Central Bank of Ireland maintains focus on fund liquidity
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Dillon Eustace, Dublin
Laura Goonan
Dillon Eustace, Dublin
Luke King-Hamill
Dillon Eustace, Dublin
luke.king-hamill@dilloneustace.ie
The Central Bank of Ireland has, like many other regulators, sharpened its focus on investment fund liquidity during the past year for a variety of reasons. Last August, the Central Bank wrote to all UCITS[1] management companies and AIFMs[2] (‘management companies’) stating that it expected the board, relevant directors and designated persons of each management company to assess on an ongoing basis the liquidity position of each fund under management to ensure ‘that the liquidity of the investment portfolio remains in line with the respective fund’s redemption policy, taking into account investors’ redemption demands’.
While liquidity oversight has always been a concern of the Central Bank, there can be no doubt that this initial communication was prompted by a combination of market volatility driven by continuing uncertainty at the time caused by Brexit allied to high profile investor losses arising in a UCITS regulated by the Financial Conduct Authority. A liquidity questionnaire was subsequently sent by the Central Bank to all funds. Management of liquidity was certainly high on the agenda when management companies convened.
In January this year, the Central Bank stated that among its priorities for 2020 was to work with the European Securities and Markets Authority (ESMA) to complete a common supervisory action on liquidity management in UCITS. The Central Bank reminded the funds it regulates that the deployment of liquidity management tools should be done in a transparent and proportionate manner, taking into account the best interests of investors. The liquidity management tools include: application of redemption gates; temporary suspension of redemptions; in-specie redemptions; side pockets; and borrowing arrangements.
The Central Bank, like other regulators, urged management companies to engage with it as early as possible when they are considering implementing liquidity management tools. The depositaries and administrators regulated by the Central Bank are reporting to it on a more frequent basis concerning any liquidity issues that they may see with the funds they are servicing.
Recent related developments
While liquidity had already clearly become an increasing focus of the Central Bank, the Covid-19 crisis, causing significant market volatility and turmoil globally for both fund managers and investors, brought it into even sharper focus. Liquidity pressures were being brought to the forefront of consideration by more investment funds with an increase in redemption requests following various fund closures. Fitch reported that 76 European mutual funds, with combined assets under management of $40bn, suspended redemptions in March. The ESMA reported that European Union-based funds with €100bn in assets under management gated or applied extraordinary measures in March.
In April the Reserve Bank of India announced a $6.6bn liquidity infusion for mutual funds after the Indian arm of a US fund group confirmed that it would cease withdrawals and wind up six higher-risk debt funds regulated by the Securities and Exchange Board of India, after market uncertainty over the spread of Covid-19 saw an increase in redemptions and a knock-on impact on market liquidity generally. This prompted the Central Bank to write to Irish regulated funds with an Indian fixed income fund.
The Central Bank recently published a notice of intention in relation to the ESMA guidelines on stress test scenarios under the Money Market Funds Regulation (MMFR). This came after the ESMA published the official translations of the guidelines. Under the MMFR, MMFs (or their managers) must conduct regular stress tests taking into consideration factors such as: (1) liquidity levels; (2) redemption levels; (3) credit and interest rate risks; (4) macroeconomic shocks; and (5) widening or narrowing of spreads among indexes to which interest rates of portfolio securities are tied. The Central Bank has convened regular calls with the management companies of MMFs that it regulates and continues to monitor issues that they are experiencing. These issues are reported at ESMA level as regulators share their experiences.
Most recently, the European Systematic Risk Board (ESRB) published a set of recommendations relating to liquidity of investment funds in which it highlighted that two types of investment funds required enhanced scrutiny from a financial stability perspective during the Covid-19 crisis: (1) funds with significant exposure to corporate debt; and (2) funds with significant exposure to real estate.
The ESRB has recommended that ESMA continue to liaise with the regulators in the EU to ensure that they undertake a focused piece of supervisory engagement with investment funds that have significant exposures to corporate debt and real estate assets to assess the preparedness of these types of funds to potential future adverse shocks.
The Central Bank has been out in front of the liquidity risks and will ensure that the funds that it regulates use the liquidity management tools at their disposal in a timely and appropriate manner to ensure they serve their purpose of protecting shareholders.
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