By Pritpal Virdee

On 6 July 2023, the FCA released a press release telling asset managers to review their liquidity management in funds after conducting a multi-firm review.

The review follows a letter the FCA issued in November 2019 to the Boards of AFMs detailing good practice in liquidity management and was carried out by the FCA to identify any improvements that have been made since 2019, and what weaknesses remain in firms’ ability to implement effective liquidity management frameworks.

The FCA assessed each firm’s governance structures, liquidity stress-testing (LST) methodologies, redemption processes, liquidity management tools, and valuation processes. The FCA reached the following conclusions:

• 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.

In addition to publishing its review, the FCA has issued a Dear CEO Letter summarising the findings of the review and reiterating what the FCA expects from firms.

The FCA expects firms to review their liquidity management arrangements, consider the application of findings in the review together with the accompanying Dear CEO letter, and make any enhancements that may be necessary.

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