Assets are considered to be HQLA if they can be
easily and immediately converted into cash at little or no loss of value. The
liquidity of an asset depends on the underlying stress scenario, the volume to
be monetised and the timeframe considered. Nevertheless, there are certain
assets that are more likely to generate funds without incurring large discounts
in sale or repurchase agreement (repo) markets due to fire-sales even in times
of stress. This section outlines the factors that influence whether or not the
market for an asset can be relied upon to raise liquidity when considered in
the context of possible stresses. These factors should assist supervisors in
determining which assets, despite meeting the criteria from paragraphs 49 to
54, are not sufficiently liquid in private markets to be included in the stock
- Low risk:
assets that are less risky tend to have higher liquidity. High credit standing
of the issuer and a low degree of subordination increase an asset’s liquidity.
Low duration,(7) low legal risk, low inflation risk
and denomination in a convertible currency with low foreign exchange risk all
enhance an asset’s liquidity.
- Ease and
certainty of valuation: an asset’s liquidity increases if market participants
are more likely to agree on its valuation. Assets with more standardised, homogenous
and simple structures tend to be more fungible, promoting liquidity. The
pricing formula of a high-quality liquid asset must be easy to calculate and
not depend on strong assumptions. The inputs into the pricing formula must also
be publicly available. In practice, this should rule out the inclusion of most
structured or exotic products
correlation with risky assets: the stock of HQLA should not be subject to wrong-way
(highly correlated) risk. For example, assets issued by financial institutions
are more likely to be illiquid in times of liquidity stress in the banking sector.
- Listed on a developed and recognised exchange: being
listed increases an asset’s transparency.
- Active and
sizable market: the asset should have active outright sale or repo markets at
all times. This means that:
- There should
be historical evidence of market breadth and market depth. This could be
demonstrated by low bid-ask spreads, high trading volumes, and a large and
diverse number of market participants. Diversity of market participants reduces
market concentration and increases the reliability of the liquidity in the market.
- There should
be robust market infrastructure in place. The presence of multiple committed market
makers increases liquidity as quotes will most likely be available for buying or
- Low volatility:
Assets whose prices remain relatively stable and are less prone to sharp price
declines over time will have a lower probability of triggering forced sales to meet
liquidity requirements. Volatility of traded prices and spreads are simple proxy
measures of market volatility. There should be historical evidence of relative stability
of market terms (eg prices and haircuts) and volumes during stressed periods.
- Flight to quality: historically, the market has shown
tendencies to move into these types of assets in a systemic crisis. The
correlation between proxies of market liquidity and banking system stress is
one simple measure that could be used.