Strengthening Liquidity Risk Management Practices for Fund Management Companies

The Monetary Authority of Singapore (MAS) has published an information paper titled „Strengthening Liquidity Risk Management (LRM) Practices for Fund Management Companies (FMCs)“. The paper follows a recent „inspection“ of LRM practices of collective investment schemes (CIS) and a review of prospectuses of CIS‘ offered to retail clients. In the information paper, MAS presents its key findings in form of „good and bad practices observed“ and outlines its expectations as to effective LRM frameworks and practices of fund management companies.
To begin with, MAS notes that the goal of LRM is to ensure that CIS can meet redemption requests in an organized manner while protecting the interests of all investors, even those not seeking redemptions. This entails minimizing potential discrepancies between the liquidity of a CIS’s underlying assets and the terms offered to investors for redemption. FCMs should also have effective LRM tools in place to address and manage liquidity mismatches that may arise in the course of their business. The key issues addressed in the paper include LRM governance, LRM aspects to consider in the design of a CIS, ongoing LRM, and stress testing. Each one is briefly discussed below.
(1) Governance: FMCs are required to establish a risk management framework to identify, address, and monitor risks associated with the assets under their management, including liquidity risk. MAS emphasizes the importance of sound governance in supporting the LRM framework and practices. Clear responsibility and accountability should be assigned to the Board and senior management for the effective implementation of LRM. Key individuals responsible for LRM should be independent and have an adequate level of authority to discharge their duties effectively. Effective oversight structures and escalation procedures should be established to address liquidity issues or concerns in a timely manner.
(2) Initial Design of Product: Liquidity risk of a CIS must be considered right from the outset, during the initial development of the product. This is essential to guarantee that the liquidity characteristics of the CIS’s underlying assets align with the intended investment objective and strategy of the CIS as well as with the redemption terms offered to investors. Therefore, when creating the CIS, FMCs should take into account several key factors, including but not limited to the investment objective and strategy of the CIS, liquidity profile of the underlying assets, target investor expectations, redemption terms, LRM tools, and disclosure to investors. If there are subsequent changes to an existing CIS, a review of the redemption terms and LRM tools should be conducted to ensure their continued suitability.
(3) Ongoing Liquidity Risk Management: FMCs should adopt a structured approach to monitor and manage CIS liquidity risk on an ongoing basis. This includes establishing liquidity risk management policies and procedures to guide staff in monitoring and managing liquidity risk. FMCs should critically assess the range and relevance of liquidity metrics, exercise due care when computing liquidity metrics, and conduct timely reviews to ensure the reasonableness of underlying assumptions. Adequate guidance should be provided to staff on LRM practices, and historical redemption patterns and expected future liquidity demands should be assessed to manage redemptions in an orderly manner.
(4) Stress Testing:
FMCs should complement their LRM tools with regular stress testing to assess the CIS’s ability to withstand liquidity stresses during market disruptions or idiosyncratic concerns. Stress testing should be performed on both sides of the CIS balance sheet, with assets stress tested at least monthly and liabilities stress tested at least quarterly. The results of stress testing should be combined to arrive at the stressed liquidity coverage ratio (LCR).
—
As these are only the key issues addressed in the paper, please refer to the original document for more detailed, comprehensive information.