The Financial Conduct Authority has written to authorised fund managers to warn them to ensure liquidity is properly managed in the open-ended funds they oversee.
A letter from Nick Miller, head of the asset management department at the regulator, was sent to the chairmen of the boards of authorised fund managers yesterday (November 4).
In the letter the regulator reminded the AFMs of their duty to ensure assets can be liquidated sufficiently quickly to meet redemption requests from investors.
It is already introducing rules for non-UCITS retail schemes (Nurs) in September 2020 but it warned in its letter that "firms should recognise that effective liquidity management is an irreducible, core function for all open-ended funds".
It suggested fund houses took action on liquidity now in anticipation of the incoming rules.
The rules will require firms to look at the composition of the assets in a fund, including the “spread of risk” that may hinder the ability of funds to pay out daily to clients. Daily liquidity is a feature of open-ended funds.
The FCA requested that firms consider whether a security is, in practice, easy to sell, and not simply state that it is liquid because it is listed on a stock market.
This concern comes in light of the suspension and eventual liquidation of the Woodford Equity Income fund, whereby the fund manager listed unquoted holdings on the Guernsey Stock Exchange.
This qualified the assets as liquid, despite trading rarely happening in that market.
The letter stated: "Please consider your obligations on portfolio composition, asset eligibility, and liquidity management.
"We would also like you to review your liquidity management arrangements against the FCA good practice."
The letter stated fund houses should have appropriate fund dealing arrangements for the type of fund they offer, and the types of assets held within those funds, regular assessment of liquidity demands, and of the available liquidity in the fund, with the latter to be assessed through an independent risk monitor.
The letter also urges AFMs to regularly “stress test” the funds they operate, to see what the liquidity position would be during a severe market shock.
Key features of robust liquidity management, according to the FCA:
• processes to ensure that the fund dealing (subscriptions and redemptions) arrangements are appropriate for the investment strategy of the fund
• regular assessment of liquidity demands
• an ongoing assessment of the liquidity of portfolio positions
• using liquidity buckets for liquidity risk management
• an independent risk function that monitors portfolio bucket exposures regularly and reports breaches to the set limits
• stress testing by fund managers to assess the impact of extreme but plausible scenarios on their funds
The Woodford Equity Income fund was suspended on June 3, having previously had redemptions running at £9m a day, due to the fund manager not being able to sell the less liquid parts of the portfolio quickly enough, and is now being wound up.