Uniquely Canadian Regulatory Expectations For Investment Fund Liquidity Risk Management - Finance and Banking - Canada - Mondaq News Alerts | Canada News Media
On September 18, 2020, the Canadian Securities Administrators
(CSA) released CSA Staff Notice 81-333 Guidance on Effective
Liquidity Risk Management for Investment Funds. The Notice
provides guidance for investment fund managers (IFMs) and portfolio
managers (PMs) on the CSA’s expectations that those firms
develop and maintain effective liquidity risk management (LRM)
frameworks in respect of the investment funds they manage. An LRM
framework supports the ability of investment funds to satisfy
redemption requests without significantly diluting remaining fund
investors and maintain the funds’ liquidity profiles. The
guidance provided in the Notice is aimed at IFMs of investment
funds that are subject to National Instrument 81-102 Investment
Funds, although the CSA note that many of the LRM practices
and examples contained in the Notice may also be relevant for other
types of investment funds.
Background
Through the Notice, the CSA respond to international initiatives
over a number of years relating to LRM practices from the Financial
Stability Board (FSB) and the International Organization of
Securities Commissions (IOSCO)1. These initiatives took
into account lessons learned from the financial crisis of 2007 with
an initial focus on LRM of open-ended collective investment
schemes. IOSCO’s 2018 Recommendations for Liquidity Risk
Management for Collective Investment Schemes – Final
Report, prompted the two Canadian participants in IOSCO
– L’Autorité des marchés financiers (AMF)
and the Ontario Securities Commission (OSC) – to seek input
from various Canadian market participants in responding to
IOSCO’s recommendations and developing the principles set out
in the Notice2.
No “one size fits all”
Liquidity risk refers to “the risk that a fund is unable to
satisfy redemption requests without having a material impact on the
remaining securityholders of a fund” (ie. the potential
mismatch between the liquidity of underlying portfolio assets of
the investment fund and the redemption terms and conditions
afforded to fund investors). The CSA emphasize that materiality
varies between funds and that different approaches to effectively
manage liquidity risk can be used according to a fund’s
characteristics such as size, structure, investment objectives and
strategies and investor base. The CSA expressly state that the
guidance does not suggest or endorse a “one size fits
all” approach to LRM, given that each investment fund has its
own unique characteristics, including liquidity risk. This will be
welcome news particularly for smaller managers.
CSA expectations and existing regulatory requirements
While the Notice is intended as guidance for IFMs and PMs, it is
clear from the language used that the CSA’s expectations will
be used as a reference point in their future compliance reviews of
LRM policies and procedures, as well as fund disclosure.
The CSA expects each IFM to establish and maintain an effective
LRM framework that is consistent with its statutory standard of
care, as well as its obligations, as applicable, under National
Instrument 31-103 and NI 81-102. By linking a fund’s liquidity
risk with the “business of the fund” and the internal
control and compliance requirements contained in NI 31-103, the CSA
highlight that registrant firms have an obligation to establish LRM
controls and supervision sufficient to manage the liquidity risks
associated with their funds.
The Notice reiterates the CSA’s views that managers of
investment funds subject to NI 81-102 must establish an effective
LRM policy that considers the liquidity of the types of assets in
which the investment fund will be invested and the fund’s
obligations and other liabilities. IFMs should regularly measure,
monitor and manage the liquidity of the investment fund’s
underlying portfolio assets, keeping in mind the time to liquidate
each portfolio asset, the price at which the asset may be sold and
the pattern of redemption requests.3
LRM framework
The CSA highlight five important key areas for an effective LRM
framework:
1. Strong and effective governance
IFMs should assess whether an existing governance body or new
committee needs to be established in order to provide adequate
oversight of the LRM function. Such assessment should consider
whether new or enhanced reporting and other compliance mechanisms
need to be implemented to ensure the necessary information is being
monitored and shared with relevant parties.
The CSA set out potential responsibilities of such an oversight
committee, including reporting and escalation procedures,
valuation, conflicts of interest, ongoing review of LRM policies
and procedures as well as establishing stress testing and reviewing
the results of such stress testing.
2. Creation and ongoing maintenance of LRM procedures
An LRM process should begin with the design phase of investment
products to ensure alignment of redemption terms and investment
strategy taking into consideration the lifecycle of the fund. An
effective LRM process may include the regular assessment of the
liquidity profile of the fund’s assets and liabilities taking
into consideration current market conditions, redemption activity,
and investor behaviour and periodic communication and review by
senior management and/or relevant personnel. A number of principles
and practical implementation strategies are set out in the Notice,
including:
Aligning investment objectives,
strategies and the redemption policy of a fund with the liquidity
profile of its underlying portfolio assets and redemption demands
of the investor. For example, in cases where the fund holds
substantial amounts of thinly traded securities, or whose
securities have longer settlement periods, an IFM could elect to
have the fund offer less frequent redemption opportunities to
investors;
Performing active, ongoing portfolio
monitoring using qualitative and quantitative metrics to ensure
adequate levels of liquidity exist to meet redemption needs and
other obligations; and
Setting internal liquidity thresholds
and targets that management can use to assess the liquidity profile
of a fund and make any necessary adjustments.
3. Stress testing
The CSA explain that stress testing may be an effective aspect
of an IFM’s LRM process, given that it will enable an IFM to
assess and respond to liquidity risks. Some of the key factors for
stress testing include:
Identification of risks including
market and redemption risks such as market stress affecting a class
or subclass of asset, interest rate risk, geopolitical risk;
Scenario analyses that are diverse
and reflect material risks relevant to the fund. IFMs may consider
factors such as a downgrade of the credit rating of an underlying
portfolio asset or of the related issuer, changes in interest
rates, widening of bid-ask spreads and economic shocks;
Historical stress testing that
include factors such as the comparison of historical cash flows
with industry-wide cash flows for funds of similar size and
strategy, or the redemption activity of the largest investor or
group of investors; and
Hypothetical stress testing which
attempts to measure the potential impact of an event that has not
yet occurred, such as interest rate changes or the potential for
counterparty default.
Frequency of stress testing will depend on the specific
attributes of a fund such as fund size, redemption frequency and
investor base. It will be important to document and analyse testing
results and communicate the results to the committee overseeing
liquidity risk.
4. Disclosure of liquidity risks
The CSA consider that disclosure of material liquidity risk is
part of full, true and plain disclosure required to be made to
investors in an investment fund. The existing disclosure
requirements of National Instrument 81-101 provide for specified
mandated disclosure of liquidity risk for public investment funds,
including the risk that redemptions may be suspended and the
specific risks associated with redemptions by holders of large
positions in the funds. The CSA expect that LRM governance matters
relating to the funds will be included in the prospectus disclosure
and if an IFM does not have written policies and procedures around
LRM, this fact should then be disclosed to investors. The Notice
gives examples of the CSA’s expectations for such disclosure
that IFMs should review in connection with prospectus filings and
renewals.
Liquidity risks should also be addressed in a fund’s
continuous disclosure documents, including the management reports
of fund performance mandated by National Instrument 81-106. This
would include disclosure of any liquidity challenge during the
period and how those challenges were addressed, along with changes
in risk level of a fund due to market conditions, significant
redemptions or liquidity of underlying portfolio assets.
5. Use of LRM tools to manage potential and actual liquidity
issues
Any use of LRM tools (such as suspension of redemptions and
borrowing) to aid in the liquidity management of a fund are subject
to certain overarching principles:
The use of a mechanism that affects
redemption rights is only justified in open-ended funds in
exceptional circumstances. Such circumstances are rare, such as
where a fair and robust valuation of the assets in which the fund
is invested is difficult or impossible to carry out, or where
redemption demands are so large/exceptional that liquidity cannot
be raised in the timeframe required to meet the demands.
The use of extraordinary LRM tools
must be in the best interest of the fund investors collectively. A
fund should only use such tools when it is in the best interest of
investors and when the fair and equal treatment of incoming,
ongoing and outgoing investors is maintained.
The CSA guidance contained in the Notice provides a uniquely
Canadian flexible response to IOSCO’s 2018 recommendations for
liquidity risk management of collective investment schemes, among
other international developments. The Notice will serve as a useful
checklist for IFMs and PMs to establish and evaluate their LRM
polices and procedures having regard to the nature of their funds.
The guidance should be applied to investment funds that are subject
to NI 81-102; however, we expect the CSA will also consider that
managers of private pooled funds and other commingled vehicles
should apply these principles.
2. Including a Task Force struck by The Investment
Funds Institute of Canada to survey its mutual fund manager members
between October and December, 2018. The mandate of the Task Force
was to identify questions that would survey investment fund
managers on their policies and procedures for managing portfolio
liquidity risk.
3. See also OSC Staff Notice 81-727 Report on
Staff’s Continuous Disclosure Review of Mutual Fund Practices
Relating to Portfolio Liquidity.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
TORONTO – Canada’s main stock index was up more than 100 points in late-morning trading, helped by strength in base metal and utility stocks, while U.S. stock markets were mixed.
The S&P/TSX composite index was up 103.40 points at 24,542.48.
In New York, the Dow Jones industrial average was up 192.31 points at 42,932.73. The S&P 500 index was up 7.14 points at 5,822.40, while the Nasdaq composite was down 9.03 points at 18,306.56.
The Canadian dollar traded for 72.61 cents US compared with 72.44 cents US on Tuesday.
The November crude oil contract was down 71 cents at US$69.87 per barrel and the November natural gas contract was down eight cents at US$2.42 per mmBTU.
The December gold contract was up US$7.20 at US$2,686.10 an ounce and the December copper contract was up a penny at US$4.35 a pound.
This report by The Canadian Press was first published Oct. 16, 2024.
TORONTO – Canada’s main stock index was up more than 200 points in late-morning trading, while U.S. stock markets were also headed higher.
The S&P/TSX composite index was up 205.86 points at 24,508.12.
In New York, the Dow Jones industrial average was up 336.62 points at 42,790.74. The S&P 500 index was up 34.19 points at 5,814.24, while the Nasdaq composite was up 60.27 points at 18.342.32.
The Canadian dollar traded for 72.61 cents US compared with 72.71 cents US on Thursday.
The November crude oil contract was down 15 cents at US$75.70 per barrel and the November natural gas contract was down two cents at US$2.65 per mmBTU.
The December gold contract was down US$29.60 at US$2,668.90 an ounce and the December copper contract was up four cents at US$4.47 a pound.
This report by The Canadian Press was first published Oct. 11, 2024.
TORONTO – Canada’s main stock index was little changed in late-morning trading as the financial sector fell, but energy and base metal stocks moved higher.
The S&P/TSX composite index was up 0.05 of a point at 24,224.95.
In New York, the Dow Jones industrial average was down 94.31 points at 42,417.69. The S&P 500 index was down 10.91 points at 5,781.13, while the Nasdaq composite was down 29.59 points at 18,262.03.
The Canadian dollar traded for 72.71 cents US compared with 73.05 cents US on Wednesday.
The November crude oil contract was up US$1.69 at US$74.93 per barrel and the November natural gas contract was up a penny at US$2.67 per mmBTU.
The December gold contract was up US$14.70 at US$2,640.70 an ounce and the December copper contract was up two cents at US$4.42 a pound.
This report by The Canadian Press was first published Oct. 10, 2024.
