The FIIA liquidity risk management rules being consulted on by the FCA place additional requirements on fund managers ranging from having detailed contingency plans in place to making more detailed disclosures to investors about the tools used for managing liquidity risks and their potential effect on investors’ funds.
The proposed changes will apply to non-UCITS retail funds investing in illiquid assets, now designated as FIIAs. These rules add to requirements already in place from the Alternative Investment Fund Management Directive and the EU Commission’s delegated regulations.
The FCA proposes to introduce a new rule requiring the managers of FIIAs to prepare and maintain contingency plans for 'exceptional circumstances'. This rule follows IOSCO’s recommendation and is based on the findings of FCA’s post-Brexit referendum supervisory work that fund managers had not adequately planned for valuing portfolios in stressed market conditions.
The new rules require, among other things, fund managers to describe how they will respond to a liquidity risk crystallising, what tools they would deploy and how they would work with relevant parties to implement their contingency plan. Where a fund manager’s plan relies on a third party (eg to purchase fund assets during a liquidity stress), the proposal requires the fund manager to seek written confirmation from these parties stating they can be relied upon to implement any steps agreed.
Additional requirements for depositaries
The proposals being consulted on include a new rule requiring depositaries to regularly assess the liquidity profile of FIIAs and liquidity risks presented by the fund’s assets. In addition, the depositary is required to put in place a process for monitoring the fund manager’s liquidity management.
The FCA recognises that these new requirements are likely to come at a cost and that depositaries will likely seek compensation for the additional work they are required to undertake. The FCA is also proposing to restrict the depositary’s ability to delegate these duties to third parties, for instance back to the portfolio manager, only allowing delegation of administrative or technical tasks.
Liquidity management tools
The FCA recognises that fund managers in the UK already have a wide range of liquidity management tools at their disposal and consider that the current regulatory framework accommodates IOSCO’s recommendations. As such, the FCA is not proposing to introduce rules requiring the use of particular liquidity management tools. Instead, they are proposing guidance to clarify how commonly used tools can and should be used in certain situations. Areas considered in the consultation include:
rapid sales of assets - if a fund needs to sell assets quickly, the fund manager should consult an independent valuer to agree a reasonable value for these assets. The fund manager must disclose in the prospectus their intention to potentially use this tool in a stressed situation.
use of anti-dilution measures – no further guidance is proposed beyond existing requirements. However, the FCA reminds fund managers against using anti-dilution tools (such as swing pricing or dilution levies) to discourage redemptions in a liquidity stress.
liquidity buffers – UCITS and non-UCITS retail schemes should not accumulate or hold cash for significant periods in expectation of higher or unpredictable volumes of redemptions. This is partly to force funds to follow their stated investment strategy, partly to remove first mover advantage for informed investors who exit funds ahead of less informed investors.