Liquidity stress testing in UCITS and AIFs

31 January, 2020

Liquidity risk in investment funds remains a key priority for regulatory and supervisory focus on both the EU and domestic front. Recent high-profile industry events, such as the Woodford Equity Income Fund and H2O Asset Management have further highlighted the need for a common liquidity stress testing framework across EU domiciled funds.

On 2 September, 2019, the European Securities and Markets Authority (ESMA) published its final report on guidelines on liquidity stress testing (LST) in UCITS and AIFs, which set down minimum standards for liquidity stress testing in EU domiciled funds.

The publication of the translations of the guidelines will trigger a two-month period in which National Competent Authorities (NCAs) must notify ESMA whether they comply or intend to comply with the guidelines. The CBI has noted its intent to comply with the new regulations following a letter sent to the Chair of Fund Management Companies on 7 August, 2019 reminding them of "the importance of ongoing, effective liquidity management".

Michael Hodson, Director of Asset Management and Investment Banking for the CBI, further reiterated this point in October 2019 at the PwC Director event. He highlighted that it was the responsibility of the board and the relevant Designated Persons to ensure “from a disclosure perspective, that all fund documentation should be clear, accurate and in line with relevant legislative and regulatory requirements”.

In November 2019 at the Irish Funds Symposium in London, Gerry Cross, CBI Director of Policy and Risk, identified liquidity risk as being a key focus of the CBI and other regulators going forward.

What will be the key focus areas for management companies?

The guidelines require management companies to not prescribe a “one size fits all approach” when constructing their LST framework. The framework must take into account the nature, scale and complexity of the fund(s) under management. The policy should address the following areas:

The role of senior management in the LST process;
Who within the Management Company is responsible for implementing the LST policy;
The reporting structure in place to communicate LST results within the Management Company;
Circumstances requiring escalation, including where liquidity limits/thresholds are breached;
The periodic review and adaptation of the LST framework where necessary; and
The types and severity of stress test scenarios used in the LST and the reasons for selecting the same.

What will be the key focus areas for depositories?

Under the new guidelines the depositary is required to set up appropriate verification procedures to check that the manager of a fund has in place documented procedures for its LST programme.
The verification does not require the depositary to assess the adequacy of the LST.
Where the depositary is not satisfied that LST is in place, it should take action as per any other evidence of a potential breach of rules by a manager.
The depositary does not need to replicate or challenge the LST undertaken by a manager.

How can we help you?

The deadline for compliance has been set for September 2020.

We have the expertise to help you in the following areas:

Review current risk policies and procedures
Validate current stress testing methodologies
Monitor your liquidity risk at any point in time on our fully customisable PwC online risk platform
Design and run stress tests on the platform specific to your needs