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Presented by:
Moderator:DeLisa White, GARP
Presenter(s):Gudni Adalsteinsson, Head of Global Liquidity, Legal & GeneralAttilio Meucci, Chief Risk Officer, KKRStefano Pasquali, Global Head of Liquidity Research, Regulatory & Accounting Products, Bloomberg
October 14, 2015
GARP Webcast
Liquidity Assessment In An Uncertain Market
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Gudni Adalsteinsson is the Head of Global Liquidity at Legal & General, responsible for the overall liquidity and cash management. His experience ranges from running the group treasury for a European bank during the credit crunch, working for the Financial Services Authority, to providing liquidity advice to UK banks. Adalsteinsson was a group treasurer for an Icelandic bank during the unprecedented liquidity shocks of 2008, which offered him first-hand experience of liquidity risk management under severe crisis. Between the years of 1998 and 2005, he was an executive director atLehman Brothers and Credit Suisse in London and Frankfurt, advising German banks on their liquidity and structured credit investments. He has been a board member of banks in the UK and Denmark.
Adalsteinsson holds an MBA degree from the University of Cambridge and a bachelor’s degree in economics from the University of Iceland. He is the author of the book, “The Liquidity Risk Management Guide – from Policy to Pitfalls” (Wiley, 2014)
Gudni Adalsteinsson, Legal & General Group Plc
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Attilio Meucci, Chief Risk Officer, KKR
Attilio Meucci is the chief risk officer at KKR. Mr. Meucci is also the founder of SYMMYS, under whose umbrella he designed and teaches the six-day “Advanced Risk and Portfolio Management (ARPM) Bootcamp”, and manages the charity One More Reason. Prior to joining KKR, Mr. Meucci was the chief risk officer and director of portfolio construction at Kepos Capital. Mr. Meucci was also the global head of research for Bloomberg’s risk and portfolio analytics platform; a researcher at Lehman POINT; a trader at the hedge fund Relative Value International; and a consultant at Bain & Co.
Concurrently, he taught at Columbia-IEOR, NYU-Courant, Baruch College-CUNY, and Bocconi University.
Mr Meucci is the author of “Risk and Asset Allocation” - Springer and numerous publications in practitioners and academic journals. Mr. Meucci earned a BA summa cum laude in Physics from the University of Milan, an MA in Economics from Bocconi University, a PhD in Mathematics from the University of Milan and is a CFA charterholder.
Attilio Meucci, KKR
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Stefano Pasquali, Global Head of Liquidity Research, Regulatory & Accounting Products, Bloomberg
Stefano Pasquali oversees product development and research for Bloomberg's liquidity and systemic risk solution. His team designs and implements models that use Bloomberg's comprehensive market data library and machine-learning techniques to estimate liquidity and risk across different asset classes with particular focus in OTC markets.
Stefano joined Bloomberg in 2009 as a quantitative analyst/specialist supporting Bloomberg’s evaluated pricing service, BVAL. In 2010 Stefano began leading liquidity research for Bloomberg's Pricing Services, focusing on fixed income market liquidity and calibrating financial models for measuring risk and market impact.
Prior to joining Bloomberg, Stefano held senior positions at several European banks and asset management firms where he oversaw risk management, portfolio risk analysis, model development and risk management committees. Stefano built a risk management process for a global asset management firm with 100 Billion+ AUM involving projects from data acquisition and normalization to model development and portfolio management support.
Stefano Pasquali, Bloomberg
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Agenda
• Factors Leading to Liquidity Constraints
• Risk Management and Regulatory Compliance Challenges
• Portfolio Optimization
• Liquidity Assessment Overview
• Fixed Income Liquidity Assessment
• What’s Next?
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Factors Leading to Liquidity Constraints
Major Financial Events over the Last 25 Yearso What do these events have in common?
Low market liquidity despite abundant central bank liquidity
• Banks are more resilient than before• Greater imbalances on the buy-side1990 US HY bond marked collapses
1991 Oil price surge
1992 Swedish banking crises
1994 Mexican crises
1997 Asian crises
1998 Russia default, Ruble crash, LTCM
2000 TMT collapse
2001 9/11 payment system disruption
2002 Argentina crisis
2004 Russian banking crisis
2008 Global credit crises
2010 Greece
2014 Ruble
2015 CHF, Greece?, EMU?
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Factors Leading to Liquidity Constraints
o Global AuM have risen sharply since the crises...
o c. $35TN (45%) in funds which offer redemption at short notice
o AuM in daily redeemable funds: +76% since 2008, almost $40TN
o Increased investments in less liquid assets (HY credit)
o IMF, Oct 2015: corporate debt of nonfinancial firms across major emerging market economies quadrupled between 2004 and 2014.
o Dealer balance sheet in corporate credit: -30% since 2010, another 5-15% decease expected
o Mutual funds offering daily liquidity have more than doubled their holdings in US credit since 2005
o CDS market shrunk > more difficult to hedgeo NSFR impact, up to $500bn stable funding
needed
Increased Imbalances…
Source: From Oliver Wyman, Morgan Stanley, Wholesale & Investment Banking Outlook March 2015
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Factors Leading to Liquidity Constraints
o Global market conditions• China risk – Greg has chart• Eurozone – Quantitative Easing (chart)
o Expectations for interest rates to riseo Regulatory risk – buy-side becoming a liquidity provider
Additional Factors
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Risk Management and Regulatory Challenges
How do you minimize the regulatory impact on the balance sheet (i.e., LCR calculation)?
How has risk management and strategy changed in light of current market conditions?
Regulatory Concerns
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Audience Poll
Poll: How can firms get better returns in the current liquidity-constrained environment?a) Change trading strategy (move to more liquid trading strategies)b) Minimize transaction cost while balancing time to liquidation and market
impactc) Focus on better execution by exploring new trading venues d) Reduce position sizes relative to liquidity
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Portfolio Optimization
How can firms get better returns in the current liquidity-constrained environment?
o Overcrowded positions are affecting portfolio managers when they move against themo Low liquidity creates an environment in which an ordinary amount of volume moves the
market more than it did in the pasto Portfolio optimization
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Poll Answers
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Audience Poll
Poll: How do you currently assess liquidity?a) Rely on expert judgmentb) Internal modelsc) Third party providerd) Still looking for a solution
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Liquidity Assessment Challenges
There is no industry-standard definition of liquidityo Several existing model a limited to specific asset class or assume data availability (i.e.
Almgren , Amihud etc.) o Liquidity is often approximated with bid-ask spread and/or volume information
Problemo Sparse datao Weak statistics o High dimensionality
• Liquidity is a multi-dimensional concept, generally referring to the ability to execute large transactions with limited price impact, and tends to be associated with low transaction costs and immediacy in execution and must be studied in an appropriately high dimensional environment.
• There are a lot of endogenous and exogenous features related to the specific asset or particular market (on top of bid-ask and volume) that need to be considered for liquidity estimation (i.e. Asset Type, Sector, Credit, Central Bank Eligibility etc.)
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Poll Answers
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Liquidity Assessment: an alternative approach
Bloomberg Researcho We define liquidity as the probability of liquidating a given volume at fair value price or
bettero The above definition requires the determination of two components:
• A market impact curve defined as the percentage price change from fair value for a given volume
• A distribution error around the market impact. A problem remains: lack of datao In our approach a Machine Learning engine allows to identify comparable assets and
then leverage all data sourced across all similar securities (cluster) to extrapolate information on the target one
Outputso Probabilityo Market impacto Time to liquidationo Liquidity Score
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Fixed Income Liquidity Assessment
How would you assess fixed income liquidity given the opaque nature of the market? Issue
o Market liquidity—the ability to rapidly buy or sell a sizable volume of securities at a low cost and with limited price impact
o Two aspects of market liquidity: level and it resilience. Highly resilient market liquidity is critical to financial stability because it is less prone to sharp declines in response to shocks
o Both the level and resilience are decliningo Risk that liquidity sources are overvalued
Approacho Focus on sources of liquidity as opposed to liquidity requirementso Asset class based rules cannot be relied upon >> market liquidity is not binary but
a rangeo A question of data rather than approach, differentiating it from other liquidity
problems. Especially for fixed-income assets
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Liquidity Assessment: Bond Example
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Use case: QE
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Use case: Portfolio Optimization
• Bloomberg US Corporate Bond Index
• The Bloomberg US Corporate Bond Index
• To be included in the index a security must have a minimum par amount of 250MM. (BBG0042YXDD5)
• 5000 constituents
• Optimizing the TOP 1000 MOST liquid bonds we end up with 523 constituents with similar Yield and much higher liquidity score.
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Use case: Balance sheet optimization
• Bloomberg Liquidity Score is based on average market impact and its uncertainty
• Wide range of liquidity scores within each US HQLA bucket
• The choice of HQLA asset should be a combination of regulatory requirements, yield and expected market impact
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What’s Next?
• How will liquidity be affected by additional transparency imposed by regulators (i.e. MiFID II, SEC liquidity management rule)
• (TBD) How will liquidity be affected by electronic trading?
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Audience Questions
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About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and organizations to make better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment management firms, government agencies, academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM®) and the Energy Risk Professional (ERP®) exams; certifications recognized by risk professionals worldwide. GARP also helps advance the role of risk management via comprehensive professional education and training for professionals of all levels. www.garp.org