8.2 Assessing liquidity risk

Competent authorities should evaluate the impact on liquid assets under severe, but plausible conditions and how the investment firm is ready to mitigate the stressed outflows in accordance with the liquidity risk management framework referred to in Section 8.4 of these guidelines.

Competent authorities should assess the amount of liquid assets needed to ensure that the investment firm maintains adequate levels of liquid resources addressing material sources to risk of the investment firm, including risk to clients, risk to market, and risk to the investment firm under both normal and severe, but plausible conditions to cover idiosyncratic, market-wide and combined shocks.

In evaluating the impact of severe, but plausible conditions on the investment firm’s liquidity needs, competent authorities should assess all material sources of liquidity risk, including risk to clients, risk to market and risk to the investment firm as well as liquid resources needed for the potential investment firm’s orderly wind-down. In particular, competent authorities should assess all of the following:

• a. if the investment firm holds clients’ assets or money and its ability to return such assets in a timely manner under severe but plausible scenarios;
• b. if the investment firm assesses its liquidity needs for its other off-balance sheet activities taking into account that the contingent nature of off-balance-sheet instruments adds complexity to the management of related cash flows;
• c. other potential sources of cash outflows including swaps, written or sold over the counter (OTC) options, other interest rate contracts, forward foreign exchange rate contracts, margin calls, and early termination agreements;
• d. if there are difficulties in accessing certain markets;
• e. if the foreign currency markets may lack liquidity;
• f. if the foreign exchange rate may depreciate sharply when the investment firm conducts transactions in foreign exchange at significant scale; and
• g. if the investment firm which leverages its positions is exposed to liquidity risk because of the risk of decrease in the market value of a position that would trigger the need for additional collateral or margin that would require to quickly liquidate its positions.

Evaluation of intraday liquidity risk

For investment firms that deal on own account, competent authorities should assess if the investment firm has a sufficient level of high-quality liquid assets and other liquidity inflows to cover liquidity outflows on a daily basis, including intraday period. Competent authorities should assess investment firms that engage into market making activity more comprehensively. However, it should take into consideration any liquidity risk mitigation provided by clearing transactions via a clearing member.

Competent authorities should base their assessment on the investment firm’s analysis of intraday liquidity risk in accordance with Article 29(1), point (d) of Directive (EU) 2019/2034. Intraday liquidity should be assessed under normal and severe but plausible conditions.

For the purposes of the intraday liquidity risk assessment, competent authorities should assess if the investment firm clears its positions via clearing members or operates in an over-the-counter market. If the investment firm is guaranteed by a clearing member or any other party, the competent authority should assess the effectiveness of the guarantees in mitigating liquidity risk.

For the assessment of liquidity needs under normal conditions and the evaluation of intraday liquidity risk, competent authorities should support the analysis with evidence from the investment firm’s internal reports and information, and from supervisory reporting data as specified in the implementing regulation adopted in accordance with Article 54(3) of Regulation (EU) 2019/2033.

Competent authorities should assess the investment firm’s exposure to intraday liquidity risk, including the intraday availability of liquid assets. Competent authorities should assess whether daily settlement requirements will be met including an evaluation of available intraday liquidity or of accessible liquidity under normal conditions as well as during financial or operational events that may affect liquidity access such as IT failures, legal constraints on the transfer of funds or trading counterparties’ default.

Evaluation of available liquid resources

For investment firms which are market makers as defined in Article 2(1), point (k) of Regulation (EU) No 236/2012, competent authorities should assess available liquid resources. Competent authorities should perform similar assessments on investment firms that do not qualify as market makers to the extent that the competent authorities deem it to be appropriate.

Competent authorities should assess the adequacy of the liquidity resources of investment firms that are market makers necessary to meet its liquidity needs over different time horizons, including intraday. This assessment should take into account all of the following criteria:

• a. the liquid assets available in a timely manner for the investment firm’s viability under normal and severe but plausible conditions;
• b. the overall liquid assets available to the investment firm over the full period of the relevant severe, but plausible conditions;
• c. the characteristics of different severe, but plausible conditions, such as severity and duration, and periods considered in the evaluation of the investment firm’s liquidity needs;
• d. the amount of assets that would need to be liquidated over the relevant time horizons; and
• e. whether the actual liquid resources, including the quality of liquid assets, are in line with the investment firm’s liquidity risk;
• f. the availability and magnitude of liquidity resources provided by a clearing member.

Competent authorities should assess the ability of investment firms that are market makers to monetise its liquid assets in a timely manner in order to meet its liquidity needs during a stress period. Competent authorities should take into account all of the following criteria:

• a. whether the investment firm tests its market access by selling or repoing on a periodic basis;
• b. whether there are high concentrations that may represent a risk of wrongly anticipated liquid resources;
• c. whether the liquidity resources are readily available and under the control of the relevant staff;
• d. whether the denomination of the liquid assets is consistent with the distribution of liquidity needs by currency;
• e. where the investment firm has borrowed liquid assets, whether it would no longer have them available to meet its outflows under severe but plausible conditions considering the net effect of the transaction; and
• f. the reliability of the committed liquidity facilities if they are used by the investment firm.

Evaluation of funding

When assessing the risk to liquidity competent authorities should assess the investment firm’s funding arrangements and stability of funding sources under both normal and severe, but plausible conditions.

Competent authorities should assess the appropriateness of the investment firm’s funding profile taking into account all of the following criteria:

• a. whether the investment firm’s obligations are adequately met with stable funding;
• b. whether – in the case the investment firm belongs groups – there are regular intragroup flows of liquidity and whether they are mandated by contracts and are still in effect; and
• c. whether the investment firm has access to credit facilities from a credit institution or another group entity or other alternative funding sources.

Competent authorities should assess the diversity of funding sources. The assessment should consider if funding is secured or unsecured, such as the use of repurchase agreements, securities lending markets, issuance of long-term debt in the public and private markets, a variety of short-term funding instruments such as bank loans, and, where relevant, the diversity of regional markets.

Competent authorities should assess whether potential shortcomings arising from the investment firm’s funding profile, such as inflows and outflows mismatches in market activities breaching acceptable boundaries, or excessive concentrations of funding sources, could lead to liquidity risk. Competent authorities should assess the level of investment firm’s reliance on particular funding sources based on investment services, nature and provider of the funds.

Competent authorities should consider factors that may reduce the stability of the funding in relation to the type and characteristics of both assets and liabilities.

Competent authorities should assess risk to the sustainability of the investment firm’s funding profile arising from concentrations in funding sources. They should take into account whether the investment firm’s counterparties are single or connected and other concentration risk that may affect the investment firm’s access to funding in the future. The assessment should include reliability of the investment firm’s alternative funding strategies, and their adequacy to protect the firm.