THE LIQUIDITY COUNTDOWN
Fund liquidity problems witnessed in 2019 with Woodford and H2O Asset Management brought liquidity back into the spotlight. Since then, the focus hasn’t really faded on the issue of liquidity, and if anything, has intensified with the COVID-19 pandemic causing market volatility resulting in several more fund suspensions.
Although 2020 has already seen a number of initiatives intended to address liquidity risk management, there are still more to come, with September due to be a particular busy month for risk management professionals.
FCA Requirements Concerning Illiquid Assets and Open-Ended Funds
On 30th September 2020, new rules come into effect which place additional obligations on managers of funds investing in inherently illiquid assets to maintain plans to manage liquidity risk. The rules also aim to reduce the potential for some investors to gain at the expense of others, and reduce the likelihood of runs on funds leading to ‘fire sale’ of assets which disadvantage fund investors.
The new rules also include a new category of ‘funds investing in inherently illiquid assets’ (FIIA). A fund would be classed as a FIIA in one of two circumstances:
- NURSs which have disclosed to their investors that they are aiming to invest at least 50% of their scheme property in inherently illiquid assets.
- NURSs which have invested at least 50% of the value of their scheme property in inherently illiquid assets for at least 3 continuous months in the past 12 months, whether or not they have disclosed their intention to do so.
In particular, the FCA are changing the COLL Sourcebook in 3 areas:
- Suspension of dealings in units
The FCA will require NURSs holding property and other immovables to suspend dealing when there is ‘material uncertainty’ about the valuation of at least 20% of the scheme property.The rules do allow an authorised fund manager (AFM) to continue to deal where they have agreed with the fund’s depositary that to do so is in the best interests of investors. - Improving the quality of liquidity risk management
Managers of funds investing mainly in illiquid assets will have to produce contingency plans for dealing with liquidity risks. Depositaries will also have a specific duty to oversee the processes used to manage the liquidity of the fund. - Increased disclosure
Additional disclosure in a fund’s prospectus of the details of their liquidity risk management strategies, including the tools they will use and the potential impact on investors will be required.A standard risk warning will also be required in financial promotions to retail clients for such funds. This will apply to all firms communicating a financial promotion, not just the fund manager.
ESMA Liquidity Stress Testing in UCITS and AIFs
Another September 2020 deadline is that of the ESMA Guidelines on liquidity stress testing in UCITS and AIFs. Management Companies will need to assess the requirements in the ESMA liquidity guidelines against their current liquidity risk management practices, policies and reporting before the September 30th deadline.
The Liquidity Stress Testing (LST) Guidelines require fund managers to stress test the assets and liabilities of the funds they manage. This includes redemption requests by investors which are the most common and important source of liquidity risk and can also impact financial stability.
The guidelines require management companies to not prescribe a “one size fits all” solution as this would not be able to take specific fund’s characteristics into account. There are 16 guidelines applicable to fund managers – more on this available here.
ESMA Guidelines on Stress Test Scenarios under the MMF Regulation
Managers of MMFs were initially due to send the results of their first reports under Article 37 of the MMF regulation by April 2020. The deadline has subsequently been delayed. MMF Managers will now have to report in September 2020 quarterly reports for both the Q1 and Q2 reporting periods.
The requirements of Article 37 of MMF regulation require MMF managers to submit data to National Competent Authorities (NCAs), who will then transmit this to ESMA.
The Guidelines include stress test scenarios in relation to hypothetical changes in MMFs’:
- liquidity levels;
- credit and interest rate risks;
- redemptions levels;
- widening/ narrowing of spreads among indexes to which interest rates of portfolio securities are tied; and
- macro-economic shocks
CSSF Launch IFM notification on fund issues and large redemptions via eDesk
On 10 March 2020, the CSSF implemented a specific monitoring of the largest investment fund managers (“IFM”) in view of the specific circumstances and risks to which these companies were exposed to as a result of the prevailing market conditions. Since then, these IFMs have had to notify the CSSF of significant developments and issues as well as on related decisions and measures taken by IFMs. This has since been repealed and replaced by the new IFM Notification announced on 13th May.
An IFM Notification has to be transmitted to the CSSF via eDesk only if the following events occur:
- significant events/issues affecting the functioning of the investment funds managed by the IFM;
- larger redemptions at the level of Luxembourg regulated investment funds (UCITS, Part II UCI, SIF) managed by the IFM (i.e. daily net redemptions exceeding 5% of the NAV, net redemptions over a calendar week exceeding 15% of the NAV and/or application of gates/ deferred redemptions).
In order to give IFMs sufficient time to prepare, the CSSF has provided that the IFM Notification will apply from 2nd June 2020.
Summary
It is clear from the above that liquidity risk management is a key priority for regulators. Given the recent impact of COVID-19, the supervisory scrutiny from regulators is only going to intensify. Our automated liquidity risk management 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 the product governance, throughout the product lifecycle.
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