Dear Chair | Release Date: 4th November 2019
To read a shorter summary of this Dear Chair letter, click here.
To access the original FCA document, click here.
Long Summary
This document serves as a directive from the Financial Conduct Authority (FCA) to Chairpersons of firms, particularly focusing on the responsibilities of Authorised Fund Managers (AFMs) regarding the critical task of managing liquidity effectively within their funds. It underlines the ongoing responsibility of AFMs to ensure that fund governance and liquidity management practices are robust, particularly in the context of open-ended funds which dominate the UK retail market. The guidance is designed to help AFMs navigate the complexities associated with these funds, ensuring they are well-prepared to meet challenges during normal operations and market volatilities.
The Imperative of Liquidity Management
The FCA underscores the paramount importance of liquidity management within the structure of fund management responsibilities. The liquidity of a fund’s underlying assets is crucial, especially when faced with heightened redemption requests from investors. Challenges typically arise in daily dealing funds, where the need for quick asset liquidation becomes more pronounced. The guide stresses that effective liquidity management can prevent significant harm to a fund’s performance and investor interests.
Regulatory Framework and Enhancements
The FCA’s policy statement (PS19/24) issued on 30 September 2019, which focuses on illiquid assets and open-ended funds, outlines new measures that aim to bolster the regulatory framework governing these funds. The changes are set to be implemented in September 2020 and include compulsory temporary suspensions of dealing under specific conditions, advancements in liquidity management processes, and enhanced disclosure requirements for investors. These changes, while initially focusing on non-UCITS retail schemes (NURS), are part of a broader initiative to instil rigorous liquidity management practices across all open-ended funds.
Detailed Areas of Focus for Authorised Fund Managers:
Portfolio Composition and Asset Management
AFMs must diligently assess the appropriateness of assets within their funds, ensuring compliance with the Collective Investment Schemes (COLL) sourcebook which dictates the requirements for asset managers and authorised funds.
Specific criteria for transferable securities eligibility are detailed in COLL 5.2.7AR for UCITS schemes, with similar criteria applicable to NURS under COLL 5.6.5AR.
AFMs are mandated to maintain a prudent spread of risk within their funds, a requirement that extends beyond the diversification mandates detailed in COLL 5.2.11R.
Compliance with redemption obligations during all dealing days as per COLL 6.2.16R(3) is essential, necessitating constant liquidity assessment and management.
Liquidity Risk Management Practices
Effective systems, controls, and governance structures must be in place to manage liquidity risks appropriately. This includes regular assessments of liquidity demands, ongoing evaluation of portfolio positions, and the strategic use of liquidity buckets within risk management frameworks.
AFMs should conduct stress tests to evaluate the impact of plausible adverse scenarios on their funds, ensuring preparedness for varying market conditions.
Governance, Systems, and Controls
Robust governance structures are crucial for effective oversight and management of liquidity risks. This involves independent risk functions that regularly monitor liquidity profiles and report potential breaches.
Firms are encouraged to adopt formal policies that include liquidity thresholds and triggers for action, which can be vital in managing fewer liquid funds and those investing in less liquid assets.
Implementation of IOSCO Recommendations
The International Organisation of Securities Commissions (IOSCO) 2018 recommendations are vital for enhancing liquidity risk management practices among open-ended collective investment schemes. These recommendations urge responsible entities to:
- Establish and maintain appropriate liquidity thresholds proportional to the redemption obligations.
- Regularly assess the liquidity of the assets held.
- Develop and test contingency plans to ensure quick and orderly use of liquidity management tools when necessary.
Conclusion and Proactive Steps
AFMs are urged to rigorously review and, if necessary, enhance their liquidity management practices aligning with the best practices and regulatory expectations outlined by the FCA and IOSCO. This review should focus on ensuring that funds are managed in a way that liquidity can be effectively managed even during periods of market stress.
Key Actions and Takeaways:
Immediate review and enhancement of liquidity management frameworks to incorporate FCA guidelines and IOSCO recommendations.
Ensuring that portfolio compositions are resilient and capable of meeting liquidity needs even under stressed conditions.
Establishing robust governance frameworks to support effective liquidity management.
Participation in FCA-offered educational events and resources to stay informed on best practices and regulatory expectations.
This guidance from the FCA is designed to ensure that AFMs not only comply with upcoming regulatory changes but also adopt a proactive approach to fund management that prioritises investor protection and market stability.