Hedge funds told to strengthen liquidity management

Hedge funds and other non-bank participants in the capital markets have been urged to hold more liquid assets by the Financial Stability Board (FSB).

The call comes in light of recent episodes of market stress, including the pandemic-induced turmoil of March 2020, the collapse of Archegos in March 2021, the volatility in the commodities market in 2022 and liquidity issues suffered by liability-driven investment (LDI) funds in the same year.

According to the FSB, these events uncovered a lack of preparedness for sudden price moves and the impact this would have on margin and collateral calls.

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Consequently, the FSB is calling on pensions funds, hedge funds and commodities traders to be better prepared and to have a more liquid trading book.

A consultation report proposes eight measures to improve market practices which focus on liquidity risk management practices at times of market stress; liquidity stress testing for margin and collateral calls; and ensuring sufficient collateral is available.

“The aim of these recommendations is to reduce the excessive procyclical behaviour of some non-bank market participants in response to margin and collateral call,” stated the FSB.

“Enhancing market participants’ liquidity preparedness will help to mitigate the impact of such calls during times of market-wide stress.”