Concern about liquidity shortfalls at year end could be alleviated by electronic market makers say traders, and the data seems to back them up.
A seasonal shortage of liquidity at year end is often attributed to the withdrawal of dealer activity as they optimise their holdings of risk assets. The quarterly reporting of capital ratios to regulators creates a skewing of activity away from capital-intensive work at quarter end. This ‘window dressing’ is a longstanding issue, and can impact market liquidity.
James Athey, senior fund manager for UK fixed interest & global fixed interest asset manager at Marlborough, speaking with Markets Media’s Trader TV, said “Year end is known as a tricky period for liquidity. What happens, is that banking regulation really is only adhered to at period ends, where regulators take snapshots of bank balance sheets in order to judge various criteria relative to regulation, things like liquidity and leverage ratios. So banks behave exactly as they wish to between quarterly earnings, and then they tidy up or window dress their balance sheets at those period ends when these snapshots are taken. Year end is a particularly big one.”
Under the Basel III regime, banks’ leverage ratio is a 3% minimum level that a bank has to meet, typically reported at quarter end, calculated by dividing their Tier 1 capital by the sum of exposures across all assets and non-balance sheet items. In some cases they are also able to report an average of exposure daily or month-end exposure levels if the national regulator agrees. The ratio acts as a buffer against excessive leverage on the sell side, addressing systemic risks that were created through dealer exposure to leverage in the 2007 financial crisis.
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