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4 Liquidity Risk Management Principles For A More Robust Approach

Blog | 08 Apr 2021 11:30/AM GMT

Deficient in liquid assets with changing of market roles and new entrants need market participants to prepare for liquidity risk management.  

Thus, market participants such as institutional or retail investors have to take the right steps to reinforce the liquidity risk management strategies and practices.  

The adequate liquidity risk management principles will enable them to navigate the changing liquidity environment. As a result, market participants are taking on new and diverse roles.  

Liquidity is the ability to rapidly exchange one currency unit for another in a financial market such as forex, and it is important for efficient trading. If the liquidity is at low levels, sudden moves will occur in a currency pair.   

Moreover, as the financial market has become unstable over the years, liquidity management has become more difficult. Therefore, you must comprehend the guiding principles of a robust approach. 

Here are the four most important principles of robust liquidity risk management for your forex business that you can consider and incorporate into your strategic plan. 

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1) An Early Clear View On Liquidity Risks 

The need to measure and report liquidity has become a core competency, but many institutional or retail investors are finding it is challenging.  

Powerful risk analytics are vital to helping you understand your investment strategy and portfolio positioning. This means it is important to have a rigorous process for identifying and measuring liquidity risk. 

The management process should include a forward-looking framework for forecasting potential cash flows.  

In addition, the following elements that can be included in this framework are:  

a) The capacity to perform risk analysis in hypothetical and serious circumstances

b) The preservation of liquid assets as a safety net in the event of a potential shortfall

If you have an early view of liquidity risks, it may reduce the likelihood that you will withdraw money from funds at times of increased volatility and uncertainty. 

2) Measure, Monitor, And Control Liquidity Regularly  

Liquidity risk is now top of mind for the participants in the forex market. After you have a clear view and identified the forex liquidity risk, you need to actively measure, monitor, and control any risk exposures or funding needs.  

It depends on your forex business size, this measuring and monitoring need to account for multiple legal entities, lines, and international currencies.  

3) Stress-Testing The Strategy 

Another important feature of any liquidity risk measurement system is the ability to stress-test main risk factors, such as various liquidity measures and under various market conditions.  

This type of stress testing incorporates both historical and forward-looking information, such as statistical data, scientific findings, and expert opinion. 

Additionally, your stress tests should include both short-term and long-term scenarios. It needs to identify sources of liquidity pressure, as well as ensure all exposures are within your defined liquidity risk tolerance. 

4) Construct A Backup Plan  

Based on the stress test result, you can change your liquidity risk management strategies accordingly. Then, using these new changes, you can construct a structured contingency funding plan that outlines the strategy for dealing with liquidity shortfalls in a variety of situations. 

It is very important to realise that structural changes in risk can appear very quickly.  

In conclusion, these four principles will guide your liquidity management efforts with greater security and confidence for the bid and ask in forex. It will be done quickly and possibly enables a greater volume of transactions.  

As a reputed and trusted liquidity provider, Doo Clearing continues to expand its liquidity offerings and update its infrastructure.  

This includes firmly establishing itself as a competitive liquidity provider that remains committed to providing reliable, advanced, and secure systems.  

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About Doo Clearing   

Doo Clearing is part of The Doo Group, aiming to offer an institutional and bespoke level of liquidity access and clearing services for Forex and CFDs in equities, future and commodities, and other financial products.   

With the robust clearing system powered by Doo Tech, Doo Clearing is now serving brokers, broker-dealers, hedge funds, family offices, fund managers, and professional traders globally.   

Currently, Doo Clearing provides liquidity access and clearing services via our regulated entity in the United Kingdom. The Doo Group has other regulated entities in the United States, Mauritius, and Vanuatu, with operating centres in Hong Kong, Dallas, Singapore, Kuala Lumpur, and among others.  

To get started, contact Doo Clearing’s Specialist team today for an insightful preview of how we can bring your brokerage to the next level.   

London Office   

Email: [email protected]   

Website: www.dooclearing.co.uk  

Hong Kong Office   

Email: [email protected]   

Website: www.dooclearing.com 

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