Global financial rule-designers have laid out new proposals aimed at bolstering fund liquidity management measures to ride out periods of market stress as well as ensuring greater equity for investors in general.
Under the Financial Stability Board (FSB) and the International Organization of Securities Commissions’ (IOSCO) proposed reforms released last week, open-ended managed funds would follow a ‘bucketed’ redemption model based on underlying asset liquidity while also adopting a globally standardised approach to ‘anti-dilution’ tools such as buy-sell spreads.
The FSB plan would categorise funds based on asset liquidity with redemption periods set accordingly. For instance, funds with 50 per cent or more invest in liquid assets would be able to offer daily pricing.
“Funds that allocate a significant proportion (i.e. 30% or more)
of their assets under management (AUM) to illiquid assets should create and redeem shares at lower frequency than daily and/or require long notice or settlement periods,” the FSB says.
However, funds that have a large allocation to illiquid assets would still be able to offer daily pricing provided they also used regulator-approved anti-dilution liquidity management tools (LMTs).
IOSCO focuses on the use and disclosure of LMTs by funds in its proposals, arguing that open-ended investment products should have anti-dilution measures to more-fairly share transaction costs at all times and better-manage outcomes during market drawdowns.
“The consistent use of well- calibrated anti-dilution liquidity management tools by responsible entities addresses these investor protection concerns by passing on to transacting open-ended fund investors the costs of liquidity otherwise born[e] by the portfolio, by adjusting the price at which they transact to account for explicit and implicit costs of trading,” the IOSCO paper says. “In a stressed market scenario, the deployment of well-calibrated anti- dilution liquidity management tools can also dampen the impact of open-ended fund buying and selling activities in underlying asset markets (including those associated with a potential first mover advantage) – and thus support financial stability.”
Last year the International Monetary Fund also put the case for globally consistent liquidity management rules for open-ended managed funds.
IOSCO lists five fund anti-dilution tools that all attack the liquidity issue from different angles, namely: swing pricing; valuation at bid or ask prices; dual pricing; anti-dilution levies; and, subscription/redemption fees.
Christina Choi, chair of an IOSCO investment management committee, said in a release: “The proposed guidance sets out key operational, design, oversight, disclosure and other factors and parameters for anti-dilution liquidity management tools, taking into consideration the barriers and disincentives to their implementation. While the guidance indicates that responsible entities are best placed to manage the liquidity of their open-ended funds, we also expect industry to improve practices in this area for the benefit of investors and markets.”
IOSCO is the peak global body for financial regulators, representing about 95 per cent of eligible jurisdictions, while the FSB monitors and recommends policy changes for the international financial system. Neither the FSB nor IOSCO has binding powers but their respective decisions often flow through to country-level policies.
The dual fund-liquidity proposals from the regulatory-influencer bodies comes in the same week as the Financial Conduct Authority (FCA) identified serious risk management gaps in the UK funds industry following a review.
Camille Blackburn, FCA wholesale buy-side director, said in a letter to fund chiefs that the study found “a wide disparity among firms in the quality of compliance with regulatory standards and depth of liquidity risk management expertise”.
“Most firms fell short in some aspects of their framework. A minority of firms had inadequate frameworks to manage liquidity risk effectively,” Blackburn said.
She said in a release that the regulator had seen evidence of investors suffering losses due to poor liquidity management.
“This review should serve as a warning to all asset managers that they need to get this right,” Blackburn said. “We expect boards to discuss our findings and assure themselves that their firms are not amongst the minority with serious gaps in managing liquidity risk.”
In 2019 the shuttering of funds run by high-profile UK investment manager, Neil Woodford, triggered a regulatory rethink of liquidity issues including in NZ where the Financial Markets Authority (FMA) launched an industry probe.
The subsequent FMA report published in 2021 found the NZ licensed fund sector was “overly optimistic” about their liquidity risk management chops, issuing 17 recommendations to improve practices.
Liquidity management tools such as buy-sell spreads are not mandatory in NZ.