In the wake of recent episodes of extreme financial market stress, global securities regulators are proposing reforms to their standards for liquidity risk management at investment funds — measures that aim to enhance investor protection and financial stability in the face of intense volatility.
The International Organization of Securities Commissions (IOSCO), a global regulator group, has published a pair of reports for consultation that set out proposed revisions to the global standards for managing liquidity risk, particularly in open-ended investment funds.
IOSCO originally published standards in 2018 that aimed to address the risks posed by liquidity mismatches in open-ended funds — namely, the risks posed by funds needing to meet daily redemption demands while holding too many longer-term illiquid assets.
Since then, markets have faced episodes of heightened stress due to events such as the pandemic and Russia’s invasion of Ukraine, that have revealed continued vulnerabilities in certain funds’ liquidity arrangements.
In response, the Financial Stability Board (FSB) recommended reforms to address these risks. IOSCO’s latest proposals aim to incorporate the FSB’s recommendations.
“Effective liquidity risk management is vital for safeguarding investors and ensuring the stability of our financial markets,” said Christina Choi, chair of IOSCO’s Committee for Investment Management, in a release.
“Our revised recommendations build on the good work of the FSB and IOSCO in 2023 and also draws from lessons learned from recent market challenges, setting out robust parameters for asset managers to consider as they look to improve their liquidity management practices,” she added.
IOSCO’s proposals include 17 recommendations that address various areas, including funds’ use of liquidity management tools, their day-to-day liquidity management practices, stress testing, governance and disclosure.
Among other things, the regulators call on fund managers to use a “broad set of liquidity management tools” to address their liquidity risks. They emphasize the importance of tools that guard against investor dilution, and that mitigate the incentives for investors to seek “first-mover advantage” due to structural liquidity mismatches in open-ended funds.
Alongside the proposed reform recommendations, the regulators also issued revised implementation guidance for consultation too, which details technical considerations for fund managers and regulators in calibrating and activating liquidity management tools.
“Today marks another landmark in our commitment to strengthening the stability and resilience of the investment fund sector, which builds on IOSCO’s close collaboration with the FSB following the release of their revised recommendations and guidance on anti-dilution liquidity management tools last year,” said Jean-Paul Servais, chair of IOSCO’s board and chairman of Belgium’s Financial Services & Markets Authority, in a release.
Both papers are out for consultation until Feb. 11, 2025.
IOSCO aims to finalize its work in this area in the first half of 2025.