Wednesday February 6 2019

News Source: Fund Regulation

Focus: Liquidity Risk Management

Type: General

Country: European Union

On 5th February 2019, the European Securities and Markets Authority (ESMA) announced a public consultation on its draft guidance regarding liquidity stress tests (LST’s) of investment funds – applicable to alternative investment funds (AIFs) and Undertakings for the Collective Investment in Transferable Securities (UCITS).


In April 2018, the European Systematic Risk Board (ESRB) published recommendations to address liquidity and leverage risk in investment funds. In the interests of promoting supervisory convergence, the recommendations provided that ESMA should “develop guidance on the practice to be followed by managers for the stress testing of liquidity risk for individual AIFs and UCITS.” The ESRB advised that ESMA’s guidance should include:

  1. The design of liquidity stress testing scenarios;
  2. The liquidity stress test policy, including the internal use of liquidity stress test results;
  3. Considerations for the asset and liability sides of investment fund balance sheets; and
  4. The timing and frequency for individual funds to conduct the liquidity stress tests.

ESMA’s guidance should focus on the stress-testing requirements provided in the Alternative Investment Fund Managers Directive (AIFMD), and how market participants conduct stress testing.

EFAMA and AMIC report on LST’s in Investment Funds

In January 2019, the European Funds and Asset Management Association (EFAMA) and the International Capital market Association’s Asset Management and Investors Council (ICMA’s AMIC) published a joint report which focused on LST in investment funds. The report considered the role of LST’s in mitigating risk and highlighted a robust existing framework for liquidity stress testing, namely with regards to the Undertakings for Collective Investment in Transferable Securities Directive (UCITS) and AIFMD.

The report provided three key findings:

  1. A principles-based approach on the LST governance and oversight is the optimal way forward;
  2. Proportionality is key for providing the correct framework for LST, enabling the fund sector to tailor stress tests to the profile of each fund, their respective investors and the invested assets; and
  3. In light of the existing EU regulatory framework, regional and national authorities should focus on minimising operational impediments and facilitating asset managers’ discharge of their liquidity risk management duties, by ensuring that they can avail themselves of a wide range of liquidity risk management tools.

ESMA’s Guidelines

Taking into consideration the ESRB’s recommendations and the 2019 joint report, ESMA’s guidelines provide criteria for managers to fulfil when conducting routine LST’s. The Guidelines broadly provide that the LST should:

  • be tailored towards the individual fund;
  • reflect the most relevant risks to a fund;
  • be sufficiently extreme or unfavourable;
  • sufficiently model how a manager is likely to act in times of stressed market conditions; and
  • be embedded into the fund’s overall risk management framework.

One guideline will also be applicable to depositaries, confirming how they should fulfil their obligations in relation to LST’s.

Next Steps

ESMA requires stakeholders’ views on the guidance fund managers should follow, including:

  • the design of LST scenarios;
  • the LST policy, including internal use of LST results;
  • considerations for the asset and liability sides of investment fund balance sheets; and
  • the timing and frequency for individual funds to conduct the LST’s.

The consultation is open for feedback until 1 April 2019.

Click on the above link for further information.