Apr 28, 2026
The ready-to-hand textbook approach to LRM
In December 2025, we published an article largely concerned with LRM guidance for fund managers that was published in May 2025 by the International Organization of Securities Commissions (IOSCO), of which the Financial Markets Authority (FMA) is a member. The guidance we wrote about was the Revised Recommendations for Liquidity Risk Management for Collective Investment Schemes (Revised Recommendations). We stated at the time that we would next produce an article on the sister guidance to the Revised Recommendations, namely the Guidance for Open-ended Funds for Effective Implementation of the Recommendations for Liquidity Risk Management (Implementation Guidance). This present article is principally focused on the Implementation Guidance.
Whereas the Revised Recommendations is primarily concerned with the latest best principles for LRM, the Implementation Guidance engages with bringing these principles into practice. We encourage managed investment scheme (MIS) managers (“responsible entities” in the parlance of the two IOSCO guidances) to read both of these inter-related documents together for invaluable lessons that can be applied when formulating or reviewing their own LRM policies, processes and practices. It is a certain bet that the FMA has been studying this pair of IOSCO guidances very closely from the time when they first came out just over a year after it published its own Liquidity risk management guide (Guide) in April 2024. It is not an exaggeration to call the two guidances the gold standard of LRM. A New Zealand MIS manager who incorporates relevant parts of these guidances into its own LRM is unlikely to be straying far down the wrong path.
The Implementation Guidance runs to around 80 pages, making it substantially longer than the Revised Recommendations at just over 60 pages. Its executive summary makes a series of nine headline recommendations (pp. 5-6). Following on thereafter are seven sections dedicated to LRM topics in greater detail. As a way into the Implementation Guidance, in this article we will consider aspects of a sampling of three of the sections. This sampling is not intended to suggest that the sections selected are more important or interesting than the others, and the analysis provided of them is not intended to be exhaustive of their implications. The article aims to give a flavour of the sections it addresses. The onus is on MIS managers to study these sections closely and extract from them aspects and elements of LRM practices that are most relevant and applicable to their own managed funds.
Section IV – Anti-dilution Liquidity Management Tools
This section corresponds with Recommendations 1, 6, 13, and 14 of the Revised Recommendations and Feature 7 of the Guide. It contains three “Elements”:
There are two principle types of liquidity management tools (LMTs): anti-dilution and quantity-based. MIS managers should understand the differences between these two types and their various sub-types, and moreover know which types and sub-types their own LMTs belong to and why and how these LMTs optimally apply to their managed funds. Similarly the boards of MIS managers should share in this knowledge as it is essential to their governance and oversight of the MIS manager’s LMT policies, procedures, and practices. The Implementation Guide has separate sections for each LMT type that are preceded by a general discussion of LMTs in Section III. Section IV specifically focuses on anti-dilution LMTs, which it defines as follows:
The principle underlying the use of anti-dilution LMTs should be the fair treatment of both transacting and existing/remaining investors with the objectives to mitigate material dilution and potential first-mover advantage arising from structural liquidity mismatch in OEFs*. Since the dilution risk differs between OEFs, the application of appropriate anti-dilution LMTs to achieve these objectives may also differ between OEFs.
(Implementation Guide, p. 25)
(*Note that “OEFs” is an acronym for “open-ended funds”. In the New Zealand context, OEFs are typically to be found in retail and wholesale MISs including KiwiSaver schemes.)
The essential purpose of anti-dilutionary LMTs is ethical and concerned with fairness to all investors in a managed fund. The secondary purpose consequently arising is elimination of first-mover advantage. There are also legal requirements in New Zealand for MIS managers to act in the best interests of investors and treat investors equitably under section 143(b) of the Financial Markets Conduct Act 2013. Arguably, section 143(b) underpins an obligation for MIS managers to have the correct anti-dilutionary LMTs at their disposal and to deploy these tools effectively as and when needed.
Section IV lists and defines five LMT types that qualify as anti-dilutionary:
The Implementation Guide comments that, “Each of these anti-dilution LMTs provides for liquidity costs to be passed to transacting investors” (ibid. p. 26). Regardless of how each of the five types of anti-dilutionary LMTs are calculated and imposed, they all entail a “tax” on investors who are transacting in fund units, usually, but not necessarily, exiting from a managed fund. In theory at least, the “tax” should ensure that transacting investors do not profit by being first movers and that the investors who were already invested and remain in the fund are left no worse off financially due to other investors’ transactions.
Element (ii) of Section IV is concerned with how MIS managers should impose the “estimated cost of liquidity” on “subscribing and redeeming investors” in managed funds (ibid. p. 28). This user-pays philosophy may be a fairly new concept in New Zealand’s managed fund industry, given that typically unit pricing is identical for both buying and selling managed fund units. The section considers topics such as the cost estimation basis, liquidity cost components, explicit and implicit transaction costs, significant market impact, how different anti-dilution LMTs incorporate cost components, disclosed ranges of liquidity cost adjustment, and expectations on the level of confidence and sophistication of estimates. IOSCO sets exacting standards in relation to the passing of transaction costs onto managed fund investors. Near enough is evidently not good enough.
Section IV is rounded off by Element (iii), which is concerned with appropriate activation thresholds for anti-dilutionary LMTs. It is debatable as to whether anti-dilutionary LMTs are in fact LMTs, in that they can apply to managed funds at all times, regardless of whether or not there is a liquidity event underway. For example, many managed funds feature buy/sell spreads for their unit pricing. It might be more accurate to consider anti-dilutionary LMTs to be situational LMTs in the event that MIS managers have discretion to apply them at times when liquidity events are underway or could potentially commence. This is certainly the conception of IOSCO, where the Implementation Guide describes anti-dilutionary LMTs as being activated when preset thresholds are triggered:
Recognising that OEFs provide investors with the benefits of collective investing, investors in OEFs should also collectively bear the reasonable costs of investing via such vehicles. As such, they should expect to share transaction costs as well as other costs of the OEF in a reasonable manner. In this regard, while proper procedures are expected to be put in place to enable the use of anti-dilution LMTs as part of the ongoing liquidity management, such LMTs are not necessarily expected to be activated at all times.
It is appropriate for responsible entities to set different levels for the activation of anti dilution LMTs for each OEF they manage. The activation threshold should be set appropriately and prudently so as not to result in any material dilution impact in the fund if it is set too high, taking into account factors such as the OEF’s AUM size and portfolio characteristics (including the investment strategy and asset liquidity), estimated cost of liquidity (as defined under Element (ii) above), investor profile and historical fund flows. If it is set too low, it can create unnecessary costs for both transacting and remaining investors and increase the volatility of the OEF’s NAV.
(ibid. p. 35)
Element (iii) then proceeds to undertake a brief discussion of how anti-dilution LMTs might be imposed in practice through partial or tiered swing pricing, activation when a pre-determined liquidity cost is exceeded, and subject to ongoing review as market conditions change.
Section V - Quantity-based Liquidity Management Tools and Other Liquidity Management Measures
This section corresponds to Recommendations 1, 6, and 14 of the Revised Recommendations and Feature 7 of the Guide. It contains two “Elements”:
Section V is a bit of a grab-bag, as it covers all sorts of LMTs and liquidity management measures (LMMs) that cannot be categorised as anti-dilutionary. Element (iv) of Section V defines quantity-based LMTs follows:
Quantity-based LMTs aim to limit the amount of liquidity available to redeeming investors. As they restrict investor redemption rights, they are typically used in response to sudden increase in redemption amount, deterioration in asset liquidity or stressed market conditions. They are different from anti-dilution LMTs in the sense that they are activated once the risk has materialised i.e., high level of redemptions or valuation uncertainty. Quantity-based LMTs are also different from other redemption terms which are set at the design phase of the fund such as redemption caps, notice periods or lock-up periods, for example.
(ibid. p. 37)
There are some noticeable differences between anti-dilutionary and quantity-based LMTs. The former can apply to both investments and withdrawals, and are subject to preset thresholds related to estimated transaction costs that might not necessarily be triggered by liquidity events but instead could apply under normal market conditions. Anti-dilutionary LMTs do not impede or obstruct transaction flows. Quantity-based LMTs only apply to withdrawals under the circumstances of liquidity events and are designed to impede or obstruct transaction flows. LMMs are something different again and are not LMTs, being instead non-liquidation procedures relating to how impaired assets are treated by MIS managers.
Element (iv) provides a list of four quantity-based LMT types and two LMM types that IOSCO has identified:
Quantity-based LMTs:
LMMs:
Beyond the six types listed above, Element (iv) of Section V also describes the following types of what could be categorised as LMMs:
The names given to the quantity-based LMTs are mainly self-explanatory. Concerning redemption gates, however, the Implementation Guide is careful to distinguish them from redemption caps:
The main difference between redemption caps and redemption gates is the level of certainty that they will be applied to investors: the former will always apply as it is one of the redemption terms that the OEF may choose to incorporate in its redemption policy; the latter, however, as it is an LMT and not a redemption term, the responsible entity will have discretion to activate it or not when the activation threshold is exceeded.
The automatic application of redemption caps could potentially induce a first mover advantage, in particular when such redemption term is used by a fund marketed to both professional and retail investors given the difference in knowledge between these two categories of investors.
(ibid. p. 41)
Of note in the distinction drawn above is that redemption caps are defined as redemption terms and not as LMTs. Moreover, redemption caps are linked with first-mover advantage, which is something that anti-dilutionary LMTs are intended to suppress. In order to understand what an LMT is, it is useful to compare and contrast it with something similar that is not an LMT, such as has been done for redemption gates as opposed to redemption caps.
The LMMs discussed in Element (iv) are of interest in that they are not considered to be LMTs. All LMTs presuppose that viable market trading actions – including asset liquidation - exist and are available for MIS managers to exploit in relation to the underlying assets of managed funds. By contrast, side-pocketing and redemption in kind (in specie redemption) entail non-liquidation of the assets affected. With side-pocketing, the assets are quarantined within a sub-fund or inside a ringfence created for that purpose because their liquidation is impaired for some reason. The MIS manager retains the impaired assets under management, perhaps indefinitely, and the investors in those assets are unable with withdraw from them. In the case of redemption in kind, the MIS manager simply passes the parcel by handing over the assets directly to investors, leaving any liquidity issues attached to the assets unresolved in the hands of their recipients.
In the final grouping of three LMMs, it is of note that debt – whether as credit facilities or interfund lending – rates a mention. Most MIS trust deeds incorporate a provision for borrowing by funds in the scheme. It is not always recognised that debt can be an LRM instrument when used to fund withdrawals. However, debt must be repaid, and if markets drop or liquidity becomes impaired, debt repayment may become problematic. If there are percentage maximum limits specified in the trust deed for the amount of debt compared with the amount of funds under management in a fund and the markets fall heavily, a breach of the trust deed may occur as the effective percentage of debt level increases.
Element (v) addresses the activation and deactivation of quantity-based LMTs and LMMs. Of note is the reappearance of the ethical purpose of LMTs where fair treatment and acting in the best interests of all investors is required, just as it is under section 143(b) of the FMCA:
If responsible entities set thresholds or criteria for the activation of quantity-based LMTs or other liquidity management measures, those thresholds and criteria should be appropriate, objective and sufficiently prudent in the best interests of investors. For instance, in the case of redemption gates, a balance to calibrate the gates has to be struck: on one hand to ensure so that they are generally activated only in response to exceptional market conditions or instances of unusually high redemptions, and on the other hand, to ensure the gates can be activated before it is too late (i.e. a wave of redemptions below the activation threshold for a long period of time). They should not result in an unfair treatment between investors or in freeing the responsible entities from their duty to endeavour faithfully to meet redemption demands in an orderly fashion.
(ibid. p. 51)
Section VI – Stress Testing
This section corresponds with Recommendation 12 of the Revised Recommendations and Feature 8 of the Guide. It has no “Elements”.
Stress testing of LMTs is a critical part of effective LRM implementation that must be got right so that when liquidity events occur, MIS managers will know in advance what they can expect their LMTs to achieve and what limitations may apply. Section VI covers a range of topics including the design of scenarios under which LMTs can be stress-tested. These scenarios are divided into two categories: backward-looking and forward-looking. The principal difference between these two types is that backward-looking scenarios use historical data from past periods of significant market stress in order to reconstruct what stresses LMTs could have been subjected to then, whereas forward-looking scenarios utilise projected extreme market events that plausibly could occur given the latest and expected market, regulatory, and technological developments.
Whichever types of scenarios are used for stress-testing LMTs, they need to be tailored to ensure applicability to the particulars of the managed funds that the LMTs are deployed upon, such as asset liquidity, trading data availability, intermediate holding arrangements, and derivatives or securities lending (if any). Scenarios should include the possibilities of simultaneous deterioration in multiple liquidity parameters and, if practical, impacts from other market participants and the MIS manager’s other managed funds that are exposed to the same or similar liquidity risks. Concerning frequency, it is recommended that stress-testing should be more frequent for backward-looking scenarios and volatile managed funds, and less frequent for forward-looking scenarios.
Section VI contains recommendations concerning redemption coverage ratios (RCRs), calculated as liquid assets divided by potential liabilities. A tabular hypothetical example is given which covers both a non-stressed base case scenario and a stressed scenario. RCRs can be used to determine optimal ratios for managed funds in the best interests of their investors, including monitoring ratio changes to determine whether fund liquidity needs to be increased or LMTs deployed.
An important point is made about who is supposed to perform stress-testing at a MIS manager:
The performance and oversight of stress testing should be sufficiently independent from the portfolio management function. In general, stress testing should be performed by the risk management function of the responsible entity, with inputs from other relevant functions such as portfolio management and trading, and that stress testing results should be reviewed by the fund board, committee or senior management responsible for liquidity risk management.
(ibid. p. 61)
This recommendation emphasises a separation of the functions of the investment management team from the functions of the risk management team, with the latter team expected to perform and report upon LMT stress testing results. Some MIS managers may struggle with implementing the recommendation, due, for example, to their scale or perhaps ingrained practices whereby the investment management team currently performs LMT stress testing, with team staff assigned to the task having a vested interest in retaining their roles. Plainly the recommendation has governance implications, because the boards of MIS managers will need to have oversight over how the LMT stress testing they review is being produced and who is doing that work. Such boards should have clear policies concerning the conduct of LMT stress testing, including specification of who is to carry out and report on that activity.
Conclusion
“Like IOSCO’s Revised Recommendations, the Implementation Guidance should be considered as required reading by MIS managers,” said Matthew Band, General Manager at Trustees Executors.
“The two guidances fit together and constitute an invaluable resource for MIS managers responding to the FMA’s expectations concerning LRM.”
“The Revised Recommendations sets out what to do concerning LRM, whilst the Implementation Guidance demonstrates how to do it.”
“As with the Revised Recommendations, the Implementation Guidance rewards close study by MIS managers, even if they happen to think that they already have satisfactory LRM policies, procedures, and practices in place.”
“There is always something more to learn where LRM is concerned.”
“The Implementation Guidance is particularly useful in the way that it identifies and classifies LMTs and LMMs, especially with the distinction made between anti-dilution LMTs and quantity-based LMTs.”
“MIS managers could benefit from applying these classifications to their own LMTs, if not having done so yet, and should consider whether they need to augment or replace the LMTs they rely upon with others listed in the Implementation Guidance”.
“Of particular note within the context of the managed funds industry in New Zealand is the recommendation in the Implementation Guidance that stress testing of LMTs should not be performed by investment managers but by risk managers.”
“This separation of the stress-testing function from investment managers is not always in force in New Zealand.”
“Trustees Executors will continue to engage with its supervised MIS manager clients concerning LRM and will be expecting that these clients have familiarized themselves with the latest IOSCO LRM guidances in order to enhance and reinforce their LRM policies, procedures, and practices with international best standards.
For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matthew Band at [email protected].