THE FUTURE OF LIQUIDITY RISK MANAGEMENT

By the Center for Financial Professionals

Ahead of the upcoming Liquidity Risk Management Congress, the research team at the Center for Financial Professionals conducted a range of one on one interviews with leading industry professionals to gain an insight as to the critical challenge areas. The results of this research will be summarized and presented to an audience of over 150 at the 2nd Annual Liquidity Risk Management Congress, taking place in NYC on October 17-18. Some summary points are outlined, but for full results visit www.cefpro.com/lrmusa and join us and industry professionals to review, debate and discuss the liquidity risk landscape and evolution of the risk function.

The results of the research study highlighted a diverse range of key points across the industry, with many concerned with regulatory updates and the influx of regulatory changes and how all of these requirements interlink and work under one unified platform. Below are just a snapshot of some of the topics identified and areas of focus over the coming 12 months for liquidity risk professionals across the industry.

The continued debate around NSFR remains at the forefront of professional’s minds across the industry and different institutions. With the focus having been on NSFR for quite some time now, many were concerned that the topic has been over debated and yet confusion and uncertainty remains. The questions still remain as to what the final rule will look like, and the impact this will have on companies’ individual progression towards compliance with timelines seemingly set.

“We want to know if that will continue because right now its targeted for 2018, we want to know if that will continue to stay on the same timeline… NSFR is going to impact companies that have a stronger or bigger investment portfolio, also FBO’s. Without seeing all their direct books, we just want to see how its changed the way they are funding themselves, is it going to impact current liquidity buffer at all?”

“Depending on the final rule, the impact on the industry may be different and maybe material, so if we have to comply to a rule that has been issued 6 or 3 months before the implementation date, it will be very hard to adapt the business”

Many respondents also expressed concern or interest in the potential impact of the financial choice act, and how that would impact regulation such as NSFR:

“At this point, although nothing has been finalized and the full implementation of NSFR is up in the air at a ground level, the regulators are pushing us to implement it. We have to think about what we are going to do, and how we are going to implement it. Some of the disclosures that have come up from the big banks, they are all acknowledging NSFR, they are all saying they are working towards compliance towards the proposed Jan 2018 deadline. There is a lot of acceptance within the industry, no matter what the administration are saying lot of people are working towards it and the proposed rule”

“It could give banks a way out, and would potentially eliminate the Volcker Rule here in the US. If you’re out from under Dodd Frank in the US that means you don’t have to do LCR, you don’t have to do NSFR and you don’t have to do a lot of these liquidity reports. So there is a whole bunch of business decisions someone would have to make… All of those impacts liquidity because it opens up new products… it changes the value of different kinds of securities that people hold for HQLA, because people can hold what they want, they don’t have to hold government and agency bonds- that would have a huge impact on liquidity and offloading to smaller banks and changing the market dynamics”

A key focus when considering regulation in general was around the interaction of different regulatory programs, particularly LCR and NSFR:

“We have started analysing NSFR at a very high level, but the point is the NSFR requires long term funding and LCR is a short-term ratio, the basic challenge is how do you go through the peaks and values of the 30 day LCR whilst not disrupting long term NSFR calculations? There will be times when you have a big maturity coming up which will impact your 30 day LCR, while you try and fix that you may deviate from the maximum requirement on the NSFR side, so how do you keep a good balance between the two?”

“So, it’s really the connections between the NSFR, LCR and capital, with the capital, how its released to capital and how the regulators use that. Last time it sounded like they did it in isolation, so lets say capital metrics and liquidity metrics. But then there were some kind of future trends to start looking at it together’

Another key area of focus across respondents within certain institutions is the requirements and changes under funds transfer pricing and how this impacts institutions and restructuring.

“The more sophisticated and robust FTP one has, would mean the better job they would do to control liquidity risk and to manage or control the amount of inventory or assets they have under the balance sheet that are not liquidity friendly. Depending on how sophisticated your methodology is, you could have an FTP model that is quite granular and goes down to the asset or product level, or you could have one that is not so robust and doesn’t allocate the cost of funding or the cost of liquidity to the produce level, you may not be able to incentivize behaviour in a dynamic way and you may not be able to influence traders or business in a real-time fashion if you’re not allocating your FTP charges or your liquidity charges appropriately””

“There is a regulatory requirement to do it, or at least regulatory pressure. It becomes critical in that a lot of business lines, profitability, a lot of traders businesses depend on what kind of liquidity charge you are putting on their positions. It goes into a profitability discussion for allocation profit between different segments or desks”

“You look at the liquidity positions and as you can imagine that become very political. There are lots of pressures to support whatever liquidity risk you are transferring through, but at the same time you want to make sure that you are capturing all of the liquidity risk you need, if a position on a desk requires you to hold more of a liquidity buffer on the LCR, or more of a liquid buffer in your intraday monitoring then there is a cost associated with holding that extra buffer for that particular desk. The whole perspective is that you want to understand if the ideas of these rules is to influence behaviours and understand the liquidity risk they are taking relative to the business decisions they are making, you want people making those decisions to understand that and FTP is the best way to present that to them”

Along the same lines of regulatory challenges and implementing the influx of changes and requirements, comes the ongoing discussions around intraday liquidity and understand the regulatory regime and what it means for specific institutions. Institutions need to better understand where they can benefit from these changes and responses. Some comments pertaining to the challenges of intraday liquidity include:

“The intraday liquidity is becoming a larger issue for a lot of banks, it goes into resolution planning and finding out minimum operating liquidity. That is based off the intraday flows and intraday flows between legal entities in jurisdictions, so that’s a key calculation”

“The whole idea Is that you need to understand what your intraday risks are and there are a sub set of people who have large intraday exposure than they have overnight exposure. A lot of the foreign banks that do operations and have somewhat limited operations in New York, and most of it is for the parent, they could have a much larger intraday liquidity requirement than they could have an LCR requirement. So, it becomes pretty important how you calculate that and how you support that.

As a whole, liquidity as an industry are facing continual change and regulatory pressure to not only implement all of these requirements, but to also align them all to ensure they run smoothly and interact efficiently. With areas such as NSFR still unclear as to what the future holds and what the final rule will be, institutions are forced to push ahead with implementation based on current guidance, with timelines remaining the same for now. In amongst such change comes the uncertainty of the future of regulation as many turn their focus to what the potential regulatory changes could be under the Trump administration and the impacts of the financial choice act. Many are in two minds as to their opinion on the proposed changes, and whether this is beneficial or detrimental to their work, if this were to take effect, institutions would have to turn their focus to work that has already been done and what should be considered best practice as they begin unravelling progress.

The Center for Financial Professionals have brought together a senior line up presenters and panellists to review and discuss the above challenges, plus many more areas that arose from the research efforts including; recovery and resolution planning, money market reform, LCR, pricing liquidity, EPS, stress testing, lines of defense and much more.

Join us on October 17-18 to network with peers, interact, debate and share best practices over two days of interactive discussions. All information can be found at www.cefpro.com/lrmusa