Liquidity management review highlights room for improvement

10 August 2023 | UK & Europe | Articles

The FCA’s multi-firm review, following on from their ‘Dear CEO’ letter highlighting that effective liquidity management and oversight is high on their priorities, has uncovered disparity among firms in the quality of compliance with regulatory standards and depth of liquidity risk management expertise.

The regulator expects Asset Managers, Authorised Fund Managers and Investment & Portfolio Managers to review and consider their findings, and make appropriate changes to their business.

Key findings across governance, methodologies and oversight

• Many firms attach insufficient weight to liquidity risk management in governance arrangements with insufficient challenge and escalation, particularly in stressed environments.
• Some methodologies being used by firms are insufficient to assess the actual liquidity of the portfolio. Many methodologies are using solely cash and the most liquid assets first to accommodate all redemptions, without any consideration of the liquidity of selling a ‘vertical slice’ i.e redeemed assets that proportionately represent the funds portfolio.
• The methodologies being used in practice are not giving an accurate view to senior management fund’s true liquidity position.
• Oversight on stress testing was also found to be deficient with lack of evidence of tracking actions and trends.
• Firms have governance arrangements in place to meet one-off redemptions but do not have robust enough oversight arrangements in the event of cumulative or market wide redemptions that could have a significant impact on a fund occurring.
• Firms have weaknesses that would not exist had they fully implemented ESMA’s Guidelines on liquidity stress testing in UCITS and AIFs.
• The review also highlighted disparity in how anti-dilution tools are applied which allow firms to consider liquidity costs when setting subscription and redemption prices in order that customers are treated fairly and avoid giving any investors a first mover advantage when placing orders.
• The valuation processes were found to be mostly adequate but internal challenge of these valuations was not evident.

FCA Expectations

The FCA expects to see clear accountabilities, and governing bodies to be composed of members with sufficient expertise who are given timely and appropriate management information about risk, including liquidity.

Governance arrangements to oversee liquidity risks, including having established lines of responsibility and escalation to enable the firm to respond to volatile market conditions or redemption stress.

The FCA expects to see evidence that asset managers who experience redemptions are meeting regulatory requirements and ensure exiting and remaining investors are treated fairly when considering the costs of redemption, and the mix of assets they use to meet redemption requests.

Next Steps

The FCA expects firms to review the firms’ liquidity management arrangements taking into account the multi firm review as well as the ‘Dear CEO’ letter and to make enhancements as necessary.

The FCA emphasis that although the review is focused on Authorised Fund Managers they expect all asset mangers and manager of alternative investment funds to utilise these findings for improvements.

Investment firms who must produce an ICARA document need to make sure that liquidity risk is assessed adequately and included in their stress testing framework. Even though many firms may think they do not have liquidity risk, when Silicon Valley Bank failed earlier this year, this risk became a reality.

Full scope AIFMs also need to run liquidity stress tests annually and include the results in their Annex 4 filings. We often see the same stress tests used without enough consideration of whether this stresses their business model.

If you need help with any aspects of liquidity stress testing please let us know