For a second time in two years, managers of investment funds in Luxembourg have been ordered to report significant redemptions as the Grand Duchy’s financial supervisor stepped up its monitoring of the impact from the war in Ukraine and the international sanctions against Russia.
The supervisor, CSSF, issued a notice on the “reactivation of notifications on fund issues and large redemptions” and told managers to report via its electronic reporting platform. The previous activation of this type of mandatory reporting was in the Spring of 2020 when fears on the impact of the Coronavirus triggered unexpectedly large redemptions from funds.
Notifications now are required for two types of events. First, “significant events/issues affecting the functioning” of the fund, such as valuation and liquidity problems, “ including also the impact of restrictive measures in response to the current situation in Ukraine” said CSSF in its notice.
Until further notice
Secondly, the supervisor wants funds to report “larger redemptions at the level of Luxembourg regulated investment funds” including Ucits, part II UCI and SIFs. Large redemptions are defined as daily net redemptions exceeding 5 percent of the net asset value (NAV) or net redemptions exceeding 15 percent of NAV over a week.
CSSF said the notification requirement remains in place until further notice.
Luxembourg is the legal home to approximately 3500 international investment funds that are often managed from offices elsewhere in Europe. The Grand Duchy had 5.900 billion euro in assets under management at the end of 2021. That is almost a quarter of fund assets managed in the EU.
Given the significant increase in popularity of investment funds, and ETFs specifically, financial supervisors are paying close attention to the effects of redemptions amid the volatility resulting from the war in Ukraine.
Swing pricing risks
The Grand Duchy’s supervisor also reminded the industry of its guidance on swing pricing for Luxembourg funds and of the Luxembourg legal requirements on potential breaches for limits on Value at Risk, amid “heightened volatility” in financial markets. The Value at Risk defines the extent of possible financial losses for a fund over a specific time frame. It is a common metric to determine the extent and probabilities of potential losses.
In Luxembourg, a passive breach of this VaR limit as a result of volatile market conditions such as for example in the recent weeks is required to be treated as if it were an active breach. This means fund managers need to take “appropriate steps”, according to CSSF, and closely monitor the fund as well as consider a “remediation plan”.
Swing pricing is a widely used liquidity management tool used by fund managers used in the event of a large redemptions but one that penalises investors which redeem their holdings. It is seen as an anti-dilution technique which helps funds manage liquidity risks internally by passing on transaction costs to the investors in the fund. One industry expert said it is a tool that is more ordinarily used to protect investors who choose to remain invested in a fund by attributing the cost of the redemption to only those choosing to redeem.
Questionable weakness?
Just before Christmas, the Basel-based Bank for International Settlements, a body that groups together the world’s central banks and financial regulators, said tools currently used to manage systemic risks, including swing pricing, are not sufficient. The problem came to light during the March 2020 market turmoil at the onset of the Covid-19 pandemic, when investors worldwide collectively sold their investments in a global dash for cash.
Federico Cupelli, deputy director for regulatory policy at European asset management industry association Efama, described the BIS conclusions on the March 2020 events “highly questionable”.
“The March 2020 references are also blown out of proportion,” he said. “Whereas several types of open-end funds did experience a rise in redemption demands these were nowhere near the types of risks the BIS is alluding to. To offer you an example, evidence suggests that in Europe alone, your ordinary open-end UCITS funds weathered the gradual imposition of government lock-down measures extremely well, with approximately 80 funds experiencing difficulties out of some 34.000. Most problems encountered had to do with the fact that the assets could not be accurately valued on a temporary basis.”
At that time, bond, money market and investment funds, including ETFs, suffered heavily from large withdrawals and some funds found it hard to maintain liquidity. The moves amplified market swings and threatened to undermine financial stability, according to BIS. Markets only calmed down after the European Central Bank intervened by launching its 750 billion euro pandemic rescue package.
Related stories on Investment Officer Luxembourg: