3.3 Liquidity and Settlement Limitations

Liquidity is the lifeblood of financial markets, yet in many asset classes—especially private equity, real estate, and bespoke debt—the ability to convert holdings into cash remains constrained by design. Lock-up periods protect managers but immobilise capital for years, sometimes a decade or more. When secondary windows do open, trading is negotiated over the phone, dependent on specialist brokers who maintain rolodexes of known buyers. Spreads can be wide and opaque, driven by asymmetric information rather than transparent order books. Sellers face a dilemma: accept a punitive discount to exit quickly or remain tied to an asset whose risk profile or personal relevance may have changed dramatically.

Fixed-income markets illustrate a different flavour of liquidity bottleneck. Settlement systems tied to regional central depositories still close at end-of-day local time. An Asian investor holding North American bonds cannot complete a same-day sale if the U.S. market shuts before Asian business hours begin. Hedging via derivatives is possible but introduces basis risk and additional margin requirements. During periods of stress—flash crashes, geopolitical shocks—windows of non-overlap amplify volatility as liquidity vanishes precisely when demand for transactions peaks.

Even supposedly liquid assets like publicly traded corporate shares are subject to T+2 settlement, meaning counter-party risk persists for two full business days. In volatile markets, that gap can represent a meaningful price swing, forcing brokers to demand margin that eats into client capital. The systemic implication is that substantial sums sit idle as collateral—even for plain-vanilla equity trades—eroding overall capital efficiency.

Price discovery suffers alongside liquidity. When transactions are infrequent or negotiated privately, published valuations become stale, making it harder for new entrants to gauge fair value. This opacity reinforces wide spreads, and the cycle perpetuates itself: poor liquidity discourages participation, which in turn begets poorer liquidity. Issuers pay the price via higher risk premiums because investors demand compensation for the anticipated difficulty of exiting. Eventually, projects that could have been financed at lower rates either scale back or fold altogether, dampening innovation and employment.