The Financial Conduct Authority has reviewed liquidity management in asset managers and found that firms need to increase their focus on liquidity risk. As things stand, gaps observed in liquidity management could lead to a risk of investor harm.
Asset managers need to manage liquidity effectively. Doing so is vital so investors are able to withdraw their investment in line with their expectations and at an accurate price that reflects its value.
Poor liquidity management can bring with it serious risks for investors and to wider market stability.
While some firms demonstrated very high standards, with the review highlighting good practices seen, there was a wide disparity in the quality of compliance with regulatory standards and depth of liquidity risk management expertise. A minority of firms in the review had inadequate frameworks to manage liquidity risk.
Camille Blackburn, Director of Wholesale Buy-Side at the FCA, said:
'We have seen examples in the market where liquidity risk has crystallised and the impact this can have on investors.
'This review should serve as a warning to all asset managers that they need to get this right. We expect boards to discuss our findings and assure themselves that their firms are not amongst the minority with serious gaps in managing liquidity risk.
'It’s vital the outliers take quick action. They risk regulatory intervention if they don’t take this opportunity to address weaknesses.'
The FCA’s review found:
- The building blocks and tools for effective liquidity management were usually in place at firms, but these lacked coherence when viewed as a full process and were not always embedded into daily activities.
- Many firms attach insufficient weight to liquidity risk management in their governance oversight arrangements, as well as insufficient challenge and escalation, particularly in volatile environments.
- A wide range of approaches to liquidity stress testing with some methodologies insufficient to assess actual liquidity of the portfolio, using assumptions that were not appropriately conservative. For example, some firms’ models assumed that they would always sell the most liquid assets, without ever giving regard to the liquidity of selling a ‘vertical slice’ of the portfolio.
- Firms typically had governance and organisational arrangements in place to meet large one-off redemptions but did not have sufficient arrangements in place to oversee cumulative or market-wide redemptions that could have a significant impact on a fund.
- Wide variations in the application of anti-dilution tools such as swing pricing, which could affect the price investors receive when redeeming.
Asset managers should take account of the findings, as many of the examples of good practice highlighted in the review and letter contribute to improved consumer outcomes and are consistent with the Consumer Duty, which comes into force on 31 July.
One of the FCA’s strategic areas of focus is to promote competition and positive change. Enhancing liquidity risk practices strengthens the UK’s wholesale markets and helps encourage growth in the UK economy.
Notes to editor:
- Read Liquidity Management multi-firm review[1].
- Dear CEO letter: Liquidity Management multi-firm review[2] (PDF)
- The review focused mainly on AFMs and authorised funds, but the findings can be applied to a wide variety of fund types. Property funds were not subject to this review.
- Find out more information about the FCA[3].