FR02/2018 Open-ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration

Open-ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration Final Report The Board OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS FR02/2018 FEBRUARY 2018 ii Copies of publications are available from: The International Organization of Securities Commissions website www.iosco.org © International Organization of Securities Commissions 2018. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. iii iv Contents Chapter Page 1 Executive Summary 1 2 Context 2 3 Ensuring consistency between a fund’s redemption terms and its 5 4 Liquidity risk management tools 20 5 Stress testing 44 Appendix 1 – Availability of liquidity management tools by jurisdiction 50 1 Chapter 1 – Executive Summary At its core, by pooling investors’ capital to invest in assets that are less liquid than cash, liquidity transformation is a key structural element to investment funds. Hence, the management of this mismatch is a key area of consideration for regulators and the industry alike. Many jurisdictions have in place a number of regulations and requirements for asset managers to develop robust liquidity management frameworks, which deal with this issue throughout the lifecycle of a fund, including in the design phase of the fund, its implementation or the day-to-day operation of the fund. There are a number of techniques and tools available to fund managers to aid in the management of liquidity needs. These include a number of ex ante fund features that can either be embedded in the product in the design phase (which can contribute to a better management of liquidity risk) or are part of regulatory requirements: • pass on the transaction costs to the subscribing/redeeming investor (swing pricing, redemption in kind); or • restrict or slow down access to investor capital (notice periods, redemption gates, suspension of redemptions etc.); or • test the robustness of liquidity requirement under different scenarios (stress testing). Ultimately, when looking at the management of liquidity within a fund, a holistic approach needs to be considered, conditioned on: • the overall consistency of the fund’s redemption terms with its investment strategy; and • the fund’s potential or existing investor base. In a number of cases, large redemptions from funds have not led to the activation of liquidity management tools, nor has there been any substantial impact on asset prices or the broader financial system. Although the efficacy of existing liquidity management requirements and tools has been tested in previous bouts of market volatility, the policy debate has recently placed increased focus in this area, including in instances where there may be a material mismatch between the redemption features of a fund (in most cases daily redemption) and the liquidity of the underlying assets the fund invests in. Consequently, many jurisdictions have been reviewing their regulatory frameworks with a view to determine if and how to strengthen existing guidance and / or requirements particularly with regard to open-ended funds. In light of these developments, including the FSB published recommendations, IOSCO has reviewed its 2013 Liquidity Risk Management standards and is making recommendations to enhance them further. In addition, this document outlines a number of practices among regulators and asset managers. As such, it is to be read in conjunction with IOSCO’s revised liquidity recommendations, as it provides practical information containing a series of examples and good practices. 2 Chapter 2 – Context Considerable attention has been given to liquidity risk management in the asset management sector over the past few years by policy makers (international financing institutions,1 central banks,2 national, regional and international regulators), various observers (e.g., credit rating agencies) and the asset management industry. While liquidity risk management has long been an important area of consideration for regulators and the industry, this heightened focus has led to an increased awareness of the challenges asset managers face alongside other market participants in certain segments of the markets. It also has supported a constructive dialogue between regulators and asset managers on actual practices and how these could be improved. Regulators have knowledge of, and have observed, a number of industry liquidity risk management policies and procedures across jurisdictions which they consider good practice. Regardless, a number of asset managers have subsequently reviewed their internal liquidi