Inspecting papers

Global policymakers are proposing reforms for investment funds that aim to address liquidity issues revealed during the stressed markets that accompanied the onset of the Covid-19 pandemic.

The Financial Stability Board (FSB) launched a consultation on policy proposals that target the risks posed by liquidity mismatches. These issues can arise when funds that invest in less-liquid assets such as private equity or real estate are met with large, rapid redemption demands they can’t easily meet.

“The objective of the policy proposals in this consultation report is to enhance the resilience of [shadow banks] by addressing the vulnerabilities that drive excessive spikes in demand for liquidity during stress and by mitigating their impact on financial stability,” the FSB said in a notice.

The revised policies would introduce a bucketing approach to funds’ assets that would classify assets differently based on their liquidity characteristics, with redemption policies to match each category’s liquidity.

For funds that invest primarily in liquid assets, daily redemption policies would still be appropriate, it said. Whereas funds that invest more than 30% of assets in illiquid vehicles would be expected to offer less frequent redemptions, or require longer notice periods from investors.

“Authorities should set expectations for [fund] managers to use a mixture of quantitative and qualitative factors when determining the liquidity of [fund] assets in normal and stressed market conditions,” the FSB said.

The proposals also aim to combat the “first-mover” advantage that may arise due to liquidity mismatches, requiring funds to impose the cost of liquidity on investors with various liquidity management tools, such as suspending redemptions, gating, and providing in-kind redemptions.

The FSB’s proposals are designed to be adopted alongside the International Organization of Securities Commissions’ (IOSCO) revised guidance on the use of anti-dilution liquidity management tools, which was also issued for consultation on Wednesday.

IOSCO’s proposed new guidance covers the design and use of anti-dilution liquidity management tools by investment funds — including swing pricing, valuation at bid or ask prices, dual pricing, anti-dilution levies, and subscription/redemption fees — along with the oversight of these tools by fund boards, asset managers’ boards or depositories, and disclosure to investors.

The policymakers’ proposals are directed to local regulators, with the intent of ensuring that local rules meet the requirements and that industry firms comply.

“While the guidance indicates that [regulated firms] are best placed to manage the liquidity of their open-ended funds, we also expect industry to improve practices in this area for the benefit of investors and markets,” said Christina Choi, chair of the IOSCO committee on investment management, in a release.

In its report, the FSB said the goal of the revised recommendations, combined with IOSCO’s liquidity management tools, is “a significant strengthening of liquidity management by [fund] managers compared to current practices.”

The deadline for submitting feedback on the consultations is Sept. 4.