• Trustees Corporate Supervision

Dec 19, 2019

FMA Gears up for First Quarter 2020 Managed Fund Survey

Whose Liquidity Risk are we talking about?

If mismatches occur between unitholder withdrawals and achievable asset sale prices and times for completion, then issues can arise for investor equity.  Some unitholders could be treated better or worse than others depending on whether or not they got their money out of the fund before mismatches blew up into crises.  Confronted with problems of this sort, dilemmas can arise for fund managers and their supervisors when striving to act in the best interests of investors.  For example, when deciding on how to react to a fund liquidity crisis, should fund unit transactions be suspended for a time, keeping the fund itself as a going concern, or should the fund be shut down, assets liquidated, and investors all paid out together?

However, it is not just the best interests of fund investors affected that may need to be taken into consideration.  Managed fund liquidity risk stresses hit individual investors but on a large enough scale can become cumulatively systemic across the economy.  There is the bigger picture to consider: is the wider economic interest more important than the interests of managed fund investors?  In weighing up these matters, regulators must decide what to focus on, and whether the most appropriate resolution should be investor-centric or system-centric.


Practical Issues for MIS Licensees

Licensees need to establish and maintain routines for managing fund liquidity risk stress events (LRSE):

  1. Developing LRSE policies, processes, procedures, regular LRST cycles, and compliance assurance programmes (CAP) in preparation for stress events.
  2. Incorporating FMCA and regulations, governing documents (trust deeds, suspensions, wind ups), PDS, SIPO, OMI etc., into LRSE planning considerations.
  3. Harmonisation of fund asset market liquidity, prices paid to withdrawing investors, and withdrawal rules (frequency, notice periods).
  4. Effective management of fund liquidity stresses, especially under distressed market conditions, including in-specie transfers of (liquid) assets or side-pocketing of illiquid assets.
  5. Internal reporting – A periodically tested action plan is needed for identifying who is responsible for anticipating, discovering, monitoring and reporting LRSE and which parts of the organisation need to know about and act upon this information.
  6. External reporting – An effective communications plan is required for notifying the Supervisor, FMA and investors about LRSE occurrences.


Appendix 1: Financial Stability Report, Financial Policy Committee Record and Stress Testing Results - December 2019 (excerpt on LRST)

Source: Bank of England 16 December 2019

Vulnerabilities in Open-ended Funds

The FPC judges that the mismatch between redemption terms and the liquidity of some funds’ assets means there is an advantage to investors who redeem ahead of others, particularly in a stress. This has the potential to become a systemic risk.

As part of the ongoing review by the Bank and FCA of open-ended funds, the FPC has established that there should be greater consistency between the liquidity of a fund’s assets and its redemption terms. In that regard:

  1. Liquidity of funds’ assets should be assessed either as the price discount needed for a quick sale of a representative sample (or vertical slice) of those assets or the time period needed for a sale to avoid a material price discount. In the US, the Securities Exchange Commission (SEC) has recently adopted measures of liquidity based on this concept.
  2. Redeeming investors should receive a price for their units in the fund that reflects the discount needed to sell the required portion of a fund’s assets in the specified redemption notice period.
  3. Redemption notice periods should reflect the time needed to sell the required portion of a fund’s assets without discounts beyond those captured in the price received by redeeming investors.

In addition to enhancing financial stability, these changes should also promote funds’ ability to invest in illiquid investments, helping to increase the supply of productive finance to the economy through business and financial cycles, in line with the Committee’s secondary objective.

Recent blogs