liquidity risk management in mutual funds

Welcome!

Mike van de Graaf

General Manager Risk & Performance Measurement

Treasury Corporation of Victoria,

and

Global Association of Risk Professionals

Melbourne Director

13 April 2016

2

The views expressed in the following material are the

author’s and do not necessarily represent the views of

the Global Association of Risk Professionals (GARP),

its Membership or its Management.

3 | © 2014 Global Association of Risk Professionals. All rights reserved.

GARP’s Mission:


Governance:


Supporting an awareness of Risk through leading education programs


GARP’s Global Reach is its USP for Australian Risk Managers


GARP’s webcasts allow us to stay in touch with developments around the globe


Liquidity Risk is binary: One day it is there, but the next day…


…and Fixed Income markets have (had) their own risk events...


…and APRA and ASIC also have taken aim at liquidity…

APRA Chairman Wyane Byres at the

AFR Banking & Wealth Summit 2016:

1. Reinforcing Capital Strength

2. Improving Stability of liquidity and

funding profile.

3. Enhancing both public and private

sectors’ readiness for adversity

4. Strengthening the risk culture within

the financial system

ANZ and WBC civil action possible fine

of $60 million

“Traders at banks are alleged to have

realised that by virtue of their size, they

could influence the supply and demand

of bank bills during the five minute

trading window when the swap rate was

set” BBG 5/4

- Note: global fines for LIBOR rigging

are estimated at U$235 billion

Short Term Major Bank Debt from 30%

to 20%

More reliance on foreign debt markets

for ST debt


…but is monetary policy driving the biggest liquidity trap of all times?

Dr Draghi “whatever it takes” is

pushing European rates down…

Dr Kuroda is taking 20 years of

Japan’s zero rates into new

territory…

Effect on liquidity:

• Japanese citizens are clamouring for Y10,000 bills and safes (FT)

• Europe is taking large notes out of circulation (“for AMLCTF”…)

• How much will low/negative rates be adding to liquidity pressures?


John Hollyer, Principal at The Vanguard Group

• About Vanguard, key numbers:

U$3T – 320f – 20m in 170c – 14k staff

• Global Head of the Risk Management Group

within Vanguard’s Investment Management

Group, based in Valley Forge, PA.

• Portfolio Manager to a number of Vanguard’s

bond and money market funds.

• Mr. Hollyer has over 25 years of investment and

risk management experience, is a Chartered

Financial Analyst, and holds a B.S. in

Economics from the Wharton School at the

University of Pennsylvania

• Mr. Hollyer is also a member of GARP’s Buy

Side Risk Managers Forum

C r e a t i n g a c u l t u r e o f

r i s k a w a r e n e s s ®

Global Association of

Risk Professionals

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14th Floor

Jersey City, New Jersey 07310

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+ 44 (0) 20 7397 9630

www.garp.org

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.


For internal use only. Not for public distribution.

Liquidity Risk

John Hollyer, CFA

April 2016

2 For internal use only. Not for public distribution.

Defining and Measuring Liquidity

The ongoing evolution of markets and liquidity

Vanguard’s approach to liquidity risk management

Regulatory activity

Agenda


Transaction cost – bid/offer spread

Trading volume

Market Impact

Liquidity is hard to measure


Market impact – a good measure, harder to calculate


1. Post crisis regulatory response

• Capital – more required

• Liquidity – hold more liquid securities

• Activities – proprietary trading prohibitions

2. Normalization of monetary policy

• Stretched valuations 3. New entrants and the evolution of electronic trading

Impact:

• Dealers have made decisions to devote less resources to market making

• Arbitrage tool kits are reduced

• Potentially larger and more rapid price changes

Assessment:

• The financial system is safer but markets are more volatile

• Large, broadly diversified, high quality markets will find a clearing level

• Policy makers are focused on bond market liquidity and mutual funds

Drivers of changes in market liquidity


Asset managers within the broader financial system

Bonds represent buy-and-hold investments in a long-term portfolio for many investors

Sources: SIFMA, Barclays, ICI

Sources: International Investment Funds Association and the IMF


There is no evidence of a run on bond funds

Source: Morningstar.com


Multi-dimensional assessment

How we are prepared

Multi-layered mitigations

Highly liquid core of securities

Routine practices

Exceptional

tools

Make up of client base

Liquidity of holdings

Portfolio construction

Stress tests


Fixed income liquidity – stress test results

Source: Vanguard. Daily data from February 1996-Sepember 2015.

0%

2%

4%

6%

8%

10%

12%

1 Day 5 Day Rolling 10 Day Rolling Active CreditFunds HighlyLiquid Assets

Municipal FundsHighly Liquid

Assets

Redemption Stress Test

Worst redemption:

Active Credit and

Municipal funds

% of highly liquid assets

held in Active Credit funds

% of highly liquid assets

held in Municipal funds

% o

f fu

nd a

ssets


• Regulatory mandate to identify SIFIs beyond banking and insurance

• Entity designation is not the right approach for asset management

• Redemption risk and misperceptions

• SEC liquidity rule proposal

• Board level liquidity risk management program

• Minimum percentage in holdings that are highly liquid

• Swing pricing available as an option

• Categorization of each holding into 6 “days to liquidate” buckets

Regulators focus on liquidity risk management


Top down liquidity metrics are better than bottom up


Liquidity emerges when demanded

Next Meeting Update


Telstra’s Chief Risk Officer, Kate Hughes, will

take us through Telstra’s approach to embed a

culture of risk awareness across the business.

Tuesday 31 May 2016

NAB, the Academy, 500 Bourke Street

Next Meeting!

liquidity risk management in mutual funds

Economy & Finance