Markit develops liquidity ranking metrics for fixed-income products.
It has become fashionable, in the wake of the financial crisis, to refer to liquidity as a “fantasy” — meaning it’s only available when you don’t need it. But a mere three years ago, most market participants assumed that market liquidity would be available for even fairly esoteric products. The issue of liquidity risk was not center stage for bank regulators, nor for corporates loading their pensions to the gills will higher-yielding but complex products and plowing their cash into auction-rate securities.
Now, of course, the failure to identify and manage liquidity risk is seen as one of the principal vectors of the crisis. Rating agencies are attempting to bake it into their credit evaluations and financial regulators are scrambling to determine how much of a problem it could be for their various charges. The latest manifestation of the recognition that it needs to be quantified somehow comes from market data vendor Markit.
The firm plans to introduce liquidity metrics for credit default swaps, bonds and loans that it provides pricing information on. Starting in April, Markit will issue liquidity ratings running from 1 (very liquid) to 5 (not so). Among the factors it will consider are market depth, bid/ask spreads and the freshness of data contributions.
Given Markit’s expertise in both the CDS and cash fixed income markets, its new product is a welcome addition to the tools providing insight into liquidity risk. Treasurers might remember, however, that the firm is also the facilitator of the CDS and CDX linked revolver pricing that elicits groans when they get together at The NeuGroup’s peer meetings. The liquidity ranking would give banks seeking to hedge an undrawn exposure to a client another “objective” benchmark to toss on the table and possibly mix into pricing or terms.
But apart from that, the liquidity crisis of 2007-08 had systemic causes that went far beyond each individual exposure’s characteristics. It was the massive leverage and cross-margining that caused the collapse in prices of even good assets when counterparties started demanding more collateral on the bad ones. Regulators are trying to defuse the crazy-quilt of bilateral exposures that led to this in the CDS market through central clearinghouses. But even if they’re successful, that leaves a lot of ground uncovered. Markit’s tool will probably be a useful one. But it and similar initiatives shouldn’t deflect attention from the bigger systemic liquidity issues.