Since then, global financial markets have faced a series of events — including the pandemic, Russia’s invasion of Ukraine and turmoil in U.S. Treasury markets — that have exposed vulnerabilities in the fund sector related to liquidity risk. These include the inherent mismatches that can occur when funds promise frequent redemptions but hold illiquid assets.
To address these issues, IOSCO’s report sets out 17 recommendations across various areas, from fund design to operational practices, liquidity management tools, stress testing, governance and disclosure to both investors and regulators.
Alongside the report, IOSCO also published updated guidance for the industry and regulators on implementing its recommendations.
“These publications are a culmination of many years’ work undertaken by IOSCO on strengthening effective liquidity risk management and serve to operationalize the Financial Stability Board’s (FSB) December 2023 recommendations to address structural vulnerabilities from liquidity mismatch in open-ended funds,” it said.
In its work, the FSB found that while existing policies in this area remained “broadly appropriate,” they could be made more effective by “enhancing clarity and specificity on the policy outcomes they seek to achieve,” IOSCO noted.
Among other things, IOSCO recommended classifying funds by their liquidity and tailoring regulatory expectations accordingly; ensuring that fund managers have a “broad set” of liquidity management tools for use in both normal and stressed market conditions; and promoting greater consistency in the use of these tools by imposing the cost of redemptions on the investors seeking to redeem.
Updated guidance
“Promoting effective liquidity risk management is one of IOSCO’s key objectives. The revised recommendations and the implementation guidance fulfil our core aims of investor protection and financial stability,” said Christina Choi, executive director at the Securities & Futures Commission Hong Kong and chair of IOSCO’s Committee on Investment Management, in a release.
“Today’s publication represents significant progress in taking forward the work we have carried out alongside the FSB and provides a clear and timely framework for investment managers to enhance liquidity management amidst current macro conditions and challenges,” she added.
IOSCO’s updated guidance said fund managers “should holistically consider quantitative and qualitative factors” to assess the liquidity of a fund’s assets and overall portfolio when designing a fund, and on an ongoing basis.
It also said managers should ensure that a fund’s redemption terms are consistent with its portfolio liquidity, and that they have internal procedures and controls in place to ensure compliance with the requirements in this area.
Additionally, the guidance stated that fund managers should have — and use — liquidity tools that guard against dilution and the potential “first-mover advantage” that may encourage investors to redeem early. Anti-dilution tools should impose the cost of liquidity on investors, it said, “including any significant market impact of asset purchases or sales to meet those subscriptions or redemptions.”
“These publications are a major milestone on a very important topic in financial markets. Regulators should carefully review the revised recommendations alongside the implementation guidance, considering appropriate requirements for responsible entities, and how to supervise liquidity management practices on an ongoing basis,” said Jean-Paul Servais, IOSCO chairman and chair of the Belgium Financial Services & Markets Authority in a release.
IOSCO said it expects securities regulators to actively promote the implementation of the revised recommendations by fund managers, and that it will review their progress in 2025 and 2026.
The findings from that review “will feed into an assessment of whether implemented reforms have sufficiently addressed risks to financial stability, including, if appropriate, whether to refine existing tools or develop additional tools,” it said.