On 1 February, IOSCO published its final report (PDF 169 KB) on Recommendations for Liquidity Risk Management for Collective Investment Schemes. These recommendations are accompanied by a “good practices” document, which provides practical examples of measures to address liquidity risk management, for the use of supervisors, fund managers and investors. Hot on its heels, the European Systemic Risk Board (ESRB) issued five recommendations addressed to the European Commission and to ESMA relating to liquidity risk management and leverage.
The final IOSCO recommendations replace the existing principles of March 2013 and include new recommendations on contingency planning. They also consider additional liquidity management tools, to the extent allowed by local law and regulation, and consistent with the fund's investment strategy, the profile of the investor base and the fair treatment of investors.
The recommendations are substantially the same as those in the consultation document (see this article in our July 2017 newsletter). The proposed principles-based approach has been adopted and most of the recommendations are aligned with existing European standards and industry best practices.
Of particular note is that the recommendations do not reflect the proposals of the Financial Stability Board in January 2017 relating to system-wide stress-tests or the prescriptive use of pre-selected liquidity “buckets”, depending on the underlying assets' contingent liquidity state.
However, fund managers should 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.
As regards ETFs, IOSCO has decided not to issue specific recommendations for this subset of funds, but it notes that it is continuing to monitor liquidity stresses in the global ETF market, with a focus on Authorised Participants and market makers. The IOSCO 2013 ETF Principles may be reviewed at a later date.
The ESRB's five recommendations are more prescriptive. It believes that the increasing size of the investment fund sector, coupled with perceived susceptibility to changes in market dynamics and structure, warrants legislative action. It is specifically concerned about mismatches between the liquidity of underlying assets and a fund's redemption policy and that leverage may impact the amplification of negative market movements.
Two of its recommendations are addressed to ESMA. It wishes ESMA to develop guidance by June 2019 on the stress testing of liquidity risk in individual funds and on assessing the extent to which leverage in funds contributes to the build-up of systemic risk. In particular, ESMA should provide guidance on the design, calibration and implementation of macro-prudential leverage limits.
The ESBR tasks the Commission to have implemented changes to the UCITS Directive and AIFMD by December 2020. This may sound a long way off, but it is a very tight timetable for the Commission to consult on and develop such proposals and for the necessary legislative and regulatory processes to take place.
Specifically, the ESBR recommends that legislation should incorporate a framework governing additional liquidity management tools, measures to limit the extent of liquidity mismatch in open-ended funds, and requirements for UCITS to report to national regulators on liquidity risk and leverage.
Fund managers may wish to consider how best to inform the impending European legislative debate, which will cover the full range of types of funds - UCITS and AIFs, open-ended and closed-ended, financial and real assets, and professional vs retail investors.