Anticipating Liquidity Stress In Times Of Market Uncertainty

CONTRIBUTOR You will need to register or log in on Mondaq.com to print this article. We have seen significant market volatility over the last few months due to market instability, rising inflation rates, and other market events. Market Uncertainty has also led regulators to pay more attention to the management of liquidity risk and the importance of liquidity stress testing in anticipating liquidity events. This topic was also a major focus of several national competent authorities, including the European Securities and Market Authority (ESMA), which introduced guidance on Liquidity Stress Testing in late 2020. This enabled Portfolio Managers and Risk Managers to be more prepared for dealing with liquidity stress. The ESMA LST guidelines were a reminder of the importance of analysing previous shocks and anticipating possible future shocks using both redemption analysis and investor analysis. One should consider the potential redemptions in the future and analyse the investor base from a hypothetical perspective. This can be done by looking at the type of investor, investor concentration and the geographic location of the underlying investor. We can try to prevent future stress as much as we can, but it is impossible to control everything. I want to highlight another important aspect, which is the involvement of the Risk Manager throughout the portfolio's lifecycle. These mechanisms should be tailored to the fund's target pool of possible asset classes. A private equity fund or real estate fund, for example, should have different liquidity structures than funds that invest in plain vanilla instruments. There are several controls and mitigants that one can use to design their portfolio at the fund setup stage. These include lock in periods, making the fund closed-ended if necessary, setting redemptions fees, deferral redemptions fees and adjusting the dealing frequency. This article is meant to be a guide. POPULAR ARTICLES BY: Financial and Banking from Malta Guernsey and ATAD III Carey Olsen Fund managers and institutional investors might consider replacing EU-asset-holding companies with Guernsey...