- Managers may decide to apply an extension of a determined period of time to the minimum notice period for investor redemption orders
- The extended period applies to all redeeming investors and shall not affect the dealing frequency of the fund or include the fund shares settlement period
The European Securities and Market Authority (ESMA) has launched two highly anticipated consultation papers on the appropriate use of Liquidity Management Tools (LMTs) for funds.
They form part of a review of the Alternative Investment Fund Managers Directive (AIFMD) and Undertaking in Collective Investment in Transferable Securities (UCITS) frameworks. ESMA suggests the proposals are consistent with the Financial Stability Board’s (FSB) and International Organisation of Securities Commissions’ (IOSCO) latest global standards.
The consultations address two areas:
- Draft regulatory technical standards on the characteristics of LMTs; and
- Guidelines on the selection and calibration of LMTs including the activation of side pockets.
Under the revised frameworks funds will be required to select at least two LMTs from ESMA's prescribed options.
Next Steps
The consultation sets the clock ticking with the deadline for industry responses due October 8, 2024 and ESMA committed to delivering its updated rules by April 16, 2025.
The additional granularity and level of prescription now expected will compel firms to redraft existing policies and procedures of liquidity risk management process documents across the UCITS and AIFMD ecosystem. Managers should review and recalibrate their existing tools and how decision making on LMT selection, calibration and activation, and deactivation occurs.
Background Despite open ended funds doing well in meeting redemption requests, regulatory scrutiny showed that industry norms and best practice for liquidity tools weren’t very consistent both across Europe and globally. As such, industry anticipated ESMA’s consultations to ensure harmonisation of approaches and bolster the already successful fund brands which UCITS and AIFMD funds enjoy globally. |
ESMA’s LMT Menu
ESMA has prescribed a menu of LMTs for use, as well as their main characteristics, and urges the appropriate tool must take account of the underlying assets of any given fund. All are to be applied consistently to AIFMD and UCITS funds apart from side pockets because the rules regarding physical asset separation are currently inconsistent between the two fund regimes.
- Once triggered, suspensions universally apply to all investors
- Subscription and redemption orders not executed before the fund suspension shall not be executed before the fund reopens
- Subscriptions and redemptions are reopened simultaneously when the fund reopens
- Funds must have an activation threshold
- Express threshold as a percentage of the funds’ NAV based on net redemptions at fund level for any given dealing date
- If an activation threshold is surpassed, redemption gates may be either automatically activated or left to the discretion of the fund manager
- The same level of redemption gate shall apply to all redeeming investors for a given dealing date
- Managers may carry non-executed part of redemption orders forward to next dealing day or cancel if requested by the investor
- Implemented to pass transaction costs and any significant market impact onto investors either by charging redemption fees, or anti-dilution levy or by adjusting the NAV of the fund at which investors transact (swing factor, dual pricing)
- Shall only be used to meet redemption requests from professional investors
- Set pro rata unless the fund is only marketed to professional investors or if it is an ETF
- The same method shall be applied to all redeeming investors
- May be created by way of physical separation or accounting segregation
- Should only be used in exceptional circumstances as defined by ESMA in the paper
- Side pockets shall be managed with the sole objective of being liquidated in time
- Managers may allocate cash from fund’s assets to side pockets to manage liabilities (margin calls)
- The rest of the fund shall be managed according to the disclosed investment strategy
- Managers should pay realised assets of the side pockets to investors and reinvest them
- Formal investor communication with details of the side pocket strategy, costs, expected timeline, and contingency planning should be provided
General Governance
As well as prescribing and defining the characteristics of eligible LMTs, the consultation also outlines some general principles which include:
- The responsibility for selection, calibration, and activation of LMTs resides with the manager
- The investment strategy, liquidity profile, and redemption policy of the fund must be consistently maintained and use of LMTs should never be considered a substitute for general liquidity monitoring and good operation of the fund on an ongoing basis
- ESMA also urges at least one quantitative-based LMT is chosen along with at least one anti-dilution tool and consider market conditions where each might be activated
- ESMA suggests that clear and objective criteria for the selection and activation / deactivation of the selected LMTs include methodology, governance framework before usage of LMT and subsequently when LMT is utilised is a key consideration
- Investor disclosures should help investors consider possible liquidity costs in their investment decisions and also clearly describe the implications of the use of LMTs on costs or ability to transact with the fund
Contact adrian.whelan@bbh.com or your BBH relationship manager for more LMT insights.
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