On 10th March 2021, the Central Bank of Ireland (CBI) wrote a letter to Fund Management Companies on ESMA ESRB liquidity Project.

These communications were written in the context of Brexit preparedness and market uncertainty due to COVID 19. The importance of effective liquidity risk management is key at all times and has been reinforced by the period of stressed liquidity conditions witnessed across many markets in the wake of the COVID 19 outbreak.

The findings in the ESMA Report incorporated the findings from the Central Bank’s supervisory analysis and engagement with selected funds, which were consistent with the overall findings of other NCAs. The firm was selected to be part of this Review in relation to the corporate bond investment funds listed in Appendix 1. As such, the ESMA Report contains findings that are relevant to firm and on which specific action is required as described in this letter.

UCITS and AIFMD legislation requires fund management companies to periodically review the adequacy and effectiveness of their risk management policies and procedures. In view of the findings of the Review, the Central Bank requires firm to now consider how liquidity risk management frameworks and fund structures should be adapted to take into account the experience and lessons learned from the market and redemption activity in 2020 and the findings of the ESMA Report. This should also consider the steps needed to increase funds’ resilience to future shocks. The following elements are important in considering what changes may be required:

  • The alignment between the liquidity profile of funds’ investments, the risk profile of investors, redemption policies and settlement periods and the development of new policies to correct misalignments in a timely manner. This is of particular importance for funds investing in less liquid assets or assets that have demonstrated variable levels of liquidity in 2020.
  • Ensuring the full suite of liquidity management tools (LMTs) are in place and used appropriately. This should include consideration of the circumstances where LMTs are appropriate outside of stress scenarios, given their potential to enhance investor protection and dampen the effect of large increases in redemption requests on market conditions. Fund management companies should consider the extent to which the use of swing pricing or anti-dilution levies are required to ensure that transaction costs, including liquidity premia, associated with redemptions are borne by those exercising their redemption rights, limiting the effect of large redemption flows on remaining investors, particularly in times of stress and market volatility
  • The firm’s policies and procedures around the use of LMTs should include appropriate disclosure in fund documentation and communication with investors to ensure clarity and transparency around the regular use of LMTs and conditions for their implementation.
  • The assessment of all other factors that could impact fund liquidity or trigger unplanned sale of assets. For example, the possibility of increased margin calls that may increase cash needs.
  • A realistic and conservative estimate of which percentage of a fund’s assets can be liquidated over certain time periods and ensure redemption policies are aligned with this assessment. Any mis-alignment in this regard should be corrected in a timely manner.
  • Information on the profile of the investor base to better understand any potential risks associated with redemption patterns, particularly in stressed market conditions.
  • Designing and testing funds’ liquidity risk management frameworks and planning for future market disruption events should not assume government or central bank intervention of the nature or scale seen in 2020.

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