BoE’s Cunliffe sees liquidity risk in rise of investment funds

Market finance in the UK has grown in importance since the global financial crisis, but it may be contributing to the build-up of liquidity risks, warned Jon Cunliffe on February 9.

Although the Bank of England deputy governor saw a valuable role for market-based finance in opening up access to funding and diversifying risks, he also observed rapid inflows into investment funds and hedge funds.

“The bulk of flows into funds since the crisis have been into funds invested in less liquid debt instruments and, due to the search for yield, in the riskier parts of the market,” said Cunliffe.

At the same time, regulations requiring banks to be “adequately capitalised” for their market-making activities have tended to constrain market liquidity. Offers of daily liquidity exacerbate the risk of a downward spiral, should funds experience a rush of redemptions.

Such concerns have informed recent recommendations from global bodies such as the Financial Stability Board. “From the Bank of England’s point of view, the most important recommendations are around fund liquidity and ensuring that the liquidity offer matches the investment profile of the fund,” said Cunliffe.