FSB consults on Liquidity Mismatch in Open-Ended Funds

What's new?

On 5 July 2023, the FSB published a consultation report in which it sets out proposals to make liquidity-related changes to its 2017 Policy document, “Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities”.

The proposed revisions would amend Recommendations 3, 4, 5 and 8 and make minor changes to Recommendation 2 in order to

• provide greater clarity on redemption terms that open-ended funds (OEF) could offer investors, based on the liquidity of their asset holdings and
• mitigate the potential first-mover advantage by imposing on redeeming and subscribing investors the costs associated with redemptions and subscriptions.

The consultation period closes on 4 September 2023 and the FSB anticipates that it will publish its final report in late 2023.

What is the FSB proposing?

The changes contained in the consultation report would have the following effects

• Recommendation 3 would be amended to provide greater clarity on the redemption terms that OEFs could offer to investors, based on the liquidity of their assets
• Recommendation 4 would be amended to encourage the authorities to make available a broad set of anti-dilution and quantity-based LMTs for use by OEF managers
• Recommendation 5 would be amended in order to achieve
  • greater inclusion of anti-dilution LMTs in OEF constitutional documents and
  • greater consistency in LMTs’ use during normal and stress times.

The FSB’s 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.

• In addition, the FSB is proposing ‘minor changes’ to Recommendation 2 in order 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.

Other related work

The revised FSB Recommendations should be read in conjunction with IOSCO’s proposed guidance on anti-dilution liquidity management tools (LMTs) on which we report here.

Both reforms aim to strengthen liquidity management by OEF managers against the background of growing regulatory concern around liquidity mismatches – see, for example, the FCA’s recent Dear CEO letter, which we covered here.