The UK’s Financial Conduct Authority (FCA) has reviewed liquidity management in asset managers and found that firms need to increase their focus on liquidity risk. As things stand, gaps observed in liquidity management could lead to a risk of investor harm.
Asset managers need to manage liquidity effectively. Doing so is vital so investors are able to withdraw their investment in line with their expectations and at an accurate price that reflects its value. Poor liquidity management can bring with it serious risks for investors and to wider market stability.
While some firms demonstrated very high standards, with the review highlighting good practices seen, there was a wide disparity in the quality of compliance with regulatory standards and depth of liquidity risk management expertise. A minority of firms in the review had inadequate frameworks to manage liquidity risk.
Camille Blackburn, director of Wholesale Buy-Side at the FCA, said in a statement: “We have seen examples in the market where liquidity risk has crystalised and the impact this can have on investors. This review should serve as a warning to all asset managers that they need to get this right. We expect boards to discuss our findings and assure themselves that their firms are not amongst the minority with serious gaps in managing liquidity risk. It’s vital the outliers take quick action. They risk regulatory intervention if they don’t take this opportunity to address weaknesses.”
The FCA’s review found:
- The building blocks and tools for effective liquidity management were usually in place at firms, but these lacked coherence when viewed as a full process and were not always embedded into daily activities.
- Many firms attach insufficient weight to liquidity risk management in their governance oversight arrangements, as well as insufficient challenge and escalation, particularly in volatile environments.
- A wide range of approaches to liquidity stress testing with some methodologies insufficient to assess actual liquidity of the portfolio, using assumptions that were not appropriately conservative. For example, some firms’ models assumed that they would always sell the most liquid assets, without ever giving regard to the liquidity of selling a ‘vertical slice’ of the portfolio.
- Firms typically had governance and organizational arrangements in place to meet large one-off redemptions but did not have sufficient arrangements in place to oversee cumulative or market-wide redemptions that could have a significant impact on a fund.
- Wide variations in the application of anti-dilution tools such as swing pricing, which could affect the price investors receive when redeeming.
- Asset managers should take account of the findings, as many of the examples of good practice highlighted in the review and letter contribute to improved consumer outcomes and are consistent with the Consumer Duty, which comes into force on 31 July.
In an emailed statement, Chris Cummings, chief executive of the Investment Association (IA) said: “The FCA has issued a clear message regarding the need for a consistent and rigorous approach to liquidity management across the fund management industry, building on the high standards identified in a number of firms visited. The industry is already modernizing its practices in liquidity management, with most firms recognized as having the right foundations in place. The IA continues to work closely with all its members to help deliver important changes in this area. We look forward to working constructively with domestic and international regulators on policy improvements in this area. The industry is committed to ensuring firms are in the best possible position to deliver good outcomes for their customers whatever the economic outlook.”