Piyasi Mitra examines how industry experts interpret IOSCO and FSB’s regulatory strategies for managing market fluctuations and liquidity mismatches.
In July 2023, global regulatory bodies International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB) issued consultation reports addressing market turbulence due to liquidity mismatches. The reports provided policy recommendations to address liquidity mismatches and enhance non-bank financial intermediaries while jointly proposing redemption fees for open-ended fund managers to address investor withdrawals.
At the September 2023 Alfi Global Distribution conference in Luxembourg, a panel explored the challenges and future opportunities for fund managers.
Geoff Radcliffe, MD at BlackRock (Luxembourg), noted ongoing interest in the asset management industry from organisations like the FSB and Iosco since the 2008 financial crisis, which led to bank nationalisations and recapitalisations.
In response, Thoreau Bartmann, chief counsel of investment management at the US Securities and Exchange Commission (SEC), clarified that the FBB “does not have the legislative ability, but it has moral suasion […] and tries to set out guidelines and other rules that the member states will then follow and work to implement on key critical issues.”
On the other hand, Iosco is responsible for setting standards in securities market regulation through its mission to establish global guidelines and best practices for implementing rigorous regulation in the securities market.
Radcliffe and Georg Kiefer, division head at the Luxembourg Financial Sector Supervisory Commission (CSSF), stated that FSB and Iosco recommendations address liquidity mismatches, “first mover advantage,” liquidity bucketing, broader utilisation of liquidity management tools (LMTs) and their application in stressed and normal market conditions.
Jessica Reyes, head of asset management policy at the French Financial Markets Authority (AMF), discussed the five facilitation tools suggested by the AMF and Iosco’s role in offering guidance on timing, governance and disclosure for tool calibration. Reyes explained the third recommendation about aligning investor liquidity with underlying asset liquidity and the fifth recommendation focusing on anti-dilution measures.
“…any automatic link between a fund’s liquidity profile with its redemption terms is too blunt an approach that ignores other important risk management considerations.”
Bartmann outlined the FSB approach for open-ended funds investing in liquid assets using a three-bucket system. For funds with over 30% illiquid assets, regulators may require longer notice periods or structural changes, potentially converting them into closed-end funds. For funds with less liquid assets, the emphasis is on the daily use of liquidity management tools, particularly for “middle bucket funds” – a focus of Iosco recommendations.
Assessing market impact
The FSB emphasises market impact, though some challenge its existence, noted Radcliffe, highlighting the complexity of this concept. Reyes also recognised the challenges in calculating market impact, including complexity, implementation costs, and data requirements.
The FSB and Iosco are currently grappling with issues related to the “assessment of market impact, efforts involved in making these assessments, and the determination of significant market impact.” Reyes anticipated that these concepts would undergo further discussions in the months ahead.
Reyes expressed Iosco’s reservations about cash buffers in open-ended funds, as they could create a “first mover advantage” when some investors tracking liquidity positions may run out more quickly than others.
Reyes also noted that asset managers can choose one of the five options that best suits their funds. Additionally, it is the asset manager’s responsibility to evaluate the potential risk of significant dilution. Kiefer mentioned the need for the proposals to have additional systems and advanced analytics for calculating market impact, emphasising that investment funds in Luxembourg are well-equipped to handle these challenges.
“Not all tools fit every jurisdiction or fund. Investment managers, in line with their fiduciary responsibilities, are best positioned to activate and adjust these tools based on their fund’s strategy and portfolio liquidity.”
Finally, Iosco and FSB plan to release a feedback statement and final report by the end of 2023.
Overly prescriptive?
Patrick Thomson, EMEA CEO for J.P. Morgan Asset Management, welcomes the efforts of Iosco and the FSB to examine current practices and consider improvements, including “increasing the availability of liquidity management tools where practicable, to mitigate material investor dilution”.
Thomson emphasises that Iosco and FSB recognise that the responsible organisation must make decisions about using and managing LMT. He also explains this approach was acknowledged in the recent EU AIFMD and Ucits regulation assessment.
However, he cautions against an “overly prescriptive” approach. “While we agree that responsible entities should have a thorough understanding of the liquidity profiles of their respective open-ended funds – an inherent feature of responsible portfolio management – any automatic link between a fund’s liquidity profile with its redemption terms is too blunt an approach that ignores other important risk management considerations,” shares Thomson.
Jurisdictional specificities
According to Sven Kasper, international head of regulatory, industry and government affairs at asset manager State Street, the FSB’s recommendations must maintain flexibility to seamlessly incorporate into each jurisdiction. Kasper questions the relevance of the FSB’s bucketing proposals for the European Ucits regime, noting that EU funds regularly engage with regulators, closely manage their liquidity, and conduct stress tests to ensure they can withstand redemption shocks. He says, “Top-down thresholds and buckets cannot substitute for this detailed and ongoing liquidity assessment, and if anything, additional regulatory guidance should remain targeted to those funds that invest primarily in illiquid assets.”
“Open-end fund managers should employ liquidity bucketing with other liquidity management tools and contingency plans.”
State Street supports Iosco’s proposals for expanding the availability and use of liquidity management tools by jurisdictional specificities, especially as LMTs have a long history of successful deployment across the European sector. However, Kasper adds: “Not all tools fit every jurisdiction or fund. Investment managers, in line with their fiduciary responsibilities, are best positioned to activate and adjust these tools based on their fund’s strategy and portfolio liquidity. Their primary focus should be preventing the material dilution of investors in the fund,” Kasper adds.
Not a silver bullet
Marshall Saffer, MD, fund services at global business administration and compliance solutions provider CSC, says hedge funds invest in a wide range of asset classes, and there’s an increasing “crossover into illiquid real assets and private equity holdings”. Therefore, having a clear, real-time view of fund liquidity across diverse assets can be challenging, especially during market stress.
While many recommendations are good practice, none are a silver bullet, states Saffer. “Open-end fund managers should employ liquidity bucketing with other liquidity management tools and contingency plans. LMT deployment must be executed cautiously to avoid eroding investor confidence and exacerbating liquidity challenges.”
“Fund managers that look at treasury and liquidity management as an essential tool for investor relations and alpha generation will be well-positioned to address regulatory and investor concerns.”
Actively managing liquidity risk is crucial for hedge funds to maintain stability and meet investor redemption requests without causing disruptions, he adds. “Fund managers that look at treasury and liquidity management as an essential tool for investor relations and alpha generation will be well-positioned to address regulatory and investor concerns.
