Liquidity is often described as the lifeblood of financial markets. Yet in recent years, market participants have increasingly asked a simple question: if markets are more electronic, more connected, and more global than ever before, why does liquidity seem to disappear so quickly during periods of stress?
The answer lies not in a lack of liquidity, but in how liquidity has been fragmented, internalised, and re-engineered across modern financial markets; often in ways that obscure where risk ultimately resides.
While South Africa retains a strong central exchange in the JSE, a meaningful share of market risk and liquidity exposure increasingly sits in OTC instruments and offshore-linked products, where liquidity is sourced dynamically rather than through committed market-making.
Liquidity has not vanished – it has moved
Traditional views of liquidity focus on central exchanges, visible order books, and designated market makers. Today, a growing share of liquidity sits outside these venues. Internalisation, OTC execution, synthetic instruments, and platform-based pricing models have redistributed liquidity across a network of intermediaries and balance sheets (BIS, 2022; IOSCO, 2023).
In normal conditions, this structure delivers tight spreads, fast execution, and low transaction costs. However, much of this liquidity is conditional– available only as long as volatility, funding costs, and risk limits remain within expected bounds (IMF, 2023; BIS, 2022).
When conditions deteriorate, this liquidity can be withdrawn almost instantaneously.
The rise of “liquidity without commitment”
A significant portion of modern liquidity is provided by entities that do not operate as traditional market makers. Instead, liquidity is dynamically priced, algorithmically managed, and tightly constrained by capital usage, hedging costs, and internal risk models (BIS, 2022).
This represents a structural shift. Liquidity provision becomes reactive rather than absorptive. Rather than stabilising markets during stress, liquidity providers often step back precisely when volatility rises.
The result is a market that appears deep and resilient — until it isn’t.
Risk is being redistributed, not eliminated
Regulatory reforms following the global financial crisis successfully reduced risk-taking within the banking sector. However, risk did not disappear; it migrated. Increasingly, risk is held by non-bank financial institutions, platforms, and end-users, often through leveraged or synthetic instruments (FSB, 2023).
While this improves access and efficiency, it also makes risk harder to trace. Interconnections between counterparties, liquidity providers, and hedging venues are often opaque, particularly in cross-border contexts.
Risk has become diffuse, embedded across market infrastructure rather than concentrated in identifiable balance sheets.
Stress events reveal the true structure
Periods of market stress expose how liquidity truly behaves. Sudden repricing, execution failures, and liquidity gaps are not anomalies — they are signals that liquidity was conditional rather than committed (Financial Times, 2023; BlackRock, 2023)
The core concern is not that markets experience volatility. It is how rapidly confidence erodes once participants realise that liquidity can evaporate simultaneously across venues.
In smaller and more open markets such as South Africa, liquidity withdrawal by a limited number of providers can translate into sharper price moves and wider spreads than those observed in deeper global markets.
Implications for market participants and regulators
For asset managers, brokers, and risk professionals, liquidity risk assessment can no longer rely solely on historical spreads or average daily volumes. Understanding who provides liquidity, under what conditions, and with what constraints is now essential (IOSCO, 2023; BIS, 2022).
For regulators, oversight frameworks designed around identifiable intermediaries must adapt to markets where risk is distributed across algorithms, platforms, and non-bank entities (FSB, 2023).
A more honest conversation about liquidity
Modern markets are not inherently weaker than those of the past; they are unquestionably more complex. Liquidity is faster and cheaper, yet more fragile under stress.
A more honest conversation is needed about where liquidity truly comes from, who ultimately absorbs losses, and how markets behave when conditions deteriorate. Only by understanding where the risk really sits can we design markets that are not just efficient in calm periods, but resilient when it matters most.
For South African market participants, this underscores the importance of understanding not only reported liquidity metrics, but also the underlying conditions and constraints under which liquidity is provided — particularly in markets where concentration and cross-border dependencies remain significant.
References
- Bank for International Settlements (BIS). 2022. Liquidity in core markets. BIS Quarterly Review. Available at: https://www.bis.org/publ/qtrpdf/r_qt2203.htm
- Duffie, D. 2020. Intermediation of Treasury securities. Journal of Economic Perspectives, 34(4): 52–76.
- Financial Stability Board (FSB). 2023. Global monitoring report on non-bank financial intermediation. Basel: FSB. Available at: https://www.fsb.org/publications
- International Organization of Securities Commissions (IOSCO). 2023. Market structure, technology and liquidity. Available at: https://www.iosco.org
- Financial Times (2022–2024) Market liquidity stress. Available at: https://www.ft.com/markets
- International Monetary Fund (IMF). 2023. Why market liquidity dries up under stress. Available at: https://www.imf.org/en/Blogs
- BlackRock Investment Institute. 2023. Liquidity risk in modern markets. Available at: https://www.blackrock.com/corporate/insights
