FR03/13 Principles of Liquidity Risk Management for Collective Investment Schemes

Principles of Liquidity Risk Management for Collective Investment Schemes Final Report BOARD OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS FR03/13 MARCH 2013 ii Copies of publications are available from: The International Organization of Securities Commissions website www.iosco.org © International Organization of Securities Commissions 2012. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. iii Foreword The International Organization of Securities Commissions’ (IOSCO) Board has published this Final Report, which contains principles against which both the industry and regulators can assess the quality of regulation and industry practices concerning liquidity risk management for collective investment vehicles. Generally, these principles aim to reflect a level of common approach and to be a practical guide for regulators and industry practitioners. The principles are addressed to the entity/entities responsible for the overall operation of the CIS, and their implementation may vary from jurisdiction to jurisdiction, depending on local conditions and circumstances. iv Contents Chapter Page 1 Executive Summary 1 2 Introduction to the Principles 2 3 Pre-launch Liquidity Risk Management Principles 3 4 Day-to-day Liquidity Risk Management Principles 7 Appendix I – Feedback Statement on the Public Comments received by IOSCO on the Principles of Liquidity Risk Management for Collective Investment Schemes – Consultation Report 12 Appendix II – Public Comments received by IOSCO on the Principles of Liquidity Risk Management for Collective Investment Schemes – Consultation Report 18 1 Chapter 1: Executive Summary Investors place money in collective investment schemes (CIS) with a view to gaining income, to preserve or to grow their capital, or a combination of these objectives. They also expect to be able to access their investments in accordance with the terms and conditions of the particular CIS they have invested in – often on a daily basis. As a general matter, the right to redeem units/shares is a defining characteristic of open-ended CIS. Good liquidity risk management is therefore a key feature of the correct operation of a CIS. The topic of liquidity has been a key concern in the current global process of regulatory reform, although discussions have tended to focus on the importance of liquidity in banking, rather than other sectors. In the context of liquidity, CIS differ fundamentally from banks in that “maturity transformation”1 is not an inherent feature of their operation, and the majority of CIS do not engage in such transformation to the extent that banks do. For example, many CIS use investors’ subscriptions to invest in highly liquid large capitalization listed company shares, which can quickly be sold if necessary to provide liquidity for meeting redemption requests from investors in the CIS. Neither does the majority of CIS provide any “promise” or guarantee that investors will get back (at least) the same amount of money as they initially invested. An investor in a CIS is a shareholder; as opposed to a depositor in a bank, who is a creditor. Liquidity crises are therefore less likely to cause systemic confidence problems in CIS than in banking. Nevertheless, a CIS may experience liquidity problems. Liquidity risk management in CIS is a complex area: poor liquidity can arise from many different sources, some of which are outside the control of the entity operating the CIS2. Liquidity risk management in CIS is directly linked to other aspects of CIS operation – in particular valuation. Although valuation is not addressed in detail in this paper, effective liquidity risk management requires effective and robust valuation arrangements3. In exceptional circumstances, a liquidity problem could lead to a CIS temporarily suspending all investor redemptions. IOSCO has published Principles on Suspensions of Redemptions in Collective Investment Schemes.4 1 At its simplest, using short-term liabilities to invest in long-term assets. 2 For example, if a market in which the CIS is invested closes unexpectedly. 3 IOSCO has consulted separately on Principles for the Valuation of Collective Investment Schemes, Consultation Report, Report of the Board of IOSCO, February 2012, available at www.iosco.org/library/pubdocs/pdf/IOSCOPD370.pdf. 4 Principles on Suspensions of Redemptions in Collective Invest