, can be implemented smoothly when required.
- Disclosure – clear and full disclosure to fund investors on liquidity risks and the tools available to the fund to manage those risks, such as swing pricing, deferred redemption and suspension.
The liquidity constraints imposed on funds by the withdrawal of the sell-side from the credit market, while manageable, do add another layer of worry into the system, especially at periods like the present where volatility is high and where there is a concern about crowding in certain parts of the market. Add to this the impacts of negative rates on the government market and it is unsurprising that investors are cautious.
