Vanishing liquidity. Recently published reports, papers and opinions (cf. summary bibliography in Annex) reveal that market liquidity has become a key concern for many financial market participants and observers, including first and foremost market regulators, supervisors and central banks.

Their new sensitivity can be traced back to several market disturbances in the recent period during which market liquidity abruptly declined or even dried up temporarily. Examples include the mini flash crash in US Treasuries on 15 October 2014, the currency market turmoil caused by the run-up in the Swiss franc after the Swiss central bank unexpectedly removed the euro peg on 15 January 2015, and the market shocks on 24 August 2015 sparked by uncertainty about the situation and outlook of the Chinese economy. Other examples, though seemingly less significant, further underline the magnitude of the issue.
Avoid a repeat of the subprime crisis. Although thankfully these disturbances were short-lived, their intensity sends a warning, given the importance of liquidity to orderly markets.

No one is forgetting that while the particular nature of the products involved played a decisive role, the subprime crisis was triggered in mid-2007 by a realisation that these products, previously thought of as liquid, were in fact virtually illiquid, posing a major risk to the representativeness of the prices at which they were traded. This created considerable uncertainty about the balance sheet value of participants that had acquired the products, especially banks, which unleashed the ensuing systemic crisis.
Build a more resilient system by strengthening the resilience of financial institutions. Since that time, the goal has been to vigorously strengthen the resilience of the financial system in general and of banks in particular, notably by bolstering the prudential requirements placed on financial institutions.

But greater resilience will have limited effect if orderly markets, of which liquidity is a key indicator, are not also in place. Without fairly stable and sustainable market liquidity, the price discovery process is undermined. This in turn raises questions about the valuation of many assets and, more generally, about the ability of economic agents to raise financing and hedge their risks cost effectively. The danger is that this situation could trigger the same spiral that in autumn 2008 dragged Western economies into a crisis whose fall-out continues to this day. Accordingly, the weaknesses exposed by the recently observed disruptions in liquidity need our full attention.

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