The UK’s Financial Conduct Authority (FCA) released a paper summarizing observations from the multi-firm review of liquidity risk management at a range of wholesale trading (sell-side) firms, particularly brokers, in scope of the Investment Firms Prudential Regime (IFPR).
The FCA identified firms applying a range of approaches to managing their liquidity risks. In many cases, these approaches were appropriate and proportionate to the nature, scale and complexity of the firm’s business model.
However, some firms had weaker approaches that were not commensurate with their size, complexity and the instantaneous nature of their liquidity risks. Often these firms had not updated their assumptions in the light of the events of the last few years (COVID pandemic, the Russia/Ukraine war, the nickel price spike, energy price volatility, the ION outage, and the failures of Credit Suisse and Silicon Valley Bank).
The FCA found that these firms:
- failed to identify the full range of liquidity risks they are exposed to, especially idiosyncratic risk requirements
- under-estimated the quantum of their liquidity risk exposures
- relied too much on having immediate access to liquidity facilities to mitigate instantaneous liquidity requirements
- had inoperable contingency funding plans (CFPs), many of which lacked action triggers, or a range of contingency actions designed to mitigate liquidity stresses
Among the “good practices” for CFPs was using repo arrangements to preclude outright sales crystallizing losses, and/or rehypothecate collateral held.
Alex Knight, head of EMEA at Baton Systems, said in emailed commentary: “The FCA’s review is a wake-up call for countless banks that still rely on legacy liquidity management systems. With most firms expressing concern over their intraday stressed cash outflows, the survey underlines starkly the importance of being able to access a real-time, enterprise-wide view of liquidity positions. Without this real-time data, and an accurate understanding of when obligations will become due and the expected timings of counterparty payments, firms cannot reliably forecast intraday liquidity demands, anticipate periods of stress and proactively manage the situation. Ultimately without these vital inputs firms have limited ability to put in place strategies such as the optimal sequencing of outgoing payments to mitigate the risk of a shortfall whilst ensuring that throughput obligations are met.
“Banks must transition to intraday liquidity management tools that offer the real-time monitoring and controls, accurate forecasting and extensive stress testing and scenario building capabilities they need as a priority. Beyond improving the resilience of the sell-side, these strengthen the stability of the global financial system – especially during periods of stress.”