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The Financial Stability Board (FSB) today published a consultation report on addressing structural vulnerabilities from liquidity mismatch in open-ended funds. The report proposes revisions to the FSB’s 2017 Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities. The proposals form part of the FSB’s work programme on non-bank financial intermediation (NBFI) and should be read in conjunction with the International Organization of Securities Commissions’ (IOSCO) consultation report providing guidance on anti-dilution liquidity management tools (LMTs).
The proposals build on the FSB’s December 2022 report on the Assessment of the Effectiveness of the FSB’s 2017 Recommendations on Liquidity Mismatch in Open-Ended Funds. The assessment report called for greater clarity on the redemption terms that OEFs could offer to investors, based on the liquidity of their asset holdings. The assessment report also suggested that there was room for greater use of LMTs, in particular anti-dilution tools that are intended to pass on the cost of liquidity to redeeming shareholders in both normal and stressed market conditions. The main amendments to the 2017 FSB Recommendations are:
Recommendation 3 – to provide greater clarity on the redemption terms that OEFs could offer to investors, based on the liquidity of their asset holdings. This would be achieved through a proposed bucketing approach, where OEFs would be grouped into different categories depending on the liquidity of their assets. OEFs in each category would be subject to specific expectations in terms of redemption terms and conditions.
Recommendation 4 – to ensure availability of a broad set of anti-dilution and quantity-based LMTs for use by OEF managers in normal and stressed market conditions.
Recommendation 5 – to achieve (i) greater inclusion of anti-dilution LMTs in OEF constitutional documents and (ii) greater use, and greater consistency in the use, of these tools in both normal and stressed market conditions. The objective is to mitigate the potential first-mover advantage from structural liquidity mismatch in OEFs by imposing on redeeming investors the costs of liquidity associated with their redemptions.
Recommendation 2 – to require clearer public disclosures from OEF managers on the availability and use of LMTs in normal and stressed market conditions. This aims to enhance investor awareness on the objectives and operation of anti-dilution LMTs.
The revised Recommendations, combined with the new IOSCO guidance on anti-dilution LMTs, aim to achieve a significant strengthening of liquidity management by OEF managers compared to current practices.