BoE's Cunliffe says fund redemptions could hurt market liquidity

(Adds BlackRock comment)

By Huw Jones

LONDON, Oct (HKSE: 3366-OL.HK - news) 22 (Reuters) - The Bank of England and international authorities are examining whether promises by funds to give investors their money back at any time could end up damaging liquidity in markets, a top BoE official said on Thursday.

Sharp moves - "taper tantrums" - in U.S (Other OTC: UBGXF - news) . government bond prices have raised concern among central banks, with asset managers worried they face heavy new rules.

"A particular concern occupying both the (BoE's) Financial Policy Committee and authorities internationally is that simultaneous redemptions from open-ended funds offering short-term redemptions could test the resilience of market liquidity," BoE Deputy Governor Jon Cunliffe said.

Asset managers and investment funds were not a source of instability in the 2007-09 financial crisis, but the past is not always a guide to the future, Cunliffe told a British Bankers' Association conference.

Banks have blamed shrinking liquidity in secondary government and corporate bond markets on higher capital requirements, making their trading activities uneconomic.

Hans Peter Lorenzen, managing director of corporate securities strategy at Citi bank, said a plethora of new regulation is a big part of why "air pockets" have emerged in bond markets.

"It (Other OTC: ITGL - news) has just become much harder to make markets," Lorenzen told the conference.

Regulatory changes need to become more coherent, Cunliffe said, after so many new rules were introduced since the crisis to make under-capitalised banks more resilient.

"It is quite conceivable that given the range and speed of regulatory reforms, there are parts of the framework that might not work in the way we intended," Cunliffe said.

But there was no going "back to the future" of tolerating more risk to financial stability as memories of the 2007-09 crisis fade, he said.

Changes in the structure of markets and the ability of technology to connect buyers and sellers could also increase liquidity, he added.

"It remains for me, however, an open question whether such liquidity would be resilient in times of stress. Automated markets may have driven down costs, but are possibly less resilient," Cunliffe said.

Funds already have ways to manage liquidity risks, but Cunliffe said investors may not fully appreciate how their ability to redeem, at or close to, current market prices could be compromised by large simultaneous withdrawals.

Joanna Cound, head of government affairs at BlackRock (Swiss: BLK.SW - news) , the world's biggest asset manager, said poor liquidity has forced the company to split up trades into smaller parcels that can be absorbed by the market.

"We started to make prices, not just to take prices, in an attempt to uncover more latent liquidity," she told the conference.

But funds came through the financial crisis well and volatility does not mean there is risk to financial stability, she said.

"Volatility in the past has not resulted in mass redemptions or fire sales, apart from in money market funds," she added.

Cunliffe said more work needs to be done on policy options, such as a more system-wide approach to stress testing funds.

"A second avenue worth exploring is better data on funds, including the development of more comprehensive metrics that capture the degree of any mismatch of the liquidity of underlying assets and the liquidity offering," Cunliffe said.

The U.S. Securities and Exchange Commission has just proposed ways for funds to manage liquidity risks. (Reporting by Huw Jones, editing by Steve Slater, Larry King)