Opportunity to re-engage with systemic risk issue

The Financial Stability Board (FSB) and European Central Bank have reasserted their view that the activities of investment managers and funds can pose systemic risk, and that some entities are “too big to fail”. While they both recognise that open-ended funds have been generally resilient and have not created financial stability concerns, they cite imperfect liquidity transformation and leverage, which could amplify the effects of market shocks as the main vulnerabilities of funds. Bond market liquidity, in particular, has hit the headlines in recent years.

The FSB has issued 14 policy recommendations, focusing on open-ended funds of all stripes, and has reactivated its work on the identification of globally systemically important financial institutions within the sector. 

The nine recommendations on liquidity management cover liquidity profile data, risk management tools, greater consistency between the underlying assets and the frequency of unit redemptions, and disclosures to investors.

Regulators are required to collect more information from fund managers and to review disclosures to investors. They are also required to make available to fund managers a range of liquidity management tools – such as swing pricing and redemption fees – and “where relevant” to consider system-wide stress testing. 

In Europe, many of these recommendations are already in place, but some, such as industry-wide stress testing, are new. However, the European Securities and Markets Agency (Esma) – the EU’s supervisory body – is also subjecting the sector to tougher scrutiny than we have witnessed before.

Steven Maijoor, Esma chairman, has questioned whether national regulators sufficiently assess and address the risks that their supervised entities might be creating in other parts of the EU, and has called for greater convergence in national supervisory approaches. Esma will develop a common procedure to impose leverage limits, and a connected approach in relation to liquidity management tools.

Some national regulators started to implement the thrust of the FSB’s recommendations ahead of their publication. The UK’s FCA has published a wide-ranging set of proposals to improve the way open-ended funds invested in illiquid assets cope with investor redemption demands during exceptional market conditions. 

In France, the regulatory body AMF has issued guidelines on best practice for the stress testing of funds.

Security of fund assets remains on the agenda, with Esma seeking a common approach to depositary functions for Ucits and alternative investment funds, and consulting further on asset segregation.

Firms around Europe will face ongoing scrutiny of their fund operations. They will need the systems and people resources to respond to regulators’ demands. Companies can use the implementation of Mifid II as an opportunity to improve their data capacity and to strengthen product processes and governance. 

There are several key questions asset managers, discretionary fund manager and advisory firms should be asking. This begins with whether the firm is on track to full compliance with the new Mifid II product governance requirements? 

Businesses must also be studying whether they have the systems to collate, analyse and report on the use of derivatives and leverage across fund ranges, and if they operate best practice when it comes to liquidity management.

Other areas for consideration include whether in stressed market conditions, firms are able to make use of the full range of liquidity management tools that the regulator currently allows. Finally, firms need to make sure they are fully engaged with EU and national debates on new leverage and liquidity requirements.

Julie Patterson is a director and regulatory specialist at KPMG

KEY FIGURES

14

Number of policy recommendations from the FSB to tackle liquidity concerns in open-ended funds

December 2015

Closing of Third Avenue’s high-yield fund amid worries about bond liquidity

$8trn

Assets under management in open-ended fixed income funds globally

17%

Share of US corporate bonds owned by mutual funds at the end of 2015, a rise from 6% in 2008