23. Key criteria for determining the relevant liquidity horizon

Institutions should document the criteria used in the determination of the relevant liquidity horizon for a position or set of positions. The methodology for converting those criteria into a defined liquidity horizon should also be documented and applied consistently for all positions.

A wide range of criteria can indicate the liquidity of a position, based on past experience, market structure, and the quality or complexity of the product. Institutions should identify a range of criteria that they believe materially define the liquidity horizon of their portfolios. These criteria include:

• i. Market activity, as reflected in number and volume of trades in an instrument or name, or in the size of historical bid-offer spreads;
• ii. Market structure, such as the number and distribution of market makers and quotes;
• iii. Size of position (relative to average trading volumes/overall market size);
• iv. Investment quality (e.g. credit rating);
• v. Geographical location of issuer;
• vi. Maturity.

At least one of the criteria considered in the determination of a liquidity horizon should be directly linked to the concentrated nature of positions (for example, through the size of position relative to the market size or average trading volumes), given that the liquidity horizon is expected to be greater for positions that are concentrated, reflecting the longer period needed to liquidate such positions.

Positions should be systematically assessed against the criteria chosen and allocated to liquidity horizons accordingly (with a floor of 3 months). Where limited data is available on a position or set of positions, institutions should be conservative in determining the relevant liquidity horizon.

The approach applied to link a criterion to a longer or shorter liquidity horizon should be documented and supported by historical evidence including evidence based on experience of liquidating similar positions during stressed periods, to ensure that assumptions which appear theoretically logical but are not true in practice are not mistakenly used in the analysis – for example it may not be true in 19 all cases that a lower credit rating implies a longer liquidity horizon if there is an active market in certain types of positions with low credit ratings. For example, in the case of the use of historical bid-offer spreads, institutions may set thresholds which determine which liquidity horizon a position is allocated to – the choice of these thresholds should be justified.