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Thomson Reuters Summary on CEBS Consultation Paper CP19: Liquidity Risk Management

Core Content

Thomson Reuters, a global leader in financial information and risk management software, provides detailed feedback on the CEBS Consultation Paper CP19, which focuses on liquidity risk management. The paper outlines the nature of liquidity risk and its integration into an institution's overall risk management framework. Thomson Reuters supports the general definition of liquidity risk but highlights several key concerns regarding its classification and management.

Main Views and Key Points

Liquidity Risk is Not a Stand-Alone Risk

• Thomson Reuters argues that liquidity risk is an operational risk that arises from mismanagement of other risks, such as funding, portfolio, and counterparty risks.
• The firm emphasizes that liquidity risk should not be treated in isolation but should be integrated with other risk factors.
• A comprehensive review of all risk factors and their alignment with the firm’s risk policy is essential for effective liquidity risk management.

Sources of Liquidity Risk

• There are three main sources of liquidity risk:
  1. Funding liquidity risk – related to the availability and cost of funding.
  2. Market liquidity risk – related to the ability to sell assets in adverse market conditions.
  3. Counterparty liquidity risk – related to the failure of counterparties to meet obligations.
• Counterparty liquidity risk can be caused by financial problems or operational failures, including data mismanagement.

Systemic Risk Concerns

• Thomson Reuters warns that homogeneous stress tests and standardized liquidity buffers across the industry could lead to systemic liquidity holes.
• Each firm must develop an individual response framework based on its specific exposures, clients, and business model.

Monitoring Concentrations and Risk Factors

• To understand liquidity risks, firms must identify and monitor root-risk factors, including those from securitization and derivatives.
• Real-time data and news monitoring is critical for detecting early signs of concentration build-up and speculative bubbles.
• Price volatility, trading volumes, and correlation changes are key indicators of potential liquidity imbalances.

Impact of Volatility and Correlation

• Volatility and correlation have a significant impact on market liquidity.
• Quantitative models may become unreliable under stressed conditions due to unexpected correlations and volatility movements.
• Historical simulations can be misleading due to market structures evolving post-crisis.

Counterparty-Generated Liquidity Risks

• Electronic monitoring of transaction flows and real-time reporting of outstanding amounts, ratings, and geographies can help mitigate counterparty liquidity risks.
• Firms should map their connectivity workflows and rate networks based on efficiency, scalability, and resilience.

Key Recommendations

• Recommendation 1: Liquidity risk management depends on operational risk management and the complexity of instruments and markets.
• Recommendation 2: Internal liquidity allocation should consider transfer pricing and liquidity under various scenarios.
• Recommendation 3: Liquidity monitoring should be segregated and handled by a dedicated unit. Regulators should also monitor market liquidity and concentration build-ups.
• Recommendation 5: Regulators should avoid one-size-fits-all solutions to prevent systemic risk.
• Recommendation 6: Liquidity assessment must be context-specific, considering the firm’s usual business environment.
• Recommendation 7: Netting agreements and collateral rules should be reviewed and adapted post-credit crisis, especially for cross-asset agreements.
• Recommendation 8: Documentation risk and covenant risk are part of counterparty liquidity risk.
• Recommendation 10: Business networks and clients should be categorized and rated based on transaction processing speed.
• Recommendation 13: Liquidity monitoring units should have enterprise-wide responsibility and be independent from business units.
• Recommendation 14: Quantitative analysis may not capture realistic liquidity impacts; monitoring vulnerabilities is more effective.
• Recommendation 16: Regulators must be cautious not to inadvertently create new systemic risks through liquidity buffer methodologies.
• Recommendation 17 & 21: Contingency funding scenarios should be dynamically updated based on concentration analysis.
• Recommendation 19: Regulators should gather and consolidate data across markets, instruments, and countries to better identify concentrations and risks.
• Recommendation 26: Standardized regulatory approaches should be discouraged to avoid inflexibility and systemic risk.
• Recommendation 29: Special attention should be given to cross-border and cross-market implications. International liquidity watch groups should be formed with data providers' support.

Conclusion

Thomson Reuters underscores the importance of a holistic and dynamic approach to liquidity risk management. It advocates for real-time monitoring, context-specific scenarios, and individualized risk frameworks. The firm also calls for regulatory flexibility and collaboration across markets to prevent systemic liquidity risks.

Contact Details
Philippe Carrel
Executive Vice President
Thomson Reuters
+41583065409
philippe.carrel@thomsonreuters.com