INTERNATIONAL: IOSCO Consultation on the Principles of Liquidity Risk Management for Collective Investment Schemes

Thursday April 26 2012

Today, The Technical Committee of IOSCO has published a consultation report on the Principles of Liquidity Risk Management for Collective Investment Schemes. This report outlines a set of principles for both the industry in general and the regulators can assess the quality of regulation and industry practices relating to liquidity risk management for collective investment schemes (“CIS”).

IOSCO Consultation on the Principles of Liquidity Risk Management for Collective Investment Schemes

 The driver of this consultation report is that since the global financial crisis began, liquidity has been identified as an areas key risk for regulators, however, to date that risk focus has been more on the banking sector rather than the asset management sector. However, the asset management sector has specificities to be kept in mind when policy is being set in this area by regulators. With this in mind IOSCO has published this consultation paper in relation to the asset management sector and liquidity to ensure that these specificities are given a chance to be addressed by the asset management industry itself and to have their concerns taken on board.

Good liquidity risk management is currently an inherent feature of CIS general operations, as the right to redeem units/shares is a basic of open-ended schemes. Liquidity risk management is complex however and a CIS may unexpectedly experience liquidity issues as, for example, when the market in which it has invested in closes or if a large volume of unitholders / shareholders decide to redeem in a very short space of time. In exceptional circumstances, a liquidity issue could lead to a CIS temporarily suspending all investor redemptions. The fundamental requirement of liquidity risk management is to ensure that the degree of liquidity that the open-ended CIS manages allows it in general to meet redemption obligations and other liabilities.

However, asset managers do currently utilise both practical and existing regulatory tools to manage liquidity both on the asset side and on the investor side and to assist in that Liquidity Risk Management IOSCO have issued a set of 15 principles in relation to same which it believes will assist asset managers in managing this risk if adhered too and also regulators by giving them a practical and common approach from which they can create effective regulation to address Liquidity Risk and the management thereof.

The Principles of Liquidity Risk Management for Collective Investment Schemes as issued by IOSCO are set out below for your review;

Note: The principles of liquidity risk management for CIS are divided into two groups related to the life span of a CIS: the pre-launch and the day-to-day liquidity risk management.

Principle 1

The responsible entity should draw up an effective liquidity risk management process, compliant with local jurisdictional liquidity requirements;

Principle 2

The responsible entity should set appropriate liquidity limits which are proportionate to the redemption obligations and liabilities of the CIS

Principle 3

The responsible entity should carefully determine a suitable dealing frequency for units in the CIS

Principle 4

Where permissible and appropriate for a particular CIS, and in the interests of investors, the responsible entity should include the ability to use specific tools or exceptional measures which could affect redemption rights in the CIS’s constitutional documents

Principle 5

The responsible entity should consider liquidity aspects related to its proposed distribution channels

Principle 6

The responsible entity should ensure that it will have access to, or can effectively estimate, relevant information for liquidity management

Principle 7

The responsible entity should ensure that liquidity risk and its liquidity risk management process are effectively disclosed to prospective investors

Principle 8

The responsible entity should effectively perform and maintain its liquidity risk management process

Principle 9

The responsible entity’s liquidity risk management process must be supported by strong and effective governance

Principle 10

The responsible entity should regularly assess the liquidity of the assets held in the portfolio

Principle 11

The responsible entity should integrate liquidity management in investment decisions

Principle 12

The liquidity risk management process should facilitate the ability of the responsible entity to identify an emerging liquidity shortage before it occurs

Principle 13

The responsible entity should be able to incorporate relevant data and factors into its liquidity risk management process in order to create a robust and holistic view of the possible risks

Principle 14

The responsible entity should conduct assessments of liquidity in different scenarios, including stressed situations

Principle 15

The responsible entity should ensure appropriate records are kept, and relevant disclosures made, relating to the performance of its liquidity risk management process

In the opinion of Funds-Axis these principles as set out are workable and practical and most asset managers would have the bases of such structures in place for the schemes they manage. Asset Managers will also however, have to consider if the structures they currently have in place to manage their Liquidity are adequate in the face of current market headwinds and as such there may be a need for Asset Managers to tighten, develop and expand those structures given the increased regulatory focus that is on this area and to prepare in advance for what may be coming down the road in terms of legislation.

Should you wish to contact the author of this article, then please email info@funds-axis.com