Speaking at the British Bankers Association International Banking Conference in London, Cunliffe said while investment funds are typically much less leveraged than banks, the increasingly offer investors a liquidity promise, that one can redeem the value of one’s investment at very short notice, resulting in liquidity mismatches between the degree of access and the ease with which the underlying investments can be sold without a big impact on price.
“A particular concern occupying both the FPC and authorities internationally is that simultaneous redemptions from open-ended funds offering short-term redemptions could test the resilience of market liquidity, with wider adverse effects through mark-to-market pricing and collateral calls,” Cunliffe said.
This risk has been magnified by the growing size and thus importance of open-ended mutual funds to the broader financial system.
Corporate bond serve as a good example, Cunliffe said, “These funds have more than doubled in size over the last 10 years, from US$2.7 trillion to almost US$7 trillion AUM. This growth has been faster than growth in the global stock of bonds outstanding over a similar period, which grew from roughly US$66 trillion to $100 trillion over 2005 – 2012.
And, he added: “While funds typically have a number of tools available to them to manage liquidity risk, some investors may not fully appreciate that their ability to redeem, at or close to, current market prices could be compromised by large simultaneous withdrawals by other investors.
“In a recent survey, the Bank and Financial Conduct Authority found that, in aggregate funds assumed that, over a one-day horizon, they could liquidate corporate bonds of a value equivalent to 2.9 times average daily US corporate bond trading volume.
As a result of this, he said, to the extent that it can, there will need to be much more work on policy options.
“A more system wide approach to stress testing could be one promising avenue for development. This would be in line with the Financial Stability Board’s advice last month encouraging the appropriate use of stress testing by funds to assess their ability individually and collectively to meet redemptions under difficult market liquidity conditions.
“A second avenue worth exploring is better data on funds, including the development of more comprehensive metrics that capture the degree of any mismatch of the liquidity of underlying assets and the liquidity offering.”
