IOSCO Launches Thematic Review on Liquidity Risk Management Recommendations

The responsible entity should draw up an effective liquidity risk management process, compliant with local jurisdictional liquidity requirements.

The responsible entity must be able to (demonstrate that they can) comply with the relevant explicit or principles-based local liquidity requirements that will apply to the CIS.

The liquidity risk management process, while proportionate, needs to be able to be effective in varied market conditions.

The responsible entity should set appropriate liquidity thresholds which are proportionate to the redemption obligations and liabilities of the CIS.

The thresholds should be in line with the principle of fair treatment of investor and the CIS’s investment strategy.

It should be noted that investor redemptions are not the only source of liquidity demand on a CIS (for example, margin calls from derivative counterparties).

The responsible entity should carefully determine a suitable dealing frequency for units in the CIS.

The dealing frequency should be realistic and appropriate for its investment objectives and approach, taking account of its liquidity risk management process, and allowing redemptions to be processed effectively.

The responsible entity should ensure that the CIS’ dealing (subscription and redemption) arrangements are appropriate for its investment strategy and underlying assets throughout the entire product life cycle, starting at the product design phase.

There should be due regard in the design process based on liabilities and the likely risk appetite of the investors a Fund is designed to target. Given the importance of design decisions, the assessment should be subject to an internal approval process at an appropriate senior management and/or board level within the responsible entity.

The responsible entity should consider liquidity aspects related to its proposed distribution channels. This should include consideration of markets conditions and effectiveness of individual distribution channels and the specific case of aggregated nominee accounts.

The responsible entity should ensure that it will have access to, or can effectively estimate, relevant information for liquidity management.

The responsible entity should ensure that liquidity risk and its liquidity risk management process are effectively disclosed to investors and prospective investors.

There should be a proportionate and appropriate explanation of liquidity risk and explanation of any tools or additional measures that could affect redemption rights – this should be readily accessible and set out clearly and appropriately for potential investors.

The responsible entity’s liquidity risk management process must be supported by strong and effective governance.

Appropriate escalation procedures should be in place if problems are envisaged or identified. Additionally, there should be an appropriate degree of independent oversight involved in reviews of the liquidity risk management process.

The responsible entity should effectively perform and maintain its liquidity risk management process. This will involve taking into account the investment strategy, liquidity profile and redemption policy of the CIS.

The responsible entity should regularly assess the liquidity of the assets held in the portfolio.

The liquidity assessment of the CIS’s assets should consider obligations to creditors, counterparties and other third parties. The time to liquidate assets and the price at which liquidation could be affected should form part of the assessment of asset liquidity.

Additionally, financial settlement lags and the dependence of these on other market risks and factors should be considered.

The responsible entity should integrate liquidity management in investment decisions.

The assessment of liquidity risk includes the consideration of the type of asset and where applicable trading information, for example:

• Volumes,
• Transaction sizes and number of trades,
• Issue size

Additionally, analysis should also take into account the number of days it would take the responsible entity to sell the asset without materially moving the market prices.

Liquidity risk management must also consider collateral arrangements.

The liquidity risk management process should facilitate the ability of the responsible entity to identify an emerging liquidity shortage before it occurs.

During stressed market conditions, the responsible entity should seek to ensure that the interests of investors are safeguarded and CIS investors are being treated fairly.

The responsible entity should be able to incorporate relevant data and factors into its liquidity risk management process in order to create a robust and holistic view of the possible risks.

One of the key challenges in liquidity management is taking appropriate account of the uncertainty in future investor behaviour both in normal market conditions and, in particular, in stressed markets. Therefore, recommendations put forward that the more a responsible entity knows about its investor base, the better able it will be to plan for and manage future liquidity needs.

The responsible entity should conduct ongoing liquidity assessments in different scenarios, which could include fund level stress testing, in line with regulatory guidance.

Appropriate stress testing should be carried out based on normal and stressed scenarios -scenarios should include backward-looking historical scenarios and forward looking hypothetical scenarios, and could be based on parameters calculated using statistical techniques or concrete stress events where appropriate to do so.

Stress testing should be carried out at a frequency relevant to the specific CIS.

The responsible entity should ensure appropriate records are kept, and relevant disclosures made, relating to the performance of its liquidity risk management process.

The responsible entity should put in place and periodically test contingency plans with an aim to ensure that any applicable liquidity management tools can be used where necessary, and if being activated, can be exercised in a prompt and orderly manner.

The recommendations provide a list of events that may request such a plan.

The responsible entity should consider the implementation of additional liquidity management tools (such as in-kind redemptions, in-specie redemptions, anti-dilution levies, swing pricing, redemption gates, limits on withdrawals) to the extent allowed by local law and regulation, in order to protect investors from unfair treatment, amongst other things, or prevent the CIS from diverging significantly from its investment strategy.