A timely directive in the wake of the Woodford debacle

The European Securities and Markets Authority (ESMA) says that European funds like UCITs, AIFs, and ETFs must conduct quarterly liquidity stress tests.

The funds must implement these tests from September 2020.

“ESMA notes that the minimum legal requirement to perform LST is annual under the AIFMD.  However, ESMA recommends a quarterly frequency for LST and recognizes that there are situations where a higher or lower frequency is necessary.”

Managers must stress test both assets and liabilities of the funds under their management.

Of critical importance is stress testing for redemption requests by investors, a significant liquidity risk, according to ESMA.

A fallout from Woodford?

The ESMA directive is timely in light of the suspension of the UK’s Woodford Equity Income Fund. As we noted this week, the fund failed to satisfy a surge in redemption demands because of its illiquid assets.

“Managers of AIFs and UCITS must be aware of the liquidity risk of the funds they manage and use stress testing as a tool to mitigate this risk,” said ESMA. “EU-based funds need to regularly test the resilience of their funds to different types of market risks, including for liquidity risk.”

European Securities and Markets Authority rejects feedback

Meanwhile, several funds offered feedback that expanded liquidity stress testing would be costly. Others raised concerns about the lack of adequate data for certain asset classes.

However, it appears that the ESMA did not consider these observations.