Global financial regulators and industry insiders clashed over the implementation of liquidity management tools (LMTs) to mitigate the impact of mass redemptions in open-ended investment funds at a meeting in Dublin on Wednesday.
The Financial Stability Board (FSB) and the International Organisation of Securities Commissions (IOSCO) faced a divergence of views with industry representatives on their proposal for an international framework to address structural liquidity mismatches in open-ended funds when investors decide to redeem funds en masse.
Such mismatches, which can trigger market-wide sell-offs, have contributed to global financial instability, notably at the onset of the Covid-19 pandemic in March 2020, and more recently in 2022 with the sell-off of funds holding Russian assets. Central banks in 2020 had to inject cash into markets as money market funds struggled to maintain liquidity amid daily redemptions.
The proposed FSB-IOSCO framework, which would update guiding principles agreed in 2017, promotes the use of anti-dilution LMTs to minimise investor dilution and counteract the potential first-mover advantage that can occur during mass redemptions. These LMTs are aimed at transferring the estimated liquidity cost from the fund to the redeeming investors.
More equitable distribution
By incorporating daily liquidity risk management, this approach, according to FSB and Iosco, could ensure a more equitable distribution of costs during high-volume redemptions and prevent liquidity crises as seen at the onset of the Covid-19 pandemic.
However, the industry viewpoint diverges. Michael Pedroni, Head of ICI Global and ICI’s Chief Global Affairs Officer, emphasised that the issue of shareholder dilution “is an investor protection issue at its core”. He explained that ICI’s data suggests dilution during mass redemptions doesn’t pose significant financial stability risks.
“Whilst a range of optional liquidity management tools (LMTs) can be beneficial, no single LMT suits all funds or fund categories. Imposing a fund to adopt an LMT should only be undertaken if the benefits to shareholders outweigh the costs,” said Pedroni, representing an association with approximately $39 trillion in fund assets.
Sector wants to flexible LMTs
He further advocated for maintaining flexibility for funds and asserted that the cost of implementing the proposed regulations must not exceed the benefits to investors. “LMTs are merely one aspect of funds’ liquidity risk management. Open-ended funds are already stringently regulated and engage in robust liquidity risk management, often including LMTs.”
European asset management association Efama also has argued in recent days that the fund sector does not pose a threat to financial stability. In an elaborate report, Efama said fund managers should be given access to all available liquidity management tools to prevent panic selling. Managers also need to have a better understanding of their end investors. At present, this is not always the case, which could potentially create risks.
FSB and Iosco’s framework proposes five critical elements:
1. Types of anti-dilution LMTs
2. Calibration of liquidity costs
3. Activation thresholds
4. Governance
5. Disclosure to investors
Appropriate cost calibration
Such a comprehensive plan underscores the use of various LMTs, such as swing pricing and anti-dilution levies, and stresses the importance of appropriate liquidity cost calibration, stringent governance, and tactful investor disclosure.
However, with industry insiders expressing concerns over the one-size-fits-all approach, the journey to a common international framework may be a challenging one. The dialogue between regulators and the industry continues.
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