Global policymakers are proposing reforms to address the kind of weaknesses that exposed liquidity issues in early 2020.
The Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) have both published policies designed to address liquidity mismatch issues — the problem posed when funds with short-term (daily) redemption obligations have illiquid portfolio holdings — in open-ended investment funds.
In a joint release, the FSB and IOSCO set out revised policy recommendations and guidance that aims to achieve a “significant strengthening” of fund managers’ liquidity management practices.
Among other things, the reforms aim to provide “greater clarity” on the redemption terms that funds offer to investors, based on the liquidity of their asset holdings and “to ensure greater use and consistency” in the use of anti-dilution liquidity management tools.
The FSB’s recommendations set out regulatory objectives for a supervisory framework to deal with liquidity mismatch issues. Its aim is to enhance the use and consistency of anti-dilution tools in both normal and stressed market conditions.
At the same time, IOSCO’s guidance targets the design and use of anti-dilution tools by fund managers, with the aim of supporting greater use of these tools to mitigate investor harm and to reduce the incentive to redeem quickly in the face of liquidity stress, which can prompt “excess redemptions.”
“Unmitigated structural liquidity mismatch may amplify shocks by driving ‘excess’ redemptions that require managers to engage in asset sales larger than in the absence of liquidity mismatch, especially in times of stress,” the FSB noted in its policy paper.
Commenting on the policymakers’ efforts, the head of ICI Global — the international arm of the U.S. fund industry trade group, the Investment Company Institute (ICI) — said the guidance provides a common-sense approach to balancing the need for robust liquidity management with viable measures to address investor protection concerns.
Michael Pedroni said, “This approach sets forth that the use of voluntary liquidity management tools should be considered, where appropriate, for each fund. This highlights the fact that not all open-end funds may need to use the liquidity management tools and just as importantly, a recognition that there is not a one-size-fits-all approach for open-end funds.”
“This guidance also addresses perceived financial stability concerns, and while ICI empirical data demonstrate that the open-end fund structure does not pose financial stability risk, we believe FSB and IOSCO’s guidance will provide long term investors with greater confidence in these investments,” Pedroni added.
The FSB and IOSCO said they will review progress on implementing their proposals by the end of 2026 — and that by 2028 they will assess whether the reforms have sufficiently addressed financial stability risks that arise from funds’ liquidity issues.
“The combined efforts of the FSB and IOSCO aim to mark a step change to liquidity risk management within [investment funds],” said FSB chair Klaas Knot in a release.
“A key part of this is a strengthening of the framework around the use of [liquidity management tools] at a global level. Swift and consistent implementation of these recommendations is critical to addressing financial stability risks arising from liquidity mismatch in [investment funds],” he added.
“The FSB and IOSCO have worked closely together to deliver a comprehensive policy package designed to strengthen open-ended fund managers’ liquidity management to improve investor protection and support financial stability,” said IOSCO chair Jean-Paul Servais.