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Compound Growth

30th March 2016

FCA: Markets Liquidity & Liquidity Management

The last month has seen particular focus by the regulator on Liquidity, with Good Practice guidelines in Liquidity Management having been issued for Investment Firms, the release of an Occasional Paper throwing new light on Liquidity in the UK corporate bond market from a review of trade data and a Speech on “Investment Funds, Markets Liquidity and the Investor” given by David Lawton, the FCA’s Director of Markets Policy and International.

And it seems it is to continue, with David Lawton informing that “2016 will see continued exploration of fund and market liquidity issues” and indeed, since his speech, the UK’s Financial Policy Committee (FPC) issued a press release on 29 March that it will look to publish an assessment of the impact of regulation on Market Liquidity during 2016.

Liquidity in the UK Corporate Bond Market:

The FCA’s Occasional Paper 14, alongside a short article, written by two of the FCA’s Economists, aims to provide further light on Liquidity in the Corporate Bond market, since warnings of falling liquidity have been commonplace in the UK market in recent years.

From the transaction data available to them, the FCA Economist’s were able to analyse the evolution of liquidity in UK corporate bond markets over the period from 2008 to 2014.

The result? A little light at the end of the tunnel and the suggestion of a more positive picture with their belief that despite a decline in “the inventory of dealers... there is no evidence that liquidity outcomes have deteriorated in the market” and “if anything, the market has become more liquid in recent years”.

FCA issues Liquidity Management Guideline for Investment Firms

On the 29th February 2016 the FCA published good practice guidelines for Liquidity Management within the Investment Fund Industry.

Together with the Bank of England the FCA had been tasked by the Financial Policy Committee (FPC) to evaluate the risks caused by open-ended investment funds investing within the Fixed Income sector. The resulting observations from this assessment are now shared as indicators of good practice applicable to Investment Firms.

• FCA’s Guideline to Investment Firms on Liquidity Management

Liquidity Risk Management & Oversight: Good Practices

The FCA found that the following practices contributed to the strong management of liquidity risk within firms.

Liquidity Management Good Practices:

• Processes to ensure that the fund dealing (subscriptions and redemptions) arrangements are appropriate for the investment strategy of the fund.
• A regular assessment of liquidity demands
• An ongoing assessment of the liquidity of portfolio positions.
• The use of liquidity buckets.
• An independent risk function that monitors portfolio bucket exposures regularly and reports breaches to the set limits.
• Stress testing used by fund managers to assess the impact of extreme but plausible scenarios on their funds.

Liquidity Action for Firms:

Given current market conditions, the FCA advises that it is especially timely for firms to “re-assess liquidity management” and take note of the examples of good practice of liquidity management with regard to improving their own. In particular firms should:

• Evaluate and continually re-assess their processes, tools and underlying assumptions to ensure they remain suitable for market conditions.
• Evaluate their operational preparedness to ensure that tools and extraordinary measures can be implemented efficiently and effectively when required.
• Review their disclosures to ensure that both clear and full disclosure is given to fund investors with regards to liquidity risks and the tools available to the fund to manage those risks.

Liquidity in Focus

Read our latest articles, news and views affecting compliance and regulation in the UK Financial Services Industry.