On September 2 2019, the European Securities and Markets Authority (ESMA) published final guidelines regarding liquidity stress testing of Alternative Investment Funds and UCITS funds. Although the guidelines are applicable to both managers and depositaries of such funds, the majority of the guidelines are applicable to the relevant fund manager.
The ESMA guidelines follow recommendations by the European Systemic Risk Board published in 2018 on liquidity and leverage risk in investment funds.
The guidelines clarify that liquidity stress testing should:
- Be subject to appropriate governance and oversight, including appropriate reporting and escalation procedures,
- Be carried out at least annually and where appropriate, employed at all stages in a fund’s life-cycle,
- Employ hypothetical and historical scenarios and where appropriate reverse stress testing.
The guidelines also clarify:
- The outcomes in which appropriate liquidity stress testing should result,
- The key factors which liquidity stress testing models should take into consideration in their construction,
- The requirements of a liquidity stress testing policy.
Fund managers should be able to demonstrate to their regulators that authorized funds’ strategy and dealing frequency enable them to remain sufficiently liquid during normal and stressed circumstances.
The guidelines, which apply from September 30 2020, should be adapted to the nature scale and complexity of the fund. A link to the guidelines is available here.