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Let’s Talk Liquidity Opportunities in a New Market Environment


We are delighted to introduce this new research, “Let’s Talk Liquidity: Opportunities in a New Market Environment.” Drawing on the findings of a major survey commissioned by State Street and the Alternative Investment Management Association (AIMA), it explores the evolving market liquidity environment, driven by regulatory change and other factors.

We canvassed the views of 300 institutional asset owners, managers and hedge funds to explore how the current environment is driving innovative approaches and paving the way for new liquidity providers to emerge.

To reflect the diversity of insight across the industry, we also interviewed several financial industry participants, who were happy to speak on the record regarding these themes. We thank them for their participation.

The findings of this research are highly encouraging. Against a backdrop of structural evolution in markets, the industry is increasingly getting to grips with the resulting challenges. Asset owners and managers continue to enhance how they measure, model and report differing forms of liquidity, from market liquidity to fund liquidity. They are also looking to adapt investment strategies and increase portfolio diversification.

The report considers important new trends and potential future developments, including a growing role for hedge funds and other nonbank institutions as market liquidity providers.

Our survey results also highlight the ways in which technology and digital innovation are driving positive change. Electronic venues are helping to connect supply and demand participants more efficiently, and facilitate new partnerships that support the evolution and strength of the financial industry as a whole.

We hope this paper and survey findings make a useful contribution to broader industry dialogue about market liquidity issues. We are pleased to share this report with you.

George Sullivan,Global Head, Alternative Investment Solutions, State Street Corporation Jack Inglis, CEO, AIMA

Introduction: Understanding the New Liquidity Environment

The 2008 financial crisis sparked a concerted effort from regulators to improve the resilience of the global financial industry. They have sought to safeguard against any repeat of the turmoil that hit the global economy.

They introduced comprehensive regulatory reforms — notably Basel III and the Dodd-Frank Wall Street Reform and Consumer Protection Act — that have required banks to strengthen their capital positions and curb their proprietary trading activities.1

Historically low interest rates and slow rates of growth in the global economy have further constrained banks’ activities as they seek to maximize their return on equity. With weaker balance sheets and shareholder pressure to improve profitability, banks have rationalized their business models, including traditional prime brokerage offerings.

Many banks may no longer be able to perform their traditional roles as liquidity providers and market makers in certain security types. Fixed income, currency and commodities trading have come under particular pressure. Regulation and banks’ consequent retrenchment have fundamentally changed market liquidity conditions.2

In a new State Street survey of 300 institutional asset owners (including pension funds, insurance firms and endowment funds), asset managers and hedge funds, 30 percent of respondents say that their portfolio has become less liquid in the past three years.3 It is not a short-term blip: nearly half (48 percent) of respondents say that decreased market liquidity is a secular shift that is here to stay.

This shift has serious ramifications for investors globally. They are seeking to develop the right strategies and tools to help them succeed in this complex new environment. This includes improving the way they measure and report on liquidity risk, and reassessing how they manage risk in their investment portfolios. More broadly, a new liquidity environment is emerging in which trading roles have been transformed, new market entrants are emerging, and electronic platforms and peer-to-peer lending are changing the way firms transact their business.

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