On 2 September 2019, ESMA published the Final Report on the Guidelines on liquidity stress testing in UCITS and AIFs (hereinafter the “Guidelines”), taking into account the feedback received by ESMA’s earlier consultation paper further to the recommendations by the ESRB in April 2018 in introducing minimum standards for liquidity stress testing (hereinafter “LST”) in AIFs and UCITS funds in Europe. The Guidelines, expected to apply as of 30 September 2020, provide clarifications and guidance on LTS practices, to managers of AIFs and UCITS (hereinafter the “Managers”), depositaries and EU national competent authorities (hereinafter the “NCAs”).
ESMA expects that the Guidelines will ensure overall lower liquidity risk in the broader financial market and strengthen the ability of relevant entities to manage liquidity in the best interests of the investors, by ensuring common, uniform and consistent standards, approach and practices with respect to LST. ESMA further anticipates that any initial and ongoing cost to be incurred by the managers by virtue of implementing the Guidelines will be balanced by the reputational and other benefits which arise from improved liquidity management when minimum LST standards are met.
The Guidelines, aimed to be adapted depending on the nature, scale and complexity of the managed fund at stake, provide for a list of non-exhaustive recommendations and suggestions to the Managers, inter alia:
- possible determining factors to be taken into consideration when designing LTS models and how Managers can overcome limitations with respect to the availability of data;
- LST to be properly integrated and embedded into the fund’s risk management framework supporting liquidity management and be subject to appropriate governance and oversight, including appropriate reporting and escalation procedures;
- LST to be documented in a dedicated LST policy, which in turn be subject to periodical review and adaptation, if necessary;
- LST to be carried out on an annual basis at all times and preferably on a quarterly basis, unless a higher or lower frequency is justified by the characteristics of the fund at stake;
- how LST can be best adapted to and customised for each managed fund;
- possible LST scenarios to be taken into account (i.e. rising interest rates, credit spread widening or political events) and how consequent LST outcomes can be interpreted and hence prepare Managers for a potential crisis; and
- the incorporation of scenarios relating to the liabilities of the fund, the risks factors related to the investor type and concentration.
Furthermore, the Guidelines suggest that depositaries should set up appropriate verification procedures to check that the relevant Manager has in place documented procedures for its LST programme and that NCAs can request the submission of a Manager’s LST to help demonstrate that a managed fund will be likely to comply with applicable rules, including regarding the ability of the fund to meet redemption requests in normal and stressed conditions.
The Guidelines must now be translated into each of the official languages of the European Union and then published on ESMA’s website, taking effect two months after the publication. NCAs must within two months as of the publication of the Guidelines in all EU official languages notify ESMA as to whether they intend to comply with the Guidelines, and if not, the reasons for non-compliance.
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