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Analysis

OMFIF report: Mastering flows, strengthening markets

OMFIF Report – Press Release

11 October 2016

London

BNY Mellon Cover Page (2)

Sovereign investment institutions are willing to help overcome constraints on global liquidity through increased securities lending and direct funding of less-liquid asset classes, according to a report by OMFIF and BNY Mellon. 

‘Liquidity has been under strain for many reasons over the last eight years since the financial crisis’, said David Marsh, managing director of OMFIF. ‘These reasons include regulation, economic developments and political and financial upsets which have conspired to slow down the flows of liquidity, which you can see reflected in the markets.’ 

The findings, in ‘Mastering flows, strengthening markets: how sovereign institutions can enhance global liquidity’, are based on a survey conducted by OMFIF and BNY Mellon of more than two dozen sovereign institutions. The findings indicate that a majority of sovereign investors expect liquidity conditions to tighten further in the next 12-24 months. 

The report says that post-crisis financial regulations, especially the Basel lll rules on capital adequacy, have lowered market-making activity and proprietary trading. 

The study shows, too, the partly contradictory effects of measures taken by central banks to increase liquidity in markets through quantitative easing and low or negative interest rates. ‘One QE goal was to pump liquidity into markets,’ says John Plender, OMFIF chairman. ‘The central banks’ bond-buying programmes have contributed to a global shortage of safe assets just when the demand for such assets has become voracious.’ 

To combat these challenges, 75% of survey respondents indicated that they are willing to play an enhanced capital markets role, especially via securities lending operations. Respondents said they would allocate between 10% to 15% of their balance sheets for securities-lending activities, with some reporting they are considering up to 60%. 

Respondents said they expect an additional return of five to eight basis points from these activities. 

‘As sovereigns begin to play a more active capital market role to offset some of the challenges of bank disintermediation and lower liquidity, the potential advantages are significant,’ writes Pooma Kimis, director of markets and institutions at OMFIF. ‘These benefits reflect not just an increase in market liquidity and resilience to destabilising shocks, but also the rewards of higher yields to offset the disbenefits of low interests rates for high-quality liquid assets.’ 

While the liquidity drought may be manageable for now, it may cease to be so when central banks retreat from their unconventional measures. As Aerdt Houben, director of financial markets at De Nederlandsche Bank says in a foreword, ‘With recognition of the different constraints sovereign investors are subject to, increasing our understanding of the channels through which they can provide relief is important. This report provides a timely contribution to the debate.’

To request a PDF of the report, please email editorial@omfif.org stating your name and institution. 

To view a video accompanying the release of the report, click here