22 October 2019
Fund managers will be subject to new liquidity stress testing requirements from 30 September 2020 according to recent guidelines published by ESMA.
The new Guidelines on liquidity stress testing in UCITS and AIFs (the ‘Guidelines’) will apply in addition to the existing requirements on liquidity stress testing set out in the Alternative Investment Fund Managers Directive (AIFMD) and the Undertakings for Collective Investments in Transferable Securities (UCITS) Directive.
What is the objective of the Guidelines?
The Guidelines set out a minimum set of standards that apply to EU fund managers when conducting LST in funds and provide guidance on how fund managers can improve their LST procedures, including by determining the appropriate use of haircuts, frequency and scenario design, and the use of historical data.
Why has ESMA adopted the Guidelines?
The Guidelines follow on from recommendations published by the European Systemic Risk Board (‘ESRB’) in April 2018, on actions to address systemic risks related to liquidity mismatches and the use of leverage in investment funds. Amongst other measures, the ESRB recommended that ESMA develop guidance on how asset managers carry out liquidity stress tests.
ESMA published a consultation paper on the draft Guidelines on liquidity stress testing for UCITS and AIFs on 5 February 2019.
By way of background, the asset management industry has experienced significant growth over the last decade and regulators are increasingly concerned that distress in the funds sector could amplify risks for issuers, investors, banks and ultimately financial stability.
What is the scope of the Guidance?
The Guidelines apply to fund managers, depositaries and national competent authorities (‘NCAs’) and relate to liquidity testing in UCITS and alternative investment funds (‘AIFs’), including money market funds to the extent that the relevant requirements are not already covered in the MMF Regulation.
The application of the Guidelines is subject to the proportionality principle, meaning that fund managers should adapt the Guidelines to the nature, scale and complexity of the relevant fund.
What obligations do the Guidelines impose on Fund Managers?
The Guidelines impose a number of requirements on fund managers, including the requirement to:
A fund manager must also ensure that LST:
Is LST relevant for product development?
Yes, according to the Guidelines, a manager of a fund that requires authorisation from an NCA should:
What obligations do the Guidelines impose on Depositaries?
The Guidelines require depositaries to set up appropriate verification procedures to check that the fund manager has in place documented procedures for its LST programme. The depositary is not required to assess the LST’s adequacy or to replicate or challenge the LST undertaken by the fund manager.
What do the Guidelines say about interactions with national competent authorities (NCAs)?
According to the Guidelines, managers should notify NCAs of material risks and actions taken to address them. Moreover, NCAs may, at their discretion request:
According to some estimates, referenced by ESMA in its earlier consultation paper, 93% of managers already undertake LST and these managers will need to review their existing policies and procedures to ensure that they comply with the Guidelines. The remaining 7% face a more extensive task and will need to implement their LST policies and procedures in a way that complies with the Guidelines, by September 2020.