US bond flash crash one year on: What have we learned?


Twelve months have passed since the nerve-shredding "flash crash" in U.S. Treasurys and the financial industry is pushing though initiatives aimed at improving stability and liquidity in global fixed income markets.

On October 15, 2014 traders and investors were left reeling after the yield, which moves inversely with a bond's price, on the 10-year U.S. Treasury plunged 33 basis points to 1.86 percent before rising to settle at 2.13 percent — seven standard deviations away from its intraday norm. U.S. Treasurys are seen across the globe as a safe haven for investors, so any wild fluctuations have massive ramifications for the financial community — and how the U.S. raises money.

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The rollercoaster ride was enough to spook leading global policymaking and regulatory bodies into reinforcing liquidity management and examine how the asset management industry has affected the fixed-income market.

Indeed, the International Monetary Fund in its September report warned that "changes in market structures — including growing bond holdings by mutual funds and a higher concentration of holdings — appear to have increased the fragility of liquidity."

The report highlighted two aspects of the asset management industry that were of particular concern: The increased tendency for mutual and hedge funds to follow benchmark-style investing — which encourages the buying of the same securities across the industry — and the ability for many investors to redeem their capital on a daily basis.

Regulators face the challenge of creating a stable infrastructure without dismantling the ability of asset managers to do their job. National authorities have also had to balance adhering to global stability measures with protecting what is a highly valuable industry for many economies — including the UK.

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Speaking to CNBC during October's IMF conference in Lima, U.K. Chancellor George Osborne said: "The asset management industry is a really important industry for getting financing into productive ventures, helping companies to grow and it's also a very important industry in its own right — it employs a lot of people — and I want Britain to be the undisputed home of that industry, the best place in the world to run your asset management business."

Osborne also reaffirmed his faith in the work of the U.K.'s central bank, saying: "l'm confident that with Mark Carney in the Bank of England doing their job well at the moment we can do that in a way that doesn't damage that industry but actually strengthen that industry."

Recent developments have seen sentiment on how to tackle the role of asset managers move away from singling out individual fund managers and toward a more holistic approach considering how combined activities of managers affect overall systemic stability.

This trend is supported by the International Organization of Securities Commissions (IOSCO). Speaking exclusively to CNBC, IOSCO's Secretary General David Wright said: "IOSCO is pleased that the work on asset management with the FSB (the UK's Financial Stability Board) is focusing now on an activities-based approach and not on a mechanical, parametric so-called "designation approach" which is now lodged in the refrigerator."

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Wright continued, "In taking this important work forward on liquidity risk mismatch issues, leverage in funds, securities lending and operational risks etc it is essential to establish the facts based on good data and analysis. In addition an holistic approach is needed i.e. looking at all parts and behavior of the market including in stressed market conditions — open-ended investment funds but also pension and insurance funds; hedge funds and sovereign wealth funds; and indeed the behavior of ordinary investors. In the policy evaluation process next year existing investment fund laws in different jurisdictions also need to be fully appraised."

Initial work begun in the U.S. in 2013 had focused more closely on the potential designation of individual managers as systemically important, raising the prospect of such firms being subject to increased scrutiny and regulation. A surge of criticism against this approach had led to an open forum in May 2014 where industry participants were invited to respond. Bennett Golub, chief risk officer and founding partner at BlackRock, the world's largest asset manager with $4.5 trillion of assets under management, is reported to have been instrumental in encouraging regulators to consider an activities-based approach during the ongoing consultation process.

Speaking exclusively to CNBC on Saturday, Golub said, "We think that an activities-based approach is the only rational way to address systemic concerns that might be present in products or markets, and policymakers have come to the same view. Asset owners, not asset managers, are the ultimate determining actors. Regulation of the actual activity raising concerns is therefore necessary, regardless of who undertakes it."

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