Liquidity Management multi-firm review

The Financial Conduct Authority, FCA, has published a press release to inform of the findings from a recent review of liquidity management practices of authorized fund managers and present some „good practices“ the FCA has observed in this context. The FCA also sets out its expectations as regards liquidity (risk) management which is why – according to the FCA – the findings should be reviewed by a variety of fund managers, including asset managers, authorized fund managers, and investment and portfolio managers. The review was conducted with the aim to assess the progress made by firms in implementing effective liquidity risk management frameworks since November 2019 when the FCA issued a Dear CEO letter on good practice in liquidity management.
Below, there’s a brief summary of the key findings particularly focusing on governance, liquidity stress-testing, redemption processes, and the application of swing pricing. Also, there’s a very brief summary of the expectations of the FCA. For the „good practices“, please refer to the original document.
## Findings from the review
#### Liquidity management and governance:
– Many firms did not prioritize or assign enough importance to managing liquidity risks.
– The quality of discussions around liquidity risk issues of funds were unsatisfactory.
– Liquidity risks were often flagged and discussed only when issues arose (reactive approach to liquidity management).
– The discussions around liquidity issues were isolated and did not take into account the broader context.
– Some firms did not have processes in place to expedite decision-making and governance during periods of stress.
#### Liquidity Stress-Testing (LST):
– Different firms utilized different stress testing methodologies, ranging from highly sophisticated models to basic tick-box exercises, suggesting a lack of standardization in stress testing across the industry.
– Some firms employed a less conservative approach in stress testing by assuming that the most liquid assets would be sold first. This approach can create a distorted view of portfolio liquidity, potentially leading to a false sense of security.
– The stress test results varied widely across the portfolios of the firms under review. In cases where few or no funds failed the tests, it raises concerns about whether the thresholds and triggers set by the firms are challenging enough to reflect volatile and stressed market conditions.
– In instances where stress tests repeatedly trigger negative results, there was a lack of sufficient follow-up actions within firms‘ governance structures suggesting that the stress test results were not effectively used to inform decision-making or drive remedial actions.
– Some firms had a limited understanding of the models and methodologies used for stress testing, which particularly held true in circumstances where the model creation was outsourced to third parties.
#### Redemption Processes:
– Most firms reviewed were lacking adequate processes to ensure a fair treatment of investors as far as redemptions are concerned – particularly in times of stress (large redemptions).
– Most firms did have thresholds for large redemptions.
– There was a lack of systems or tools to observe and monitor the cumulative trends and effects of small redemptions and their impact on portfolio composition and liquidity.
#### Swing Pricing and valuation:
– Thresholds for triggering swing pricing were often the same across all funds, regardless of their underlying asset classes suggesting a lack of customization or tailoring to the specific characteristics of each fund. Different types of assets may have varying liquidity profiles and different sensitivities to large redemption orders, so a one-size-fits-all approach may not be optimal, so the FCA. Also, this approach may lead to confusion and potentially unfair treatment of investors across different funds and firms.
– Some firms dynamically adjusted their thresholds and pricing procedures based on prevailing market conditions. However, there were also firms that entirely failed to make any such changes, if market conditions so require which indicates a potential lack of oversight or responsiveness to changing market conditions.
– Also, some firms overly relied on third parties for swing price calculations which puts them at risk if the calculations are inadequate.
—
## Expectations of the FCA
1. Firms should have governing bodies composed of knowledgeable members who receive timely and appropriate management information about risks, including liquidity risks.
2. Asset managers should have strong governance arrangements in place to effectively oversee liquidity risks. This includes clearly defined lines of responsibility and escalation procedures to handle volatile market conditions.
3. Firms have tools available to enhance liquidity management and have consistent, defined processes in place for their usage. Also, asset managers need to meet regulatory requirements in this context (liquidity management strategy).
4. Asset managers should ensure that both exiting and remaining investors are treated fairly when considering redemption costs. They should also consider the mix of assets that can be used to meet redemption requests.
5. Asset managers should work with service providers to ensure that operational systems and processes are suitable, can be executed efficiently, and can be scaled up to handle increased demand.
6. Firms are expected to consistently utilize liquidity stress testing and employ liquidity management tools appropriately.
7. Alignment with Consumer Duty: While the review was conducted prior to the implementation of the new Consumer Duty, which focuses on delivering good outcomes for retail customers, firms should nevertheless consider their liquidity management practices in light of the new Duty.
—
The key findings are also topic in a concurrently issued Dear CEO Letter addressed at asset managers. Please see EventID 21959 for more information in this context.