GERMANY: BaFin Report on Liquidity Risks

Tuesday February 13 2018

BaFin is currently taking a heightened interest in the issue of liquidity risk in funds and asset management companies. The key driver for this is the concern that “liquidity spirals” might form, with negative consequences for financial stability. Liquidity spirals are self-perpetuating: when there is a high level of redemptions of fund units, this can sometimes make it necessary for assets to be sold in certain segments or in a number of segments. This can lead to significant falls in prices, which can result in further sales.

In order to gain a better understanding of these risks, BaFin investigated companies’ own requirements in open-ended funds for liquidity management and liquidity stress testing more closely; in BaFin’s view, sound risk management at fund level is the first line of defence against the threat of contagion in the financial system. This article focuses primarily on liquidity risk management. The detailed results in the area of liquidity stress testing can be found in a report that BaFin published recently.

The key takeaway from the guidelines regarding liquidity risk management is that the business model of the specific asset management company and the funds managed by it will be significant in determining the most sensible way of managing liquidity risk. However, reporting channels and responsibilities must always be clearly defined. The assessment of liquidity risks in particular should be based on the company’s own deliberations and assessments. There is therefore no one-size-fits-all solution for liquidity risk management – and for good reason. This makes asset management companies themselves responsible for developing the most suitable tools for risk management.

In Germany, the provisions restricting liquidity risks in open-ended funds are set out in the Investment Code (Kapitalanlagegesetzbuch – KAGB) and are principle-based. Compliance with these provisions is subject to BaFin’s ongoing supervision. Every asset management company must have an appropriate liquidity risk management system and ensure that the investment strategy, the liquidity profile and the redemption policy are in line with each other. They also have to conduct regular stress tests for all open-ended funds. These are to be conducted using both normal and exceptional liquidity conditions.

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