Managing Liquidity Risk in Times of Stress
Historically, liquidity risk has been the poor cousin of market risk and credit risk. While the global financial crisis of 2008/2009 first pushed the issue of liquidity risk to the forefront of attention, the most recent market dislocation due to the COVID-19 pandemic has once again highlighted the salient significance of the topic. This is particularly so for institutional investment managers who have to meet margin calls, perform regular fund rebalancing, execute redemptions, among other potentially liquidity-threatening activities. Failure to afford liquidity risk management the focus and priority jeopardizes the health of an institution, perhaps fatally so.

In the worst days of the recent COVID-19 sell-off, some instruments witnessed their biggest price movements in three decades, and initial and variation margin spiralled higher. Recent data released by the Bank of England shows that in March the daily variation margin calls by UK central counterparties were up to five times higher than seen in January and February.

Proper evaluation and provision of liquidity risk is not a quick fix; it requires diligent contemplation of needs, and a reliable partnership with the right technology and data provider. But, by doing so, liquidity risk management is place on a par with credit and market risk management – where it deserves to be. It shouldn’t be left to rudimentary methodologies and chance any more. COVID-19 has reshaped many of our previously firmly held beliefs about life and the workplace; it might also be the case that it has justly refocused attention upon the pressing need to tackle liquidity risk management.

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