1

On24 Tech Tips

• Make sure your speakers are on• Hit F5 any time your console freezes• For a LIVE event you should be hearing music now• Use the “Ask a Question” feature to report issues• Webcast starts at the top of the hour

Presented by:

Moderator:DeLisa White, GARP

Presenter(s):Gudni Adalsteinsson, Head of Global Liquidity, Legal & GeneralAttilio Meucci, Chief Risk Officer, KKRStefano Pasquali, Global Head of Liquidity Research, Regulatory & Accounting Products, Bloomberg

October 14, 2015

GARP Webcast

Liquidity Assessment In An Uncertain Market

2

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 atLehman 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 bachelor’s 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)

Gudni Adalsteinsson, Legal & General Group Plc

3

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 Bloomberg’s 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.

Attilio Meucci, KKR

4

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 Bloomberg’s 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.

Stefano Pasquali, Bloomberg

5

Agenda

• Factors Leading to Liquidity Constraints

• Risk Management and Regulatory Compliance Challenges

• Portfolio Optimization

• Liquidity Assessment Overview

• Fixed Income Liquidity Assessment

• What’s Next?

6

Factors Leading to Liquidity Constraints

Major Financial Events over the Last 25 Yearso What do these events have in common?

Low market liquidity despite abundant central bank liquidity

• Banks are more resilient than before• Greater imbalances on the buy-side1990 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?

7

Factors Leading to Liquidity Constraints

o Global AuM have risen sharply since the crises...

o c. $35TN (45%) in funds which offer redemption at short notice

o AuM in daily redeemable funds: +76% since 2008, almost $40TN

o Increased investments in less liquid assets (HY credit)

o IMF, Oct 2015: corporate debt of nonfinancial firms across major emerging market economies quadrupled between 2004 and 2014.

o Dealer balance sheet in corporate credit: -30% since 2010, another 5-15% decease expected

o Mutual funds offering daily liquidity have more than doubled their holdings in US credit since 2005

o CDS market shrunk > more difficult to hedgeo NSFR impact, up to $500bn stable funding

needed

Increased Imbalances…

Source: From Oliver Wyman, Morgan Stanley, Wholesale & Investment Banking Outlook March 2015

8

Factors Leading to Liquidity Constraints

o Global market conditions• China risk – Greg has chart• Eurozone – Quantitative Easing (chart)

o Expectations for interest rates to riseo Regulatory risk – buy-side becoming a liquidity provider

Additional Factors

9

Risk Management and Regulatory Challenges

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?

Regulatory Concerns

10

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

impactc) Focus on better execution by exploring new trading venues d) Reduce position sizes relative to liquidity

11

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 themo Low liquidity creates an environment in which an ordinary amount of volume moves the

market more than it did in the pasto Portfolio optimization

12

Poll Answers

12

13

Audience Poll

Poll: How do you currently assess liquidity?a) Rely on expert judgmentb) Internal modelsc) Third party providerd) Still looking for a solution

14

Liquidity Assessment Challenges

There is no industry-standard definition of liquidityo 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

Problemo Sparse datao 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.)

15

Poll Answers

15

16

Liquidity Assessment: an alternative approach

Bloomberg Researcho We define liquidity as the probability of liquidating a given volume at fair value price or

bettero 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 datao 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

Outputso Probabilityo Market impacto Time to liquidationo Liquidity Score

17

Fixed Income Liquidity Assessment

How would you assess fixed income liquidity given the opaque nature of the market? Issue

o Market liquidity—the 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 decliningo Risk that liquidity sources are overvalued

Approacho Focus on sources of liquidity as opposed to liquidity requirementso Asset class based rules cannot be relied upon >> market liquidity is not binary but

a rangeo A question of data rather than approach, differentiating it from other liquidity

problems. Especially for fixed-income assets

18

Liquidity Assessment: Bond Example

19

Use case: QE

20

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.

21

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

22

What’s Next?

• How will liquidity be affected by additional transparency imposed by regulators (i.e. MiFID II, SEC liquidity management rule)

• (TBD) How will liquidity be affected by electronic trading?

23

Audience Questions

23

Best Practices – Stress TestingCreating a culture of risk awareness®

Global Association ofRisk Professionals

111 Town Square Place14th FloorJersey City, New Jersey 07310U.S.A.+ 1 201.719.7210

2nd FloorBengal Wing9A Devonshire SquareLondon, EC2M 4YNU.K.+ 44 (0) 20 7397 9630

www.garp.org

© 2015 Global Association of Risk Professionals. All rights reserved.

About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and organizations to make better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment management firms, government agencies, academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM®) and the Energy Risk Professional (ERP®) exams; certifications recognized by risk professionals worldwide. GARP also helps advance the role of risk management via comprehensive professional education and training for professionals of all levels. www.garp.org