The Financial Conduct Authority (FCA) has told asset managers to review fund liquidity management after spotting gaps that could lead to a risk of investor harm.
It issued the statement following a review of liquidity management by asset managers.
The FCA found firms fell short of the required regulatory standards and depth of liquidity risk management expertise.
It said many firms attach insufficient weight to liquidity risk management in their governance oversight arrangements particularly in volatile environments.
It also found a wide range of approaches to liquidity stress testing with some methodologies insufficient to assess actual liquidity of the portfolio.
And that firms are using assumptions that were not appropriately conservative.
It noted that 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.
Other shortfalls identified in the review include insufficient arrangements in place for firms to oversee cumulative or market-wide redemptions that could have a significant impact on a fund.
And wide variations in the application of anti-dilution tools such as swing pricing which could affect the price investors receive when redeeming.
FCA director of wholesale buyside Camille Blackburn said: “We have seen examples in the market where liquidity risk has crystallised and the impact this can have on investors.
“This review should serve as a warning to all asset managers that they need to get this right. We expect boards to discuss our findings and assure themselves that their firms are not amongst the minority with serious gaps in managing liquidity risk.
“It’s vital the outliers take quick action. They risk regulatory intervention if they don’t take this opportunity to address weaknesses.”
The FCA urged asset managers to take account of the findings, adding that many of the examples of good practice highlighted in the review contribute to improved consumer outcomes and are consistent with the Consumer Duty which comes into force on 31 July.
The review focused mainly on AFMs and authorised funds, but it said the findings can be applied to a wide variety of fund types.
Property funds were not subject to this review.
Reacting to the FCA’s warning shot on liquidity, AJ Bell head of investment analysis Laith Khalaf said: “The FCA has found that some fund groups have gaps in their liquidity management measures which could lead to consumer harm, and the watchdog is asking asset managers to tighten up their approach to liquidity risk.
“Managing the liquidity of the underlying portfolio is crucial for open-ended funds, because they can face large withdrawals at the drop of a hat, and need to sell assets in an orderly fashion in order to meet redemptions.
“While the FCA acknowledges that some firms have achieved high standards in this regard, it broadly thinks there is plenty of scope for improvement, particularly within a minority of asset managers with serious weaknesses in their approach.”
