Liquidity Stress Testing in Asset Management -- Part 3. Managing the Asset-Liability Liquidity Risk

TL;DR

This paper develops a comprehensive framework for managing asset-liability liquidity risk in asset management, focusing on stress testing, measurement, management, and monitoring tools aligned with regulatory standards.

Contribution

It introduces a practical methodology for liquidity stress testing and evaluates various ALM tools for controlling liquidity gaps in asset management.

Findings

Redemption coverage ratio (RCR) is central to stress testing.

Liquidity buffers and special arrangements have distinct advantages and limitations.

Macro- and micro-approaches to liquidity monitoring offer complementary insights.

Abstract

This article is part of a comprehensive research project on liquidity risk in asset management, which can be divided into three dimensions. The first dimension covers the modeling of the liability liquidity risk (or funding liquidity), the second dimension is dedicated to the modeling of the asset liquidity risk (or market liquidity), whereas the third dimension considers the management of the asset-liability liquidity risk (or asset-liability matching). The purpose of this research is to propose a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers. In this third and last research paper focused on managing the asset-liability liquidity risk, we explore the ALM tools that can be put in place to control the liquidity gap. These ALM tools can be split into three categories: measurement tools, management tools and monitoring tools. In terms of measurement tools, we focus on the computation of the redemption coverage ratio (RCR), which is the central instrument of liquidity stress testing programs. We also study the redemption liquidation policy and the different implementation methodologies, and we show how reverse stress testing can be developed. In terms of liquidity management tools, we study the calibration of liquidity buffers, the pros and cons of special arrangements (redemption suspensions, gates, side pockets and in-kind redemptions) and the effectiveness of swing pricing. In terms of liquidity monitoring tools, we compare the macro- and micro-approaches of liquidity monitoring in order to identify the transmission channels of liquidity risk.