The last “Managing Fund Liquidity Risk in Europe” report by the Asset Management and Investors Council (AMIC) and European Fund and Asset Management Association (EFAMA) was written in 2016 due to concerns that the approach to liquidity had become more fragmented.

The focus of the 2016 report was on regulatory requirements for UCITS funds and Alternative Investment Funds (AIFs), practical liquidity risk management processes for fund management companies (FMCs) and the availability of liquidity management tools (LMTs) in EU jurisdictions that have proven successful in enabling FMCs to counter a wide range of market events.

Regulatory developments since 2016

The updated report shows that since 2016, the EU regulatory framework has been further enhanced as a result of important new policy developments, including:

• The EU Regulation on Money Market Funds (MMFs) (June 2017) and the European Securities and Markets Authority’s (“ESMA”) Guidelines on Stress Test Scenarios under the MMF Regulation (July 2019): following the Financial Stability Board’s (FSB) 2017 recommendations, MMFs are now subject to dedicated regulation including, among others, stringent asset diversification and liquidity rules, and specific liquidity stress tests
• ESMA’s Guidelines on Liquidity Stress Testing (LST) in UCITS and AIFs (September 2019): following the 2017 FSB and the European Systemic Risk Board (ESRB) recommendations, UCITS and AIFs, already subject to LST requirements under level 1 and 2, will have to comply with ESMA guidelines which will converge and enhance LST practices, and
• International Organization of Securities Commissions (IOSCO) Recommendations on Liquidity Risk Management for Collective Investment Schemes (February 2018): this report shows that following IOSCO’s 2018 recommendations, several EU jurisdictions have decided to make LMTs available or introduce new provisions at national level.

Purpose of the updated report

The main objective of the report is to highlight existing European and international regulatory frameworks in the area of liquidity risk management and to remind stakeholders that there should not be a presumption of liquidity.

The report also serves as a reminder to FMCs of their own duties and provides an overview for supervisors and policy makers of what was accomplished at EU level over the last number of years.

Since 2016 the comprehensive liquidity framework in place has been tested under various market conditions and scenarios via a number of additional reports, by ESMA in particular, which showed that despite potential areas of vulnerability, “overall most AIFs do not have significant liquidity mismatches” and “overall most UCITs were able to cope with extreme but plausible shocks, as they have enough liquid assets to meet investors’ redemption requests”.

Recommendations

1. Focus on supervision and enforcement of the current comprehensive EU rules: the report states that the focus should now be on supervision and enforcement of the updated rules, which is instrumental to the framework’s effectiveness. The report is supportive of ESMA’s intention to ensure, in 2020, an effective and consistent implementation of existing liquidity provisions contained in the UCITS Directive.

2. Make the full IOSCO suggested LMTs available across the EU: LMTs are not yet fully available across the EU. The report encourages ESMA to work with national authorities to make LMTs available to fund managers when appropriate, and in this context, the forthcoming IOSCO’s 2020 assessment of local implementations of its liquidity risk management recommendations for investment funds is welcomed.

3. Improve transparency and managers’ knowledge of end-investors to enhance liquidity stress tests and ease the management of potential redemption shocks: access to certain data from distributors on underlying investors would assist the completion of liquidity stress tests, which involves considering investor behaviour, as required by ESMA LST Guidelines adopted in September 2019. The report is of the view that the communication of basic information to fund managers, including at least investor profiles and shares/units held by these categories of underlying investors, should be mandatory and free of charge.

4. Enhance market liquidity for corporate bonds and small and medium cap stocks: the report calls on the European Commission to follow up on the recommendations of its expert policy group on corporate bonds and to repeal (or at least phase in) the implementation of the mandatory buy-in regime under The Central Securities Depositories Regulation (CSDR), which could significantly hinder market liquidity as shown by a recent study released by the International Capital Market Association (ICMA).

Conclusion

The publication of the updated report indicates that fund liquidity looks set to remain a regulatory and supervisory priority at both domestic and EU level over the coming year.

At an EU level, ESMA has stated that a specific area of focus for it will be liquidity management in UCITS.

The Central Bank of Ireland will be continuing its work on monitoring investment fund liquidity, as evidenced by its industry communication issued in August 2019 and following recent statements by Michael Hodson, the Central Bank’s Director of Asset Management and Investment Banking in December 2019, outlining the Central Bank’s supervisory priorities for 2020. Mr Hodson noted that new convergence measures continued to be rolled out across the EU and stated that the Central Bank will be participating in ESMA’s 2020 common supervisory action on liquidity management by UCITS.

As highlighted by ESMA’s chair, Steven Maijoor in a recent address, this body of work and the related sharing of practices across national competent authorities “is expected to help ensuring consistent application of EU rules on UCITS liquidity management and ultimately enhance the protection of investors across the EU”.

If you would like to discuss the scope of the updated report and how the new rules and standards affect your business, contact a member of our Investment Funds team.

This article was contributed by Caoimhe Dunne, Senior Associate and Sarah Cloonan, Senior Associate.

The content of this article is provided for information purposes only and does not constitute legal or other advice.