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IOSCO consults on liquidity risk management in investment funds

IOSCO consults on liquidity risk management

It includes a section that discusses the specific characteristics of exchange-traded funds (ETFs). IOSCO is also consulting on good practice guidance, which provides practical information, examples and good practices regarding liquidity and risk management in funds.


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IOSCO is consulting on proposed enhancements (PDF 391 KB) to its 2013 guidance on liquidity risk management in collective investment schemes (CIS), taking into account the FSB’s Recommendations (see January 2017 article) and investor protection considerations. It includes a section that discusses the specific characteristics of exchange-traded funds (ETFs). IOSCO is also consulting on good practice guidance (PDF 642 KB), which provides practical information, examples and good practices regarding liquidity and risk management in funds. Both are open for comment until 18 September 2017.

In response to the FSB’s recommendations and investor protection considerations, IOSCO proposes to enhance its 2013 guidance on liquidity risk management in CIS by additional guidance on or elaboration of:

  • determining the appropriate dealing frequency;
  • alignment between the type of assets invested in and the redemption expectations of investors and other liabilities;
  • key design features, to assist with increased transparency and disclosure;
  • maintaining the investment strategy and meeting redemptions in stressed market conditions;
  • developing a strong understanding of the CIS’s obligations and liabilities and incorporating this in liquidity risk management;
  • the organisation and design of liquidity stress tests;
  • appropriate periodic operational test(s) to test readiness to use additional liquidity management tools and to ensure that these tool(s) can be implemented in an orderly and prompt manner; and
  • the availability and, in appropriate circumstances, use of additional liquidity management tools to protect investors from unfair treatment and to prevent the CIS from diverging significantly from its investment strategy.

On a first reading, the enhanced guidance broadly reflects what is currently regarded as best practice in the European fund management industry, flowing from the specific requirements in the UCITS Directive and the AIFMD. However, fund managers will wish to note the need for full documentation of decisions in both the design and operational phases. Also, the proposed liquidity disclosures on page 25 will not easily fit within the prescribed narratives for the PRIIP KID.

For ETFs, IOSCO suggests that the distinctive potential issues relate to in-kind redemptions, significant selling pressures in the secondary market, the (temporary) cessation of activity by the designated broker-dealer leading to significant discrepancies between ETF share prices and the value of underlying assets, and the lack of contingency arrangements to provide liquidity in times of market stress. It seeks views on whether further work is needed.

The accompanying draft good practice guidance provides a useful summary of how various jurisdictions regulate liquidity risk practices, the techniques and tools (both ex ante and ex post) made available to fund managers, and the use of these tools. It covers consistency between the liquidity of a fund’s assets and liabilities, liquidity risk management tools and fund-level stress testing. It does not comprise standards, recommendations or proposals for regulators or firms to address liquidity risks in a standardised way.

The tools available to managers vary between jurisdictions, but include: those that aim to pass on transaction costs to redeeming investors (swing pricing, anti-dilution levies, bid or ask prices); those that restrict access to investor capital (redemption gates, side pockets, notice periods, suspension of redemptions); and others (for example, redemption in kind).

IOSCO notes that many jurisdictions have in place regulations and requirements on the need for a robust liquidity management framework for the lifecycle of a fund, and that jurisdictions have been reviewing their regulatory frameworks to determine if and how to strengthen existing guidance or requirements. It also notes that open-ended funds have historically been able to manage their day-to-day liquidity requirements even during periods of high redemption demand in an orderly manner, with the exception of some money market funds.

Importantly, IOSCO observes that when examining the management of liquidity within a fund, its specificities need to be considered, including investment objectives and strategy, dealing frequency, investor base, the nature of its assets, and liquidity needs under the applicable market conditions.

Other than the development of consistent leverage measures (expected by end-2018), the FSB does not identify the need for any additional regulatory action at global level to deal with financial stability risks from shadow banking, but recommends some enhancements and strengthening of data collection and oversight (see July's article on shadow banking).

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