GARP Webcast

Liquidity Assessment In An
Uncertain Market
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
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Gudni Adalsteinsson, Legal & General Group Plc

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 at
Lehman 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
bachelors 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)

Attilio Meucci, KKR

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 Bloombergs 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.
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Stefano Pasquali, Bloomberg

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 Bloombergs 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.
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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?

Factors Leading to Liquidity Constraints

Major Financial Events over the Last 25

Years
o What do these events have in common?

1990

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?

Low market liquidity despite abundant

central bank liquidity
Banks are more resilient than before
Greater imbalances on the buy-side

Factors Leading to Liquidity Constraints

Increased Imbalances
o
o
o
o
o

o
o
7

Global AuM have risen sharply since the

crises...
c. $35TN (45%) in funds which offer redemption
at short notice
AuM in daily redeemable funds: +76% since
2008, almost $40TN
Increased investments in less liquid assets (HY
credit)
IMF, Oct 2015: corporate debt of nonfinancial
firms across major emerging market economies
quadrupled between 2004 and 2014.
Dealer balance sheet in corporate credit: -30%
since 2010, another 5-15% decease expected
Mutual funds offering daily liquidity have more
than doubled their holdings in US credit since
2005
CDS market shrunk > more difficult to hedge
NSFR impact, up to $500bn stable funding
needed

Source: From Oliver Wyman, Morgan Stanley, Wholesale &

Investment Banking Outlook March 2015

Factors Leading to Liquidity Constraints

Additional Factors
o

o
o

Global market conditions

China risk
Eurozone Quantitative Easing (chart)
Expectations for interest rates to rise
Regulatory risk buy-side becoming a liquidity provider

Risk Management and Regulatory Challenges

Regulatory Concerns

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?

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
impact
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-constrained

environment?
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 the
market more than it did in the past
o Portfolio optimization

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Poll Answers

12
12

Audience Poll

Poll: How do you currently assess liquidity?

a)
b)
c)
d)

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Rely on expert judgment

Internal models
Third party provider
Still looking for a solution

Liquidity Assessment Challenges

There is no industry-standard definition of liquidity

o 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 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

15
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Liquidity Assessment: an alternative approach

Bloomberg Research
o 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 for
a 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 and
then leverage all data sourced across all similar securities (cluster) to extrapolate
information 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 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 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 but
a range
o 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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Whats Next?

How will liquidity be affected by additional transparency imposed by

regulators (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

23

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Creating
a culture of Stress Testing
Best
Practices
risk awareness

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