FCA publishes a Dear CEO Letter about liquidity risk in asset managers

On 6th July, the FCA sent a Dear CEO Letter to the boards of 14 asset managers who had previously been selected for the Liquidity Management multi-firm review.

The FCA found “a wide disparity” among firms in how they comply with regulatory standards and in the depth of their liquidity risk management expertise. In the view of the FCA, most fell short in some aspects of their framework.

The FCA’s key suggestions include:

• the introduction of a separate liquidity management committee
• the appointment of competent persons to governing bodies
• the use of conservative (pro-rata) stress testing models
• robust triggers for small and large redemptions

Background

Back in 2019, the FCA wrote a UK AFM Board letter asking firms to review their liquidity management against the FCA good practice standards. The Liquidity Management multi-firm review chose a sample of 14 firms to evaluate what improvements have been made since 2019 and what weaknesses still remain.

The new CEO letter follows this work up.

What did the FCA find?

Governance

• With few exceptions, many firms did not attach sufficient weight to managing liquidity in their frameworks and governance structures.
• Board and committee-level discussions on liquidity risks fell short of the FCA’s expectations and were done in isolation of the wider context.

Liquidity Stress-Testing

• The firms’ approach to stress testing varied between sophisticated modelling and box-ticking.
• However, many firms operated less conservative models assuming liquid assets can be sold first (in contrast to the pro-rata approach).
• Stress test results were often the only measure of liquidity reported to committees, were discussed in isolation and were not acted upon.

Redemptions

• Most firms had processes for smaller and larger redemptions, but these processes did not go far enough to ensure investors were treated fairly.
• Many firms had a trigger for enhanced governance in cases of large redemptions, but they did not have processes to assess the impact of multiple small redemptions on the liquidity of their portfolio.

FCA’s recommendations

The FCA emphasises the importance of good governance, noting that firms with a separate liquidity management committee do a far better job at managing liquidity risks. The review adds that asset managers must have established protocols and escalation lines alongside a liquidity playbook which will outline governance actions when liquidity triggers are activated.

The CEO letter also encourages the use of conservative pro-rata models and stresses the need to select appropriate thresholds when performing Liquidity Stress-Testing. The letter further reminds asset managers facing redemptions that they should ensure equal treatment of investors when considering the costs of redemptions and a mix of assets to meet the redemption requests.