The Financial Markets Authority (FMA) has released its updated Liquidity Risk Management Guide (LRM Guide) which follows the Proposed Liquidity Risk Management Guidance Consultation Paper of September 2023 (Consultation Paper).
Our previous update on the Consultation Paper can be found here.
The LRM Guide replaces the existing Liquidity Risk Management Good Practice Guide from April 2020, and provides guidance on liquidity risk management (LRM) for Managed Investment Scheme (MIS) Managers and Supervisors under the Financial Market Conduct Act 2013 (FMCA).
The LRM Guide can be found here.
Who should read this? Why?
The LRM Guide is an important read for all MIS Managers and their Supervisors, to be clear about the FMA’s expectations in respect of liquidity management, and what is “best practice”. The FMA considers effective LRM as a necessary part of MIS Managers (and Supervisors) demonstrating that they are meeting their statutory duties under the FMCA, to act in the best interests of investors and to act as prudent managers.
What does it cover?
The focus of the LRM Guide is on considering liquidity risk at all stages of funds management and effectively managing this risk in all market conditions.
MIS Managers are responsible for ensuring their schemes have adequate systems, policies, and processes to manage and monitor liquidity risk, and that they have appropriate liquidity management tools (LMTs) available to use, particularly when market conditions become volatile. MIS Managers are responsible for deciding on the necessary standards, testing, and reporting requirements of their schemes and the LMTs available.
The LRM Guide reiterates the 11 features from the Consultation as features that the FMA considers MIS Managers should apply to their operations and to their funds in order to demonstrate effective LRM. These features were set out in detail in our previous update, and are summarised as:
- Overarching framework and strategy.
- Governance.
- Contingency plans.
- Product design.
- Disclosure and communication.
- Monitoring framework.
- Liquidity management tools.
- Stress testing.
- Use of leverage to adjust risk/return.
- Record keeping, data, and systems.
- Evaluation and review.
The FMA considered feedback received from submissions to the Consultation Paper and has implemented these changes in the LRM Guide. These changes include:
- Statutory duties for MIS Managers and Supervisors: clarification that MIS Managers and Supervisors are expected to have considered the 11 features in order to demonstrate they are meeting their statutory duties under the FMCA. The FMA has also indicated that where the features have not been taken into consideration, it will “likely ask questions” of the Manager and the Supervisor (particularly given the active oversight role of the Supervisor and its duty to identify and make reports under s 203 FMCA).
- Defining illiquid assets: The revised guidance includes an expectation that a MIS Manager will include a definition of “illiquid asset” as part of their LRM framework. MIS Managers and their Supervisors are expected to work together to adopt definitions that are appropriate for the funds they manage and oversee. While the FMA conceded it would be valuable to have a standardised approach to defining illiquidity (like has been used internationally in other markets) they chose not to do so, citing a variety of factors including the size, scale, and complexity of New Zealand’s managed funds compared with global markets.
- Disclosure and investor communication: clarification of how MIS Managers can ensure effective communication with investors about LMTs including use and impact of these tools.
- KiwiSaver and voluntary transfers: clarification where a KiwiSaver member transfers from one KiwiSaver scheme to another, that the old and new scheme providers can agree to a timeframe longer than 10 (ten) working days required to process the transfer.
- Not a ‘one-size fits all’ guide: clarification of the purpose of the LRM Guide, which will help MIS Managers and Supervisors understand LRM in respect of their statutory duties under the FMCA and what (discretionary) changes should be made to their LRM practices, rather than function as a guide which should be “implemented”.
- Stress testing: the frequency of stress testing has been removed where it is to the discretion of MIS Managers to determine what (if any) stress testing is appropriate.
- Updating governing documents: MIS Managers are encouraged to consider what LMTs they see as appropriate for their funds, and work with their Supervisor’s to update all relevant governing documents, as necessary.
Our view
We agree with the FMA that effective liquidity risk management is a key responsibility of MIS Managers (and Supervisors in their oversight role).
The focus of the original LRM guidance in 2020 was on the market turbulence caused by the impact of COVID-19 on the markets, as well as the lessons of the 2008 global financial crisis. In the new LRM Guide, the FMA has broadened its focus to include challenges New Zealanders were facing with continued inflation and unsteady investment returns, which remains relevant in today’s market.
In our view, the clarifications made to the LRM Guide following the Consultation Paper are positive in that they emphasise that MIS Managers and Supervisors retain discretion and the primary responsibility in respect of their liquidity management frameworks relative to the scale and context of their business and the financial products they offer.
We were encouraged to see that the FMA recognises that the LRM Guide is guidance, and not does not prescribe “requirements” to be “implemented” by MIS Managers and Supervisors.
However, it is clear that the FMA expects MIS Managers and their Supervisors to consider the LRM Guide in its entirety in designing, running and monitoring an LRM framework. We have no doubt that in the event of the failure of a scheme due to illiquidity, whether the LRM Guide has been followed would influence the FMA’s response. Therefore, we encourage MIS Managers and Supervisors to familiarise themselves with the new LRM Guide, the FMA’s expectations, and to ensure that their LRM frameworks, including governing documents, governance practices LTMs, align with the new expectations, and their own analysis of the liquidity risks.
Finally, as the FMA points out, under the KiwiSaver Act, in relation to transfers, the old and new scheme providers can agree to a longer timeframe than the prescribed 10 working days. However, our concern is that requires the provider to which the transferring member is moving to be co-operative. That may not always be the case. Further, we query whether this also extends to default providers who are bound by the minimum service obligations set out in their Instrument of Appointment which may not include the same degree of flexibility. And any LMTs for KiwiSaver schemes, eg fund suspensions or redemption gates, would not override the entitlement to permitted withdrawal requirements in the KiwiSaver Scheme Rules.
This article was co-authored by Andrew Walker, a Law Clerk, in our Financial Services team.
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