IOSCO has published its final report on liquidity risk management for collective investment schemes (“CIS”). This report sets out the principles against which the industry and regulators can assess the quality of regulation and industry practices governing liquidity risk management for CIS. The principles are addressed to the entity responsible for the overall operation of the CIS (the “responsible entity”) and, in particular, its compliance with its local legal and regulatory framework. The material principles are as follows:
- The responsible entity should draw up an effective risk management process, compliant with local jurisdictional liquidity requirements. The liquidity risk management process, while proportionate, needs to be able to be effective in varied market conditions.
- The responsible entity should set appropriate liquidity thresholds which are proportionate to the redemption obligations and liabilities of the CIS. The thresholds should act as a signal to the responsible entity to carry out more extensive in-depth, quantitative and/or qualitative liquidity analysis as part of the risk management process.
- The responsible entity should consider how the planned marketing and distribution of the CIS are likely to affect its liquidity. This should include consideration of market conditions when forecasting their expectations for the volume, type and distribution of investors, as well as the effectiveness of individual distribution channels.
- There should be a proportionate and appropriate explanation of liquidity risk in a CIS’s offering documentation. This should include an explanation of why and in what circumstances it might crystallise, its significance and potential impact on the CIS and its unitholders, and a summary of the process by which the responsible entity aims to mitigate the risk.
Additional principles to be applied include the careful determination of a suitable dealing frequency for units in the CIS and the inclusion in the CIS’s constitutional documentation of the ability to use specific tools or exceptional measures which could affect redemption rights. The responsible entity should regularly assess the liquidity of the assets held in the portfolio and integrate liquidity management in investment decisions.
IOSCO state that the principles are not directly applicable. When the principles are being implemented, they have to be transposed within the context of the specific legal structures prevailing in each jurisdiction (for example, some jurisdictions set out in their law quantitative limits on investment by CIS for liquidity purposes). Hence, the implementation of the principles may vary from jurisdiction to jurisdiction, depending on local conditions and circumstances.