The newly published document revisits the 2018 liquidity recommendations and is a response to market and policy developments. It is intended to address issues observed during the Covid crisis as well as the market turbulence following Russia’s attack on the Ukraine. It aligns IOSCO’s recommended approach with the FSB’s corresponding recommendations on liquidity risk management.

Continuing regulatory concern in this area stems from the fact that some investors, particularly those with holdings in open-ended funds, may “overestimate the liquidity of the underlying assets”.

They may not be aware, when making investment decisions, of the potential additional costs as well as the difficulties connected with the funds exiting positions in illiquid assets or rebalancing their portfolios in response to redemption requests. This problem exists even under normal market conditions, but is accentuated in conditions of market stress.

Asset liquidation

And additional investor protection concerns can also arise “when exiting investors do not bear the true costs of asset liquidation, and remaining investors are disadvantaged.” First-mover advantage could also result in excess redemptions as investors expecting others to redeem holdings would try to redeem their own.

The consequence could be greater than expected volatility and downward pressure on asset prices impacting not only the assets held by the investment schemes, but potentially having a contagious effect and affecting the stability of the financial markets more generally.

Editorial changes have been made to all 17 recommendations, but only recommendations 3, 6, 7 and 17 include substantive changes.

Recommendation 3 incorporates the FSBs categorization approach, which groups open-ended funds into categories based on the assessment of their liquidity. Each category is subject to differing expectations on the terms and conditions governing redemptions.

Recommendation 6 (2018 Recommendation 17) covers the use of anti-dilution liquidity management tools (LMTs), quantity based LMTs and other liquidity management measures under normal and stress conditions. These are to be employed as part of robust liquidity management practices in compliance with local laws and regulations.

Recommendation 7 is new and focuses more specifically on the wider use of anti-dilution LMTs in order to ensure that subscribing and redeeming investors bear the explicit and implicit subscription and redemption costs, including, in connection with the latter, any significant market impact of asset sales required to meet such redemptions.

And a newly introduced Recommendation 17 covers disclosures to investors regarding liquidity management measures and the use of LMTs as outlined in Recommendations 6 and 7.

The recommendations are accompanied by a guidance document to support their effective implementation. It includes guidance on:

• minimizing structural liquidity mismatches in open-ended funds;
• the design and use of liquidity management tools and other liquidity management measures;
• use and calibration of anti-dilution liquidity management tools;
• use of quantity-based liquidity management tools and other liquidity management measures;
• stress-testing; and
• addressing challenges and disincentives that might discourage the adoption and use of liquidity management tools, which broadly fall into two categories:
  • negative perceptions that affect the ability to attract investors; and
  • market-wide structural and operational barriers such as additional costs or lack of data.

Christina Choi, Executive Director at the HK SFC and chair of IOSCO’s Committee on Investment Management, alluded to the “current macro conditions and challenges” as the backdrop and driver militating for investment managers to enhance their liquidity management practices and suggested that the published documents provide “a clear and timely framework” to help accomplish this.