This month marked one year since the collapse of Neil Woodford’s LF Woodford Equity Income fund. The Woodford fund was suspended in June, after it became overwhelmed by redemption requests from investors.
One year on and investors are still awaiting their final pay-out.
One year on and questions concerning the liquidity mismatches in open-ended funds still remain.
Liquidity Risk Issues in Real Estate Funds and Funds of Funds Sectors
ESMA published a report in early 2020 which found that Fund of Funds and Real Estate Funds, despite being the two sectors with the largest percentage of retail investors (FoF: 31%, Real Estate: 21%), are also the sectors with substantial liquidity issues.
The liquidity vulnerabilities of Real Estate Funds that offer daily liquidity are well documented, however, an ESMA report also found that for the Funds of Funds sector there is also a mismatch in liquidity, as 35% of the NAV is redeemable within a day, while only 24% of assets can be liquidated within that timeframe.
COVID-19 has exacerbated the liquidity mismatch issue and if possible, brought it even further to the forefront. Following the unprecedented challenges brought by the pandemic, we saw a wave of UK open-ended property fund suspensions trapping almost £13 billion of investor cash. Standing independent valuers determined that there was “material uncertainty” over the value of commercial real estate (CRE).
Due to the suspensions, the FCA published a statement stating “suspensions can be used by managers of open-ended funds, in line with their obligations under applicable regulations. In these circumstances, suspension is likely to be in the best interests of fund investors”.
“At least USD62 billion of global mutual funds have suspended redemptions this year to date due to coronavirus-driven market stress” – Fitch Ratings
Increased Scrutiny during COVID-19
The liquidity mismatch is not confined to the UK. Heavy redemptions during the COVID-19 induced sell-off sparked concerns amongst Regulators across Europe, who subsequently increased the scrutiny on the liquidity of asset managers in varying manners.
In Luxembourg, the CSSF introduced a weekly questionnaire, the objective of which is to provide the CSSF with weekly updates on financial data (total net assets, subscriptions and redemptions) and an update on governance arrangements in relation to the activities performed by IFMs.
In France, the AMF issued a reminder to AMCs of their obligations to put in place adequate and effective arrangements, procedures, and techniques to measure and manage at any time the liquidity risks which the UCITS and AIFs they manage are, or might be exposed to. The AMF went on to state that AMCs that breach investment restrictions or experience liquidity difficulties and have to activate certain liquidity management mechanisms (gates, side pockets, suspension of subscription and redemption orders, etc.) must notify the AMF on a daily basis.
In January 2019, in response to Brexit preparedness, the Central Bank increased its monitoring of investment funds liquidity and redemption activity. This involved putting in place arrangements for the collection of new data or increasing the frequency of collection of certain information. These arrangements have remained in place during the COVID-19 pandemic and in some instances have been supplemented.
In Germany, liquidity tools are enshrined in the German Capital Investment Code (KAGB) and were expanded by Article 5 Federal Law Gazette. The new liquidity tools have long been at the disposal of fund managers in other EU countries and includes redemption notices and swing pricing. It also been reported by the FT, that BaFin has been holding daily calls with managers of retail funds categorised as having the “most critical liquidity risk status” to discuss measures to mitigate the situation.
Addressing the Mismatch
Edwin Schooling Latter, FCA Director of Markets and Wholesale Policy recently gave a speech to the Association of Investment Companies. In his speech, Mr Latter discussed the continuing work by the FCA and Bank of England (BoE) to evaluate the costs and benefits of possible policy measures to achieve greater consistency of fund redemption terms with the liquidity of funds’ assets.
In his speech, Mr Latter explored measures used to address liquidity issues, including:
- Asset Restrictions;
- Swing Pricing; and
- Notice Periods
Summary
The liquidity mismatch is clearly not a new issue within the industry. From a regulatory perspective, both the UCITS Directive and AIFMD have various requirements in relation to liquidity management which are designed to mitigate this risk, as does the Money Market Fund Regulation discussed in our previous blog.
It is also clear that addressing fund liquidity issues is at the core of ESMA’s activities. Earlier in the year, 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. Additionally, later this year in September the Liquidity Stress Test guidelines for UCITS and AIFs enters into force. So to do the ESMA Guidelines on Stress Test Scenarios under the MMF Regulation, which requires MMF Managers to report their quarterly reports for both the Q1 and Q2 reporting periods.
To assist mangers with their liquidity risk management monitoring, our automated solution is designed to meet international requirements in respect of liquidity risk management and liquidity stress testing. It is a holistic solution which embeds liquidity risk management into product governance, throughout the product lifecycle.
