Written by Harrison Folland
On 26 March, the Bank of England ("BOE") and Financial Conduct Authority (“FCA”) published a report on liquidity management and potential mismatch within UK open-ended funds following on from their recent survey findings.
The report, which forms part of an ongoing joint regulatory review, aims to identify potential liquidity issues and vulnerabilities within open-ended funds, such as the fact that some funds may offer frequent (e.g. daily) redemptions whilst holding certain assets that can take longer to sell in an orderly way.
The report notes that the survey explored areas such as the use of liquidity management tools by funds, fund managers’ approach to liquidity assessments and classifications, liquidity governance processes, cash management, and valuations of "less liquid assets" (i.e. primarily corporate bond funds but also mixed-bond funds and a small number of small and medium cap equity funds).
Non-exhaustively, key insights from the report included:
- Swing pricing is the most commonly used liquidity tool, but funds often have a variety of other tools at their disposal. These tools are deployed more intensively during stress periods. Which tools are used, and when said tools are used, tends not to be specific for each individual fund, and will often rather be set for families of funds or at fund manager level;
- Whilst swing pricing is used more frequently during stress periods, there appear to be significant variations in its application across the market. There were notable differences in the thresholds for applying swing pricing, as well as differences in how these thresholds are changed in stress periods;
- Liquidity management tools are not the only ways funds manage liquidity - funds often utilise liquidity buffers (in the form of cash and non-cash liquid assets). The most common non-cash assets held by the funds surveyed were units in money-market funds and UK government bonds;
- COVID-19 prompted a review of liquidity management processes in some of the surveyed funds. Despite processes generally working well under stress, many funds either made changes or launched process reviews as a result of the pandemic; and
- The report notes that an indicative liquidity classification suggests that managers of corporate bond funds may be overestimating the liquidity of their holdings - the report identifies that some fund manager's suggestions that a large proportion of their holdings would be liquid in "almost all market conditions" would be at odds with the liquidity conditions for corporate bonds (particularly during periods of market stress).
The BOE's Financial Policy Committee has welcomed the report and noted that the survey's findings mean that open-ended funds will need to:
1. Ensure that the time it takes investors to redeem their money matches the fund’s ability to sell its assets to meet redemptions;
2. Classify the fund's assets according to how easy they are to sell; and
3. Adjust prices to reflect market conditions.
The survey was launched in August 2020, and covered a reporting period from 2019 Q4 to 2020 Q2, incorporating the extreme market conditions in March 2020 in the wake of Covid-19 [...] Fund managers responded on behalf of 272 authorised funds investing in less liquid assets.