Liquidity risk arising from a mismatch between the liquidity profiles of the assets and the liabilities of open-ended funds is a key danger faced by funds and it is elevated during times of market stress or volatility, according to an SFC circular issued at the end of last week.
“The risks are not restricted to any specific asset class or their sub-sectors, nor would we highlight any particular fund management firm,” an SFC spokeswoman told FSA.
“However, it is a constant concern and we need to ensure that the industry knows that we are keenly monitoring their ability and willingness to contain those risks,” she added.
Recent inspections by the regulator found that some authorised fund managers failed to maintain proper liquidity risk management systems and controls in several areas.
These included: overall risk management framework; assessments of liquidity profiles of fund assets and liabilities; stress testing; governance structure for risk management; reporting; and documentation.
The SFC’s findings come in the wake of several high-profile fund meltdowns stemming from their illiquid investments.
The former UK star fund manager Neil Woodford chose to freeze his Equity Income fund earlier this year when he was unable to make asset sales to meet withdrawals, and last year heavy exposure to illiquid assets forced Swiss fund manager GAM to gate its Absolute Return Bond Fund. Most recently, top-performing H2O, a subsidiary of Natixis Investment Managers, suffered substantial outflows after media reports highlighted its allocations to illiquid, high-risk corporate bonds linked to German entrepreneur Lars Windhorst.
Official responses
In June, the governor of the Bank of England, Mark Carney, described funds that invest in illiquid assets but allow investors daily access to their money as “built on a lie”. He called for changes to regulations.
Last week, the China Securities Regulatory Commission (CSRC) said that a guideline has been drafted for a so-called “side-pocket” mechanism in mutual funds that would keep illiquid assets separated from the fund’s other liquid investments.
However, the SFC spokeswoman insisted that its circular was not prompted by the recent crises.
Instead, “they were part of our continual assessment of their compliance with the SFC’s July 2016 circular on liquidity risk management [following A-share suspensions in the China equity markets] as well as their implementation of enhanced requirements under the Fund Manager Code of Conduct (FMCC),” she said.
The FMCC requirements, effective from November 2018, set out the principles which type 9 (asset management) licensed and registered managers of SFC-authorised funds (as well as non-SFC authorised fund managers) should observe when establishing their liquidity risk management policies and managing funds. The requirements for SFC-authorised funds were later codified in the revised Code on Unit Trusts and Mutual Funds in January this year.
Although the warnings apparently derived from the SFC’s continual monitoring process, the circular emphasised the heightened risks in current markets.
“In light of global market volatility, fund managers are reminded that…they should perform more frequent and enhanced liquidity stress testing to assess the potential impact on liquidity as well as the adequacy of their action plans regarding how they would meet the fund’s liquidity needs,” it said.
“It is of paramount importance for fund managers…to minimise the risk of not meeting investors’ redemption requests,” added the SFC.
