FMA Updates Guidance on Liquidity Risk Management for Investment Funds

The Financial Markets Authority (FMA) has released draft guidelines for Managed Investment Scheme (MIS) managers and their supervisors regarding the effective management of liquidity risk (LRM).

Efficient LRM is crucial in mitigating the risk of harm to investors when faced with substantial fund redemption requests. Inadequate LRM in such situations might compel an investment manager to sell less liquid assets, such as certain types of property investments, at prices below their market value, adversely affecting the returns of all fund investors. Alternatively, the manager might need to sell a significant portion of more liquid assets, like shares in large companies, which would cater to the withdrawing investors but increase the overall risk of the fund, resulting in unfair treatment of the remaining investors. Effective LRM also plays a role in preventing a liquidity crisis in one fund from spreading to other managed funds.

This proposed guidance outlines the FMA's expectations for MIS managers in effectively managing liquidity risk as part of their legal responsibilities. It also delineates the corresponding expectations for supervisors of MIS.

The proposed guidance updates and supersedes the LRM good practice guide issued by the FMA in April 2020 to align with draft international policy recommendations from the International Organization of Securities Commissions and the Financial Stability Board. It identifies the areas where MIS managers and supervisors need to make improvements.

These updates follow a self-assessment survey on LRM conducted by the FMA in 2021, which involved 51 regulated MIS managers. The FMA's observations observed that:

• MIS managers tended to be overly optimistic about their LRM capabilities, even when their responses revealed gaps in specific areas, including the frequency of stress testing and the utilization of available liquidity management tools and metrics.

• ​MIS managers should avoid becoming complacent about their capabilities, and MIS boards/oversight bodies must maintain effective oversight and provide constructive challenges. This includes forming their own assessment of the LRM capabilities, maturity, and culture of their entity and ensuring that these align with the MIS's defined risk appetite and policy settings. They should also identify any necessary changes and ensure that management takes steps to address them.

The FMA invites feedback on these proposed guidelines, with submissions closing on Friday, November 10.