GARP - Liquidity Assessment in an Uncertain Market

7/24/2019 GARP - Liquidity Assessment in an Uncertain Market

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Presented by:

Moderator:DeLisa White, GARP

Presenter(s):

Gudni Adalsteinsson, Head of Global Liquidity, Legal & General

Attilio Meucci, Chief Risk Officer, KKR

Stefano Pasquali, Global Head of Liquidity Research, Regulatory & Accounting

Products, Bloomberg

October 14, 2015

GARP Webcast

Liquidity Assessment In AnUncertain 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 experienceranges from running the group treasury for a European bank during thecredit crunch, working for the Financial Services Authority, to providingliquidity advice to UK banks. Adalsteinsson was a group treasurer for anIcelandic bank during the unprecedented liquidity shocks of 2008, whichoffered him first-hand experience of liquidity risk management under severecrisis. 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 hasbeen a board member of banks in the UK and Denmark.

Adalsteinsson holds an MBA degree from the University of Cambridge and abachelors degree in economics from the University of Iceland. He is theauthor of the book, The Liquidity Risk Management Guide from Policy toPitfalls (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 thefounder of SYMMYS, under whose umbrella he designed andteaches 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 anddirector of portfolio construction at Kepos Capital. Mr. Meucci was

also the global head of research for Bloombergs risk and portfolioanalytics platform; a researcher at Lehman POINT; a trader at thehedge fund Relative Value International; and a consultant at Bain &Co.

Concurrently, he taught at Columbia-IEOR, NYU-Courant, BaruchCollege-CUNY, and Bocconi University.

Mr Meucci is the author of Risk and Asset Allocation - Springer andnumerous publications in practitioners and academic journals. Mr.Meucci earned a BA summa cum laude in Physics from theUniversity of Milan, an MA in Economics from Bocconi University, aPhD in Mathematics from the University of Milan and is a CFAcharterholder.

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 forBloomberg's liquidity and systemic risk solution. His team designsand implements models that use Bloomberg's comprehensivemarket data library and machine-learning techniques to estimateliquidity and risk across different asset classes with particular focus

in OTC markets.

Stefano joined Bloomberg in 2009 as a quantitative analyst/specialistsupporting Bloombergs evaluated pricing service, BVAL. In 2010

Stefano began leading liquidity research for Bloomberg's PricingServices, focusing on fixed income market liquidity and calibratingfinancial models for measuring risk and market impact.

Prior to joining Bloomberg, Stefano held senior positions at severalEuropean banks and asset management firms where he oversawrisk management, portfolio risk analysis, model development andrisk management committees. Stefano built a risk managementprocess for a global asset management firm with 100 Billion+ AUMinvolving projects from data acquisition and normalization to modeldevelopment 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

Whats Next?


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Major Financial Events over the Last 25

Years

o 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 collapses1991 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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o Global AuM have risen sharply since thecrises...

o c. $35TN (45%) in funds which offer redemptionat short notice

o AuM in daily redeemable funds: +76% since

2008, almost $40TNo Increased investments in less liquid assets (HY

credit)

o IMF, Oct 2015: corporate debt of nonfinancialfirms across major emerging market economiesquadrupled between 2004 and 2014.

o Dealer balance sheet in corporate credit: -30%

since 2010, another 5-15% decease expectedo Mutual funds offering daily liquidity have more

than doubled their holdings in US credit since2005

o CDS market shrunk > more difficult to hedge

o NSFR impact, up to $500bn stable fundingneeded

Increased Imbalances

Source: From Oliver Wyman, Morgan Stanley, Wholesale &Investment Banking Outlook March 2015


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o Global market conditions

China risk

EurozoneQuantitative Easing (chart)

o Expectations for interest rates to rise

o Regulatory riskbuy-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 marketimpact

c) 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-constrainedenvironment?

o Overcrowded positions are affecting portfolio managers when they move against them

o Low liquidity creates an environment in which an ordinary amount of volume moves themarket more than it did in the past

o 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 judgment

b) Internal models

c) Third party provider

d) 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

Problem

o Sparse data

o Weak statistics

o High dimensionality

Liquidity is a multi-dimensional concept, generally referring to the ability to executelarge transactions with limited price impact, and tends to be associated with lowtransaction costs and immediacy in execution and must be studied in anappropriately high dimensional environment.

There are a lot of endogenous and exogenous features related to the specificasset or particular market (on top of bid-ask and volume) that need to beconsidered for liquidity estimation (i.e. Asset Type, Sector, Credit, Central BankEligibility 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

better

o The above definition requires the determination of two components:

A market impact curve defined as the percentage price change from fair value fora given volume

A distribution error around the market impact.A problem remains: lack of data

o In our approach a Machine Learning engine allows to identify comparable assets andthen leverage all data sourced across all similar securities (cluster) to extrapolateinformation on the target one

Outputs

o Probability

o Market impact

o Time to liquidation

o 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 liquiditythe ability to rapidly buy or sell a sizable volume of securities ata low cost and with limited price impact

o Two aspects of market liquidity: level and it resilience. Highly resilient marketliquidity is critical to financial stability because it is less prone to sharp declines in

response to shockso Both the level and resilience are declining

o Risk that liquidity sources are overvalued

Approach

o Focus on sources of liquidity as opposed to liquidity requirements

o Asset class based rules cannot be relied upon >> market liquidity is not binary buta range

o A question of data rather than approach, differentiating it from other liquidityproblems. 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 CorporateBond Index

The Bloomberg USCorporate Bond Index

To be included in the

index a security musthave a minimum paramount of 250MM.(BBG0042YXDD5)

5000 constituents

Optimizing the TOP 1000

MOST liquid bonds weend up with 523constituents with similarYield and much higherliquidity score.


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Use case: Balance sheet optimization

Bloomberg LiquidityScore is based onaverage marketimpact and itsuncertainty

Wide range ofliquidity scoreswithin each US

HQLA bucket

The choice of HQLAasset should be acombination ofregulatoryrequirements, yieldand expectedmarket impact


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Whats Next?

How will liquidity be affected by additional transparency imposed byregulators (i.e. MiFID II, SEC liquidity management rule)

Liquidity management in intrinsically very illiquid markers

(alternative/private equity)

Proper inclusion of liquidity factor in risk management models


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Audience Questions

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Best PracticesStress TestingCreating a culture ofrisk awareness

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Risk Professionals

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www.garp.org

2015 Global Association of Risk Professionals. All rights reserved.

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

GARP - Liquidity Assessment in an Uncertain Market

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