Recent proposals by the International Organization of Securities Commissions (Iosco) to categorise investment funds based on liquidity could hinder effective risk management, the European Fund and Asset Management Association (Efama) has warned. The Iosco recommendations, developed in response to market disruptions such as the covid-19 pandemic, build on findings from the Financial Stability Board (FSB), which issued its own proposals in December 2023.
Iosco’s new framework, in November 2024, reinforced key principles of fund liquidity management, including the primary role of asset managers and the need for flexibility in selecting liquidity management tools (LMTs). However, Efama argued that several proposed measures could limit asset managers’ ability to manage funds effectively.
One major concern was the requirement for asset managers to classify funds into three categories based on liquidity, each subject to different LMTs during periods of stress. In a on Wednesday 12 February 2025, Efama warned that this approach would force supervisors to impose uniform risk model requirements across funds. If asset managers were required to operate multiple risk models, it would create regulatory duplication. Conversely, if they were unable to tailor risk models to fund-specific characteristics, the overall quality of risk management could decline.
Costs and limitations
The report also raised concerns about the mandatory use of anti-dilution tools (ADTs), which allocate transaction costs to investors redeeming their holdings to protect remaining investors in less liquid assets during market volatility. While acknowledging the value of ADTs, the findings suggested that making them compulsory for all funds investing in less liquid assets could lead to unnecessary operational costs. The burden would be even greater if supervisors required funds to calculate implicit transaction costs before every trade, adding an extra financial strain on investors.
Restrictions
The proposed restrictions on quantity-based LMTs, which limit subscriptions and redemptions, were also criticised. These tools help prevent funds from resorting to fire sales when redemption requests exceed expectations. The report found that Iosco’s recommendation to limit their use could have unintended consequences. Providing a predefined list of exceptional circumstances in which such measures could be applied would create rigid investor expectations. If a crisis fell outside these predefined scenarios, uncertainty could arise over whether such tools could still be used.
Another concern was Iosco’s proposal to prohibit asset managers from applying different LMTs depending on the type of investors exiting the fund or from separating subscriptions and redemptions. The report suggested that such restrictions could reduce asset managers’ ability to respond effectively to market stress.
Liquidity stress
A report by the Bank of England in November 2024 analysed the sources of liquidity stress during financial crises and found that 93% of liquidity pressures came from margin calls--when investors need to repay money borrowed from a broker--while investment fund redemptions accounted for just 7%. Efama argued that these findings challenged the assumption that fund redemptions pose a significant systemic risk, raising concerns about the focus of Iosco’s proposed liquidity management framework.
Marin Capelle, regulatory policy advisor at Efama, stated that European asset managers should not be required to categorise funds based on portfolio liquidity. Capelle noted that asset managers already conduct extensive liquidity stress tests, which provide a reliable basis for assessing the effectiveness of different LMTs. Introducing mandatory liquidity categorisation under the revised Iosco framework, Capelle asserted, would contradict the EU’s goal of regulatory simplification while offering no clear financial stability benefits.