The Financial Markets Authority (FMA) has published a report on its managed investment scheme (MIS) liquidity management review. It contains recommendations on liquidity stress testing frameworks, processes and procedures.
The report is available here.
Who needs to read it? Why?
The report is relevant to all fund/investment managers, supervisors, and other businesses dealing with MIS (including KiwiSaver Schemes). The FMA’s views in this report are particularly important for the directors, senior management and investment personnel of MIS.
What does it cover?
The report comes after the FMA’s survey in August 2020 which was completed by 51 licensed MIS managers to self-assess their liquidity risk management capabilities. The FMA considered that the responses were overly optimistic, based on their responses to specific questions, and that “even the stronger performers showed some significant gaps across particular areas of capability”.
The report sets out the FMA’s findings from the survey, and provides 17 specific recommendations across four key areas in relation to MIS liquidity risk.
The FMA’s recommendations are summarised as follows:
Overview of the market
- MIS managers should define explicit internal investor concentration thresholds and targets, and report these regularly.
- MIS managers should undertake sensitivity analysis/stress-testing to gauge the potential impact of withdrawals by their or each fund’s largest investors.
Liquidity stress testing scope, extent and frequency
- MIS managers should review and constructively challenge the adequacy of their liquidity risk management frameworks, policies, procedures and risk appetite against their MIS manager licensee obligations.
- MIS managers should undertake liquidity stress testing for all the funds they manage at least annually and more frequently if their fund structure and/or market conditions warrant. Stress testing undertaken by third parties on behalf of the fund does not absolve MIS management from responsibility.
Liquidity management tools (LMTs)
- MIS managers should explicitly define the LMTs they have available for use, assess conditions under which they will be deployed (and withdrawn), and how their use ensures ‘fair treatment’.
- MIS managers should maintain a written chronological record of their use of LMTs, as this information will inform their future use of LMTs.
- MIS managers should review and expand their suite of available LMTs beyond those they currently use, with a particular focus on LMTs suited to the ‘pending’ phase in an emerging liquidity crisis.
- MIS managers should consider the use of LMTs in conjunction with other complementary/related tools (e.g. early-warning metrics) to effect better outcomes.
- Mortgage MIS managers in particular should actively explore augmenting their LMTs across all groups as described in the report. The report groups LMTs by indicative timing of use – pending, imminent, and current liquidity crisis groups.
Liquidity risk governance, frameworks, policies, procedures and metrics
- Liquidity risk management (LRM) policies should be reviewed in accordance with good practice principles and implemented in a way that reflects the particular characteristics of each fund.
- MIS managers should have a formal LRM policy endorsed by the board. This helps ensure accountability and consistency in application, provides a starting point during a crisis, and provides visibility to the board of levers available in a crisis.
- MIS managers should have an asset valuation policy that includes ‘fair valuation’ rules, particularly when market valuations are unavailable.
- MIS managers should consider more training on liquidity risk and LRM.
- MIS managers should consider improving the measuring and reporting of all risk types against respective risk management policies.
- All fund of funds MIS managers should have good oversight and proactively consider on an ongoing basis the liquidity stress testing and use of LMTs undertaken by their underlying MIS managers. MIS managers should form their own responses from these tests and have visibility of when/how underlying managers may use LMTs.
- Managers should implement relevant liability liquidity metrics. E.g. investor types, investor concentrations, and projected (and stressed) redemptions. This could allow for better visibility of potential redemption factors that could impact on performance/liquidity of the fund.
- MIS managers should have a definition of ‘illiquid assets’ suited to their funds’ asset composition. A clear definition, with metrics to track the performance, could enhance oversight of the assets.
Our view
The recommendations do not have the status of regulatory requirements in themselves.
The report states MIS managers should consider the report as guidance as to the level of care, diligence and skill that “a prudent person in the profession would exercise in respect of liquidity risk management in most circumstances”, referencing the obligation in section 144 of the Financial Markets Conduct Act 2013. Further, the report states that the FMA will use the report as a benchmark for assessing capability to effectively perform licensed services.
Our view is that while the recommendations are not directly legally binding, all MIS managers should carefully review their arrangements, and consider what changes, if any, are required to be made to processes, policies and practices so that these are strengthened as a matter of good practice. The changes to be made will then be a matter for discussion and agreement between the manager and their supervisor, having regard to the best interests of the investors in the relevant scheme.
The findings of the report will need to be considered with the FMA’s liquidity risk management good practice guide for MIS published last year.
What next?
The FMA has proposed a further survey to understand how MIS managers would deploy the policies, procedures and tools at their disposal in two hypothetical liquidity risk stress scenarios. The timing for this is yet to be determined.
If you have any questions in relation to MIS management practices or are considering how to implement changes in light of the report, please contact one of our experts.
