Fund managers must stress test the liquidity risk of their investment funds under new guidance adopted by European securities regulators.

The European Securities and Markets Authority (ESMA) issued final guidance for liquidity stress-testing of investment funds, which requires fund managers to stress-test the assets and liabilities of their funds.

The most important source of liquidity risk for investment funds is redemption demands from investors, the regulators note. The new guidance requires fund managers to deploy stress testing to monitor for this risk and to mitigate its impact.

“Fund managers will need to apply a comprehensive set of guidelines when designing the scenarios, policies and frequency of liquidity stress tests for the funds they manage,” ESMA says.

The guidance also recommends that fund managers alert regulators to material risks that their testing uncovers, and the action they take to address these risks.

The new guidance aims to address a call from the European Systemic Risk Board (ESRB) for regulatory action to address systemic risks stemming from liquidity mismatches, and the use of leverage, in the investment fund sector.

ESMA’s new guidance takes effect Sept. 30.