Regulators scrutinising bond liquidity risks at asset managers

Regulators are harnessing data on asset managers to analyze the impact mass investor redemptions could have on market liquidity, particularly within the bonds market.

Regulatory capital charges through Basel III have forced a number of banks to reduce their fixed income trading activities, which in turn has led to asset managers increasing their exposure to bonds. The Bank for International Settlements’ (BIS) annual report in June 2015 warned bond holdings were concentrated with a handful of fund managers. BIS estimated the top 20 managers accounted for 40% of all assets. There are fears that a rise in US interest rates could precipitate mass redemptions facilitating bond volatility.

Gareth Murphy, director of markets at the Central Bank of Ireland (CBI), speaking at the Irish Funds Symposium in London, said regulators were collecting data to determine the consequences mass redemptions would have on certain securities markets. “We need to identify which securities would suffer the greatest pressure in the event of a market crisis. Equally, asset managers need to be conducting their own stress tests to measure the potential impact,” he said.

The Bank of England (BOE) recently warned fund managers that bond liquidity could not be taken for granted. Meanwhile, Andrew Bailey, chief executive of the Prudential Regulation Authority (PRA), warned the BOE could introduce rules forcing fund managers to hold larger liquidity buffers to allow more seamless redemptions, or to introduce tougher redemption terms to prevent a rush for the exit by investors and a potential liquidity dry up.

While asset managers have faced scrutiny over their bond exposures, they have been given a reprieve insofar as global regulators have decided against designating them as Systemically Important Financial Institutions (SIFIs). The Financial Stability Board (FSB), under pressure from the US and UK, announced in July 2015 that it would refocus its efforts on liquidity risk at fund managers as opposed to whether individual fund houses were SIFIs.

The Financial Stability Oversight Council (FSOC), the entity monitoring systemic risk in the US capital markets under Dodd-Frank, also confirmed it would focus on products and activities of asset managers rather than their perceived systemic risks. Had fund managers been designated SIFIs, it would have subjected them to bank-style restrictions including capital requirements. This would have been uneconomical for many fund managers.