Esma begins consultation on investment fund liquidity stress tests

Liquidation road signEsma, the independent authority safeguarding investor protection and stable financial markets in the EU, has launched a public consultation on draft guidance for liquidity stress testing of investment funds. This applies to Ucits and alternative investment funds (AIFs).

Investment fund managers in the EU are required to test the resilience of their funds when exposed to different types of market risk. This includes liquidity risk, the risk that assets cannot be sold quickly to meet redemption requests.

These draft guidelines are intended to provide consistency across the EU in terms of how financial regulators supervise liquidity stress testing for funds.

The draft consultation defines 14 principles-based criteria that asset managers should apply when conducting these tests.

These draft principles must be embedded in the fund’s overall risk framework and must be tailored to reflect the risks most applicable to the individual fund. These should also model how the fund manager is likely to behave in stressed market conditions.

One guideline is targeted directly at fund depositaries, defining how they should fulfil their responsibilities regarding liquidity stress testing.

The consultation asks fund managers to provide feedback on the design of liquidity stress testing scenarios and liquidity stress testing policy, including how the test results are used internally. This will include considerations for the asset and liability sides of investment fund balance sheets.

The window for consultation will close on April 1 2019 and Esma will then review the feedback that it receives in early Q2 2019 prior to publishing a final report by the summer.

Esma’s Chair, Steven Maijoor, said that managers should be aware of the liquidity risks applicable to funds that they manage and take appropriate steps to mitigate these risks, particularly in situations where redemption requests from investors exceed the ability of the fund to liquidate assets quickly. 

“Redemption scenarios need to be tested at fund level to avoid contagion to the wider market and any impact on financial stability,” he said.

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