The following is an evaluation by the Financial Policy Committee of the Bank of England in relation to the liquidity risks of financial markets:
Market liquidity risks
The Committee remains concerned that investment allocations and pricing of some securities may presume that asset sales can be performed in an environment of continuous market liquidity, although liquidity in some markets may have become more fragile. Trading volumes in fixed income markets have fallen relative to market size and recent events in financial markets, including in US Treasury markets in October 2014, appear to suggest that sudden changes in market conditions can occur in response to modest news.
This could lead to heightened volatility and undermine financial stability. The Committee judges that there is a need for market participants to be alert to these risks, price liquidity appropriately and manage liquidity prudently.
The Committee asked the Bank and FCA to work together to:- Encourage and contribute to international work to address data gaps and build a common understanding of vulnerabilities in capital market and asset management activities.
- Deepen understanding of the channels through which UK financial stability could be affected by any market correction and reduction in market liquidity. This will include analysis of the reliance of UK corporate financing and economic activity on market-based sources of finance.
- Gather information from asset managers in the United Kingdom about their strategies for managing the liquidity of their funds in normal and stressed scenarios. This would inform assessment of the extent to which markets are reliant on investment funds offering redemptions at short notice.
- Assess how and why liquidity in relevant markets might have become more fragile drawing on evidence from recent episodes of heightened market volatility.
This information should clarify the extent of any macroprudential risks associated with market liquidity and allow the Committee to assess potential policy mitigants. The Committee asked for a full report at its meeting in September and for an interim report in June.
Source: Bank of England
Financial Policy Committee statement from its policy meeting, 24 March 2015 (pdf)