7.2.4.3 Liquidity

292. Supervision of liquidity1 is an aspect of prudential supervision which is primarily focused on the (prudential) supervision of credit institutions. Credit institutions, given their liquid funding profile2 in the form of deposits, should be subject to liquidity supervision to prevent shortages of cash in the credit institution, which would then be unable to repay its deposits. Investment firms, however, have a smaller need for liquidity. The funds and securities belonging to clients should be segregated from the funds and securities belonging to the investment firm, as discussed in Chapter 4. The investment firm should then be able to ensure that their investors always have access to their funds and securities. In the end, if an investment firm fails, the own funds requirements should (theoretically) provide enough capital to wind down the firm’s business and transfer the investor’s funds and securities to another investment firm, with minimal disruption of service to the investor and no loss of funds or securities for the investor.

293. Given this reasoning, the liquidity requirements of the CRR are only applicable to certain types of investment firms, namely those which are authorized to perform the investment services and activities of ‘trading on own account’ and ‘underwriting on a firm commitment basis’.3 These activities require investment firms to have a more liquid funding profile since they are inherently riskier for the investment firm itself than other investment services such as investment advice or portfolio management. Especially if these activities are combined with brokerage or asset management activities in one investment firm, the risks of failure of the investment firm and therefore the risk of disruption of services increases. Further research could be conducted into whether the liquidity metric as included in the CRR is the best prudential requirement for supervision of investment firms, as there is a greater separation between client assets and firm assets as compared to a credit institution.

294. For firms which only deal on own account and have an own funds requirement according to Article 96, Paragraph 1, point b,4 the benefits of a liquidity requirement as included in the CRR are not directly apparent. These types of investment firms have no external clients and only trade for the benefit and risk of the owners of these investment firms. If these ‘traders on own account’ fail, the only investors affected are the owners of the company. Therefore, a liquidity requirement to protect these investors, which are also the main risk takers of the company, seems redundant. The second reason for prudential supervision is the protection of financial stability. To ensure that these traders for own account pose a controllable risk to the financial sector, the own funds requirement should be increased. A liquidity requirement does not seem to have much merit for investment firms which will not usually have a highly liquid funding profile.