There can be tensions between regulators in these fraught circumstances.  Central banks tend to be concerned with systemic threats applying widely across the economy as a whole, whereas financial markets regulators may see the problem as one of avoiding unnecessary losses for retail consumers of financial products.  It may not always be possible to reconcile individual investor needs with systemic economic requirements, or for regulators to agree on a solution that suits everyone’s interests.  That leads to the question: who gets thrown under the bus first?

The FMA’s LRST Plans

The FMA has publicly committed to an LRST work project.  In its Annual Corporate Plan 2019/20 the regulator states:

“Stability of funds – Managed Investment Scheme (MIS) managers have insufficient processes and controls to respond to a liquidity crisis event, which could lead to investor losses” (p. 12).

“MIS stress testing – work with supervisors to test the readiness of MIS managers to respond to a liquidity crisis event” (p. 13).

At the MIS Lab #5 seminars, the FMA announced that its LRST working method will be a survey of all licensed MIS managers.   Category 2 fund managers will be excluded unless they are also licensed MIS managers.  The regulator has employed a team to conduct the survey and hired consultants to write the questions.  February 2020 is the proposed target time for the survey to go out to retail fund managers to complete, but the FMA will send out prior communications on the matter, including exact timing, in January. 

From what the FMA has said thus far, the LRST survey could potentially be a substantial piece of work for fund managers to complete.  The survey is proposed to be in two parts:

Part 1: Fund managers’ current understanding of and approach to LRST

Part 2: Fund managers’ response to a specific LRST scenario

The survey will combine tick-box and long-form questions, with recipients given a four-week completion period.  The purpose of the survey is to gather sufficient information to publish an initial report on the status of LRST issues for managed funds in New Zealand.   The report will treat the survey findings in aggregate, but the FMA is open to including additional material such as a guide, information sheet, good and bad practice examples, and individualised feedback.

The FMA has further announced that the fund manager LRST survey and report are planned to become regular annual events.  If so, they will attract ongoing investor attention and news media commentary.

Are there any clues for what the FMA’s LRST survey might ask?

Wholesale fund managers will be excluded from the survey because the FMA does not presently regulate them.  However, there are likely to be questions for MIS managers concerning their knowledge and oversight of wholesale managers and the redemption terms of their investments in wholesale funds.

As luck would have it, the Bank of England’s Financial Policy Committee (FPC) has just issued its latest Financial Stability Report, which contains a section on its most recent conclusions concerning how assessment of fund liquidity risks should be addressed (See Appendix 1 for the section verbatim).  These conclusions have been reached in agreement with Britain’s Financial Conduct Authority (FCA) and concur with those of the US Securities and Exchange Commission (SEC).  A spot of cribbing over the hols might be in order for those expecting to be surveyed next February.

2. Applying LRST Considerations in Practice

Quirks and Wrinkles

Matching fund liquidity and withdrawal rules is not without complications.  Some kinds of funds (mortgage, real estate, hedge funds, private equity) are traditionally low liquidity and do not permit unitholder withdrawals upon demand anyway.  In an era of chronically low interest rates, investor search for yield has driven some active fund managers into less liquid assets to try and boost returns at higher risk.  Implications for returns if managers pull funds away from less liquid assets in order to ease withdrawal constraints may not be palatable to investors.

Passive funds have been widely used as cash liquidity substitutes by fund managers, but could get caught up in liquidity crunches themselves or even contribute to them, as research by financial markets regulators has shown.  Locked-in funds (KiwiSaver, workplace superannuation, QROPS) limit or obstruct investor withdrawals deliberately, typically due to legislative constraints, and so are not dysfunctional just because they do not offer withdrawal on demand.  Muddying matters further, “parallel portfolios” have become common whereby managers offer identical funds under both retail and KiwiSaver formats, but these funds differ in respect of withdrawal rules.  On the disclosure front, PDS, SIPO and OMI clarity and accuracy could be called into question concerning consistency with actual fund design around liquidity and withdrawal requirements.  In future years, LRST surveys might also be sent to wholesale funds, which the FMA has announced it wants to start researching with a view to greater oversight and potential regulation.