On 19 May 2021, the Central Bank of Ireland (the “Central Bank”) published a letter it sent to all Irish authorised UCITS managers (including self-managed UCITS) on 18 May 2021 relating to its review of UCITS liquidity risk management (the “Industry Letter”). The Central Bank’s review formed part of the European Securities and Markets Authority’s (“ESMA”) common supervisory action (the “CSA”) on this topic. By way of reminder, ESMA issued a public statement relating to the CSA on 24 March 2021 and the Central Bank in the Industry Letter notes that the findings set out in ESMA’s public statement incorporate the findings from the Central Bank’s own supervisory analysis and engagement with UCITS managers.

Action to be taken 

The Central Bank requires that entities to whom the Industry Letter is addressed conduct a specific review of their practices, documentation, systems and controls relating to liquidity risk management, taking into account the findings set out in ESMA’s public statement as well as those specifically referenced in the Industry Letter. In addition, such entities must prepare an action plan based on the results of their review for consideration and approval by their boards before the end of the fourth quarter of 2021.

This review must be documented and include details of actions taken to address any of the findings in ESMA’s public statement and the Industry Letter. 

Key findings set out in the Industry Letter 

The Industry Letter summarises the work undertaken in Ireland to collect and analyse the data provided by the entities involved in the review process. While the Central Bank has engaged directly with individual entities in respect of specific findings, the Central Bank notes that the Industry Letter has been issued to all Irish authorised UCITS managers and requires them to carry out a review of their activities in light of the findings of the CSA. In addition to ESMA’s public statement on the CSA, the Industry Letter should be read in conjunction with: 

  1. ESMA’s report to the European Systemic Risk Board on investment funds that have significant exposures to corporate debt and real estate assets. By way of reminder this report sets out the findings from a common supervisory exercise undertaken in 2020 which sought information on the preparedness of investment funds with significant exposures to corporate debt and real estate assets to potential future adverse liquidity and valuation shocks; and 
  2. the Central Bank’s letter issued in March 2021 to fund managers in the context of that supervisory exercise and its findings.

The Central Bank sets out key findings from the CSA that it identifies as essential to highlight to all UCITS managers and not just those managers where specific concerns were identified. 

Instances of liquidity risk management frameworks that were not clearly defined, adaptable and/or independent

  • There is an expectation that UCITS managers have a cohesive, comprehensive, practical, live documented liquidity risk management framework that accounts for all known dynamics relating to liquidity risk. 
  • Liquidity risk management frameworks should be driven by the liquidity profile of funds and profiles of their investors.

A lack of formal liquidity escalation policies 

  • A formal process should be in place in respect of the identification and escalation of liquidity issues and/or concerns to the board of directors.

A lack of formal documented pre-investment forecasting frameworks 

  • Expectations and required actions in respect of pre-investment forecasting form an important part of the overall risk management policy with respect to liquidity risk management.

Cases where no pre-investment forecasting performed 

  • For securities which are not admitted to trading on a regulated market, the Central Bank notes that given the heightened liquidity risk of such securities, failure to perform pre-investment forecasting for such investments results in non-compliance with the relevant UCITS regulations.  

Over-reliance on the presumption of ongoing liquidity 

  • Over-reliance should not be placed on historical performance, entities should consider hypothetical scenarios to prepare for potential future liquidity events. 

Oversight of delegates below expectations 

  • There should be regular engagement with delegate investment managers through receipt of ongoing liquidity reporting. Evidence of regular challenge and interaction with these investment managers should be available.

Shortcomings in the role of the designated person for fund risk management 

  • Designated persons should constructively challenge delegates, should not necessarily accept information from delegates at face value, should interrogate information received and should follow up on issues raised to ensure that they are concluded satisfactorily.

Cases of no liquidity reporting to the board of the UCITS manager 

  • The reporting of liquidity risk and the manner in which it is reported to the board of directors is an essential part of a properly functioning and robust risk management policy. 
  • The risk management policy must state the terms, contents and frequency of reporting to the board of directors.

Shortcomings in internal control framework 

  • Second level controls (the compliance function), and where appropriate and proportionate, third level controls (the internal audit function), should have sufficient input into and oversight of liquidity risk management framework.

Next Steps 

A detailed review of the Central Bank’s letter should be undertaken and its contents brought to the attention of the board of directors. A project plan can be prepared to ensure that all of the findings set out in the documents referenced above are considered as part of the review process.