ICI's Pan in FT on Liquidity FIxes
ICI President Eric Pan comments in the Financial Times on "Liquidity strains in markets need structural fixes." He writes, "While high inflation is making the headlines, another potentially worrisome development for markets this year has been the deterioration of liquidity in trading. As the US Federal Reserve discussed in its latest Financial Stability Report in May, liquidity has been falling since late 2021 in US Treasuries as well as in futures contracts on the S&P 500 index and oil. Liquidity -- measured in the ease with which buyers and sellers can transact -- is critical to a well-functioning market for everyday investors and borrowers. Seeing strains across these multiple markets ought to be raising real concerns." His comment letter continues, "In fact, underlying structural weaknesses have been evident for some time. This is particularly so in wholesale funding markets where historically banks, acting as dealers, have played a key role in providing liquidity. More stringent regulatory capital regulations adopted in response to the financial crisis are often cited as making intermediating fixed-income trades more costly. To their credit, policymakers -- both in the US and globally -- have identified that there may be some fundamental structural issues at play in market-making activities. But supposed weaknesses in money market and open-end mutual funds have also been subject to scrutiny." Pan adds, "Policymakers have been looking at the risk that money market and open-end mutual funds might amplify liquidity shocks -- whether any advantage in being the 'first-mover' in fund redemptions could spur further selling or create challenges in offloading assets during stress. So we are seeing a raft of proposals aimed at money market and open-end mutual funds to increase liquidity buffers and require measures such as 'swing pricing' which seek to pass on some of the costs of redemptions to the sellers in times of stress. Some of this is due to a misreading of the evidence from previous episodes of stress, in particular the events of March 2020 when the pandemic caused an abrupt shutdown of the global economy. The fact is that money market and open-ended mutual funds were not the cause of the March 2020 liquidity crisis, and their supposed role in amplifying the crisis is not supported by data." Finally, the letter says, "Our research shows funds' total net sales of bonds, especially Treasuries, were much smaller than has been claimed by policymakers. And the timing of bond mutual funds' daily net sales don't align with the evolution of the dislocation in the Treasury market at the time. In addition, their small share of Treasury market trading volume indicates little, if any, amplification of stress. The main lesson to be drawn from the experience of March 2020 is this: we need to ensure that secondary markets can supply adequate liquidity to all when investors most need it."
