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Comment by Joy Dunbar, Editor of Absolute UCITS
One of the most frightening consequences of the so-called Volcker Rule is that it could dry up liquidity and seize global markets, according to the European Fund and Asset Management Association.
Liquidity, as we saw in 2008, might be a good servant but is also a dangerous master. The new rule being proposed as part of the Dodd-Frank Act could result in liquidity becoming a tyrannical and unruly master. Tightening liquidity in markets impacts open-ended investment funds like UCITS as asset managers are dependent upon it to satisfy redemption requests.
We saw a couple of years ago the impact that a sudden loss of liquidity had on the hedge fund sector. Liquidity shortfalls meant that some funds were forced to suspend investor redemptions and it also skewed markets which created unnecessary volatility. And for funds that did not gate, suspend or side-pocket it resulted them being used as cash machines – and in many cases forced to realise losses which could have been avoided.
The risks of liquidity for UCITS are more poignant because most investors are able to redeem their funds on a daily or weekly basis (most alternative UCITS funds do not have monthly lockups). For UCITS specifically it creates a number of problems, particularly if a certain strategy suffers a liquidity mismatch – as that will probably result in the entire UCITS brand being tarnished, especially if retail investors are unable to get their investments returned.
In my view a new standard liquidity tool needs to be created to address liquidity risk – which obviously varies by strategy depending on the instruments used and market conditions.
UCITS fund managers currently use a well developed measurement tool, Value at Risk (VaR), for price variation risk. A liquidity tool should also be developed so that the investor knows how the UCITS fund manager will respond to a potential ‘liquidity event’.
But probably more importantly, the Volcker Rule should take into account that the financial services industry is a global sector and one of the unintended consequences of the Act could be that it creates more problems than the ones it proposes to resolve.