In an article posted by Ignites Europe, the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg declared that it has “stepped up its supervisory focus on the liquidity aspects that are related to the recent developments” of Neil Woodford’s flagship fund and H2O Asset Management, an affiliate of Natixis Asset Management.
In the U.S., we have just seen the SEC’s Reporting Modernization program go live – this ushered in a new rule 22e-4 – which forces all 40 Acts to set up a formalized and documented Liquidity Risk Management Program (LRMP). The initial rule 22e-4 on establishment of a written LRMP was quite onerous with respect to classifying each holding into specific “liquidity buckets” – including quarterly public disclosures via Form N-PORT. This rule was watered down prior to going live, and while the public disclosure is no longer required, it has been replaced with a requirement to discuss briefly the operation and effectiveness of a fund’s LRMP in the fund’s report to shareholders. The formalization of the LRMP and profiling of individual positions and redemption stress testing are all part of the rule. The SEC estimates the rule will cost firms about $1.4 billion in one-time costs and $240 million annually after that as financial firms implement LRMPs to mitigate redemption risk.
As with many regulations in the US, ESMA have been keeping a close eye on the progress of Rule 22e-4 and have run their own CP process.
In ESMA’s draft principles they propose stress tests that are:
- Tailored towards the individual fund
- Reflect the most applicable risks to a fund
- Sufficiently extreme or unfavorable (yet plausible)
- Sufficiently model a manager’s actions in times of stressed market conditions
- Embedded into the fund’s overall risk management framework
The SEC and ESMA initiatives have their roots in the IOSCO consultations:
- CIS Liquidity Risk Management Recommendations
- Open-ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration
We can see that there is now a broad focus across the ESMA NCAs to focus on liquidity profiling and redemption stress testing of collective investments. As the vast majority of UCITS and US 40 act funds offer daily liquidity, it is of utmost importance that we understand how long each position would take to wind down in an orderly fashion by the profiling of the portfolio holdings. We can also see (even pre-Woodford) that questions on liquidity/redemption stress testing arise more frequently in audit.
Fund directors are (since Woodford) acutely aware of how exposed they would be were they not to maintain oversight of the liquidity risk diligently. For many open-ended funds, extracting portfolio-level liquidity data and identifying the necessary information needed for reporting can present an array of operational challenges.
CSS’s compliance consulting group Ascendant has extensive experience in LRMPs. If you need assistance addressing this evolving concern, contact us at email@example.com or 860-435-2255.
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