The International Monetary Fund (IMF) has flagged growing concerns about liquidity risks within pension and superannuation funds, especially as these funds increase their investments in illiquid assets such as private equity and credit. The findings, outlined in the IMF’s global Financial Stability Report, also warns about potential liquidity stress in banks that use synthetic risk transfers (SRTs), a complex financial product used to reduce risk from loans made without selling those loans, to manage credit risk.
The IMF highlighted that many pension and superannuation funds, particularly in countries like Australia, face a significant mismatch between the long-term nature of their assets and the short-term liabilities they carry. Fund members are often able to switch investments quickly, within just a few days in some cases, forcing these funds to be more liquid than their underlying investments, which can take years to mature. This imbalance could become a serious issue during market stress, potentially triggering broader financial instability.
The trend of increasing allocations to illiquid assets has been encouraged by regulatory frameworks in regions such as the US and Europe, which aim to enhance returns for investors. However, the IMF warns that this shift leaves funds more vulnerable during times of financial stress when liquidity becomes scarce.
The report also points out that banks using synthetic risk transfers (SRTs) to shift credit risk may find themselves exposed to liquidity challenges, especially if markets for these instruments seize up during downturns. While SRTs are designed to bolster capital ratios, the IMF cautions that deteriorating asset quality could amplify liquidity problems for banks relying on these structures.
In light of these risks, the IMF emphasizes the need for liquidity stress tests tailored to pension funds and insurers holding illiquid assets. These tests would help ensure that the timing of asset sales aligns with the notice periods for client redemptions, preventing a run on liquidity during periods of market volatility. Additionally, there is a call on central banks to prepare for future liquidity crises by setting up frameworks to provide emergency assistance. This would involve making liquidity available against a broad range of assets, while carefully managing risks tied to solvency.
Jo Burnham, margin expert at the derivatives analytics firm OpenGamma, said in emailed commentary: “As liquidity risks become more pronounced, the focus on effective management and stress testing is becoming increasingly critical to safeguarding not just institutional funds, but the entire financial system.
“The trouble is that liquidity management is not a one-size-fits-all approach. Fund managers are in the best position to make these calls because they understand the intricacies of their portfolios. But to help them make the most informed decisions, they need capital and liquidity risk management solutions that build resilience while minimizing the cost of trading.”