The Financial Stability Board (FSB) has released a consultation report highlighting the need for policy adjustments to address liquidity strains in the non-bank financial intermediaries (NBFI) sector – such as hedge funds – particularly during periods of heightened margin and collateral calls amidst market stress.
Reflecting on past instances such as the March 2020 turmoil, Archegos incident, and stress in liability-driven investment funds in 2022, the report underscores the impact of such events on liquidity dynamics within the NBFI sector.
In response, the FSB has outlined eight policy recommendations aimed at strengthening the liquidity preparedness of non-bank market participants for margin and collateral calls across both centrally and non-centrally cleared derivatives and securities markets, including securities financing such as repo.
The first three recommendations focus on enhancing liquidity risk management practices and governance. These include the incorporation of liquidity risk stemming from spikes in margin and collateral calls into existing frameworks, establishing liquidity risk appetites, and conducting regular reviews to ensure effectiveness, particularly during times of stress.
Recommendations four and five centre on liquidity stress testing and scenario design, emphasising the importance of tailored stress tests to identify liquidity strains and the inclusion of extreme yet plausible scenarios.
The subsequent recommendations, six to eight, concentrate on collateral management practices. This involves ensuring resilient operational processes, maintaining adequate levels of cash and liquid assets, and fostering transparent engagement with counterparties and service providers.
FSB’s report highlights the critical balance between margin and collateral calls as necessary risk management measures and their potential to amplify liquidity demand during periods of stress. It identifies liquidity risk management and governance weaknesses as key factors contributing to inadequate liquidity preparedness among market participants.
These recommendations are being proposed to be applied regularly, with a focus on non-bank market participants with significant exposures to margin and collateral calls during stress events.
The FSB is now seeking feedback on the consultation report and the outlined recommendations, with submissions welcomed until 18 June 2024.