FMA releases highly anticipated liquidity risk management guidance for consultation
Last week the Financial Markets Authority - Te Mana Tātai Hokohoko (FMA) released its proposed liquidity risk management guidance for consultation.
The proposed guidance is to replace the FMA’s April 2020 “Liquidity risk management good practice” guide and makes updates to reflect changing market conditions, international experience and highlight areas the FMA sees as requiring improvement.
It also incorporates the findings from the FMA's 2021 self-assessment survey of 51 managed investment scheme (MIS) managers on their liquidity risk management (LRM). The FMA’s resulting report said it thought some MIS managers were “overly optimistic” about their LRM capabilities and even strong performers had gaps, such as infrequent stress testing and lack of available liquidity management tools. The FMA has warned MIS managers against complacency regarding their LRM capabilities.
Who should read the proposed guidance?
All MIS managers and their supervisors should review the proposed guidance and consider submitting on the consultation.
The guidance makes it clear that the FMA's view is having, and overseeing, effective LRM is a legal obligation of MIS managers and supervisors respectively.
What does the proposed guidance say?
The proposed guidance describes the 11 essential features for effective LRM and sets out what the FMA considers good practice. These features remain largely unchanged from those in the FMA’s 2020 LRM good practice guide, and include establishing an LRM framework and strategy, effective disclosure and communication, regular monitoring and stress testing, and ensuring appropriate liquidity management tools are readily available.
The FMA also made the following recommendations:
- Have a range of liquidity management tools available - MIS managers should ensure they have a range of liquidity management tools to deal with different circumstances and that these tools are sufficiently described in empowering documents (eg, trust deeds). The liquidity management tools should also ensure equitable treatment across scheme participants. For example, swing pricing or buy/sell spreads may be used to impose trading costs on investors driving those trades rather than on the fund as a whole.
- However, do not rely solely on liquidity management tools - LRM frameworks, strategies and processes should include contingency plans, product design and stress testing. MIS managers should not rely solely on liquidity management tools (such as side pocketing and swing pricing) to manage liquidity.
- Communications and disclosure should be effective - MIS managers should disclose the fund's liquidity risk and proactively engage with investors, especially during market stress. This includes disclosure about the fund’s redemption terms, liquidity risk and use of leveraging. Disclosure should also include how any liquidity management tools would operate and how they may affect investors.
- Stress testing needs improvement - The FMA has highlighted stress testing as an area for improvement. The FMA expects MIS managers to conduct fund stress testing under a range of market conditions, including normal and extreme (but plausible) conditions. Stress testing should be completed at least yearly.
- Review processes annually - MIS managers’ boards and senior management should ensure LRM practices are reviewed regularly (and no less than annually). Supervisors are expected to take a risk-based approach to assessing MIS managers’ LRM practices.
The proposed guidance has been highly anticipated by the industry and, in some respects, is a welcome update to the FMA’s expectations for what constitutes good practice when MIS managers are designing and embedding their LRM practices.
However, the proposed guidance strikes a stricter tone than previous FMA liquidity guidance by focussing on LRM as a legal obligation. Under the Financial Markets Conduct Act 2013, MIS managers have a duty to act in the best interests of scheme participants and to treat scheme participants equitably. Supervisors also have a duty to act in the best interests of scheme participants. The FMA considers effective LRM is required to comply with these duties.
Some MIS managers may also be concerned by the strength of the FMA’s statements about using enforcement powers where it considers MIS managers are not meeting its expectations for “effective” LRM. The FMA details these enforcement powers in the proposed guidance, which include issuing direction orders, censures, stop orders and civil liability orders (the last of which can be made not only against the person in contravention, but also against all “involved” in the contravention).
The consultation also contains a question relating to the ability of MIS KiwiSaver managers to suspend redemptions. We note that a number of KiwiSaver trust deeds contain side pocketing provisions. Both suspension and the use of side pocketing in KiwiSaver schemes may not be practical given the right of investors to seek a transfer to another scheme and (in the case of side pocketing) the inability of a member to belong to more than one scheme.
Submissions on the consultation close on Friday, 10 November 2023. The FMA will create a final version of the proposed guidance after considering submissions received.
Please get in touch if you have any questions regarding the consultation or liquidity management generally, or would like assistance preparing a submission.