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Bank of England to run rule over asset managers' liquidity strategies

The UK central bank is set to gather information from asset managers over strategies to manage liquidity, as long-term concerns over the “fragile nature” in some fixed income markets turns into action.

The announcement came from the Financial Policy Committee (FPC), the Bank of England’s (BOE) team charged with monitoring the UK economy, taking action to remove systemic risks and protecting the UK financial system.

In a meeting last week, the FPC agreed it would ask the Financial Conduct Authority (FCA) to gather information from UK-based asset managers on how they manage liquidity in investment funds in both normal and stressed conditions. 

The FPC said the exercise would inform a study on which markets relied on investment funds offering redemptions at short notice.

The committee also said it would work with the FCA to better understand how UK financial stability could be affected by a market correction or a reduction in market liquidity, analysing the corporate finance sector specifically.

It will also assess how liquidity may have become more fragile recently, and said it would use evidence from episodes of “heightened” market volatility.

“The Committee remains concerned investment allocations and pricing of some securities may presume asset sales can be performed in an environment of continuous market liquidity, although liquidity in some markets may have become more fragile” the FPC said. 

“Trading volumes in fixed income markets have fallen relative to market size, and this could lead to heightened volatility and undermine financial stability.”

Concerns from the BoE had been raised before the latest move.

In its December meeting, the FPC said the concern that market liquidity could prove illusory would contribute to disruption.

In December, the FPC wrote that heightened volatility had been seen in markets often considered to have deep liquidity.

“Financial markets had recovered relatively quickly, in part because longer-term asset holders had maintained their positions,” it said.

“But tail events could trigger a larger and more prolonged reaction in asset prices and volatility. Some asset managers might be assuming they could sell assets quickly in the event of redemptions. If many asset managers tried to do this simultaneously, this might amplify price falls and market volatility.”

Fixed income, particularly corporate bond markets, have become a source of increasing concern among institutional investors, as the lack of banks and primary dealers has left buyers with few opposite parties in times when liquidity is needed.

This growing concern comes as the high-yield market saw record issuance in 2014, across both the US and euro-zone, driven by the ‘search for yield’ and changes to the legal structure of issuance.

Concerns from the BoE over the risk of asset managers trying to exit a market simultaneously fall into existing work in both the US and Europe over whether asset managers or investment funds carry systemic risk to financial stability.

Work is currently underway to decide whether asset managers are ‘too big to fail’, and whether capital reserves could be a potential solution.

The BoE’s executive director for financial stability, Andrew Haldane, said in a speech last year that distress at an asset manager could increase friction in financial markets and liquidity.

Central bank concerns over market corrections comes as ING Investment Management publishes research showing institutional investors are split over whether to prepare portfolios for a market correction.

Among 226 global institutional investors, ING found 47% were positioning portfolios expecting corrections, with 47% not.

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