Liquidity Management Tools in Open-Ended Investment Funds: The Right Tools in the Right Hands?

Abstract

A number of high-profile liquidity crises have pushed liquidity risk in investment funds higher on the policy agenda in Europe. Most recently, in November 2021, the European Commission adopted a proposal for a review of the Alternative Investment Fund Managers Directive (‘AIFM Directive’) and the Undertakings for Collective Investment in Transferable Securities Directive (‘UCITS Directive’), with liquidity risk management featuring as a central component.

This article examines the allocation of the decision-making power over the design and application of liquidity management tools in open-ended funds. Liquidity management tools – such as pricing arrangements, notice periods, and suspension of redemption rights – can help alleviate the liquidity risk generated by investment funds. However, there is no one-size-fits-all and their use requires continuous judgment on the appropriate mix of tools given the specifics of each fund and the conditions on the market.

The analysis shows that asset managers tend to be best placed to make decisions on the application of liquidity management tools, especially if these decisions require fund-specific or ‘micro’ information. However, prudential authorities have an important role to play with respect to information gathering on the macro-level as well as through direct intervention in specific systemic scenarios.

Against that context, the article outlines the policy interventions necessary to improve decision-making in this area and in doing so creates a yardstick against which policy initiatives can be evaluated. While the article focuses on European policy, the analysis and its policy implications are more widely applicable.

Keywords: Open-ended investment funds, liquidity risk, liquidity mismatch, systemic risk, governance, liquidity risk management tools, transparency, supervisory convergence, UCITS, asset management, swing pricing, suspension of redemption, macroprudential policy