IOSCO defended its 2018 Liquidity Risk Management ("LRM") recommendations for investment funds against recent criticism, reasserting that the recommendations offer regulators a "comprehensive framework" for liquidity risks in investment funds.
As previously covered, IOSCO provided recommendations for entities responsible for managing collective investment scheme operations. The LRM recommendations addressed, among other things, (i) liquidity incongruence between fund investments and redemption terms and conditions for open-ended funds ("OEFs"), (ii) leverage within investment funds, (iii) operational risks and challenges in transferring investment mandates in stressed conditions, and (iv) the securities-lending activities of asset managers and funds.
In its Financial Stability Report, the Bank of England Financial Policy Committee ("FPC") highlighted how mismatches in redemption terms and fund liquidity have the potential to become a systemic issue. Within the report, the FPC criticized IOSCO's LRM recommendations, saying that they do not address how to ensure that a fund's assets and investment strategy are consistent with redemption terms. Additionally, other concerns were raised as to whether IOSCO's recommendations adequately address risks in OEFs.
In response to these criticisms, IOSCO said that the LRM recommendations state that "throughout the entire lifecycle of the fund . . . there should be an appropriate alignment between portfolio assets and redemption terms" and provide guidance for achieving this. IOSCO stated that while a global one-size-fits-all prescriptive approach for fund liquidity is impractical, the LRM recommendations offer "practical, actionable principles" that regulators may use. Specifically, the LRM recommendations outline that:
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OEFs should not be managed in such a way that the investment strategy "relies on any additional ex-post measures such as suspensions";
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stricter liquidity requirements should be in place for those OEFs with daily redemptions, as compared to those with longer-term redemptions;
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a stock of comparatively more liquid assets should be held for OEFs invested in real estate, or other illiquid assets, with more frequent redemptions; and
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ex-post liquidity management measures (i.e., suspension and swing pricing) are "important and necessary components of a comprehensive OEF risk management toolbox."
IOSCO reminded securities regulators that they are expected to ensure effective implementation of the LRM recommendations. Further, IOSCO said it intends to conduct an assessment beginning in 2020 on the implementation of the LRM recommendations in practice.
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