Liquidity Risk Management is now central stage for Regulators and Investment Managers globally.
In Europe, there are liquidity provisions included in 3 different sets of European Regulation.
Introduction to Liquidity
- UCITS
- AIFMD
- EU Money Market Funds Regulation
For details on these, see the Liquidity Risk Management e-Learning training course.
However, much of the UCITS and AIFMD provisions are increasingly being built-upon by emerging best practice and Regulatory Guidelines, including by ESMA’s 16 Guidelines on the Liquidity Stress Tests for UCITS and AIFs which comes into force 30th September 2020. These also apply to EU Money Market Funds as they are either UCITS or AIF.
There is also a huge amount of work being done internationally, e.g. by IOSCO, at a European level (e.g. by ESMA) and at a national level, including across Europe, by the US SEC and Hong Kong SFC.
Of these some of the stand-out developments include:
- IOSCO Statement on Liquidity Risk Management Recommendations
- UK Non-UCITS Retail Schemes Investing in Illiquid Assets Instrument 2019
- ESMA Common Supervisory Action on UCITS Liquidity Management
- Hong Kong SFC Circular to Licensed Corporations Managing the Liquidity Risk of Funds
Details of all these Regulations and Guidelines can be found at this section below and links to the regulations and guidance can be found here.
International Rules & Guidelines
United Kingdom
Non-UCITS Retail Schemes Investing in Illiquid Assets Instrument 2019
New rules apply to certain types of open-ended fund investing in inherently illiquid assets such as property.
New rules will apply to non-UCITS retail schemes (NURSs), but will not to UCITS, which are already subject to restrictions relating to such assets.
Introduce a new category of ‘funds investing in inherently illiquid assets’ (FIIA).
New requirement that NURSs investing in inherently illiquid assets must suspend dealing where the independent valuer determines there is material uncertainty regarding the value of more than 20% of the fund’s asset.
FCA handbook changing in 3 area:
- Suspension of dealings in units (Chapter 3)
- Improving the quality of liquidity risk management (Chapter 4)
- Increased disclosure (Chapter 5)
New rules enter into force 30th September 2020.
FCA Letter to Authorised Fund Managers on Effective Liquidity Management
In November 2019, FCA published a letter to Authorised Fund Managers on Effective Liquidity Management. The FCA identified the following good practices:
- Processes to ensure that the fund dealing (subscriptions and redemptions) arrangements are appropriate for the investment strategy of the fund.
- A regular assessment of liquidity demands.
- An ongoing assessment of the liquidity of portfolio positions.
- The use of liquidity buckets.
- An independent risk function that monitors portfolio bucket exposures regularly and reports breaches to the set limits.
- Stress testing used by fund managers to assess the impact of extreme but plausible scenarios on their funds.
FCA and Bank of England Statement on Joint Review of Liquidity Vulnerabilities in Open-ended Funds
The Report sets out the initial findings of a joint review by the Financial Conduct Authority (FCA) and the Bank of England on open-ended investment funds and the risks posed by their liquidity mismatch.
The Financial Policy Committee stated that if greater consistency between the liquidity of a fund’s assets and its redemption terms is to be achieved:
- Liquidity of funds’ assets should be assessed by reference to the price discount needed for a quick sale of a representative sample (or vertical slice) of those assets or the time period needed for a sale which avoids a material price discount. In the US, the Securities and Exchange Commission has recently adopted measures of liquidity based on this concept.
- Redeeming investors should receive a price for their units in the fund that reflects the discount needed to sell the required portion of a fund’s assets in the specified redemption notice period, ensuring fair outcomes for redeeming and remaining investors.
- Redemption notice periods should reflect the time needed to sell the required portion of a fund’s assets without discounts beyond those captured in the price received by redeeming investors.
Hong Kong
Hong Kong SFC Circular to Licensed Corporations Managing the Liquidity Risk of Funds
SFC issued a circular highlighting deficiencies or inadequacies noted in fund managers’ liquidity risk management practices.
The SFC’s survey and inspections noted inadequacies or deficiencies on the part of some Authorised
Fund Managers in maintaining proper liquidity risk management systems and controls in the following areas:
- overall liquidity risk management framework;
- assessments of liquidity profiles of fund assets and liabilities;
- stress testing;
- governance structure for risk management;
- risk management reports; and
- documentation.
Europe
ESMA Liquidity Stress Test Guidance
Fund managers will need to apply a comprehensive set of guidelines when designing the scenarios, policies and frequency of liquidity stress tests for the funds they manage.
Recommend managers to notify National Competent Authorities (NCAs) of material risks and actions taken to address them.
Depositaries required to verify that the fund manager has in place documented procedures for its liquidity stress testing programme.
The Guidelines set out in Annex III, provide the compliance and reporting obligations which include:
- Liquidity Stress Testing on UCITS and AIFs;
- Guidelines applicable to managers;
- Guidelines applicable to depositories; and
- Interaction with National Competent Authorities
- The Guidelines will become applicable on 30 September 2020.
Common Supervisory Action on UCITS Liquidity Management
ESMA launched a Common Supervisory Action (CSA) with national competent authorities (NCAs) on the supervision of UCITS’ managers liquidity risk management across the European Union (EU).
The CSA will be conducted during 2020.
The first stage of the CSA will involve NCAs requesting quantitative data from a large majority of the UCITS managers based in their respective Member States, to get an overview of the supervisory risks faced.
In the second stage, NCAs will focus on a sample of UCITS managers and UCITS to carry out more in-depth supervisory analyses.
In terms of reporting, the e Investment Company Reporting Modernization (ICRM) rule introduced new monthly and annual reporting forms:
U.S. SEC Liquidity Risk Management
On October 13, 2016, the U.S. Securities and Exchange Commission (SEC) adopted new rules and forms to promote effective liquidity risk management for open-end management investment companies.
The legislative changes to the Investment Company Act 1940 included:
- Fund Liquidity Risk Management Programs (rule 22e-4)
- Investment Company Reporting Modernization (new and amended forms)
- Investment Company Swing Pricing (amendments to rule 22c-1)
Key elements of the liquidity risk management program includes:
- Liquidity risk assessment
- Liquidity classification
– 15% limit on illiquid assets
– Highly liquid investment minimum requirement - Board oversight
In terms of reporting, the e Investment Company Reporting Modernization (ICRM) rule introduced new monthly and annual reporting forms:
- N-PORT
- N-CEN
This is documented in our separate ATLAS Module on SEC Liquidity Risk Management. Click here to access.
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