Fund liquidity issues

The purpose of fund liquidity management is to ensure that the fund is able to pay the redemption requests made by investors to the fund at a predetermined date. In order to ensure this, the investment strategy of the fund and the liquidity profile of its underlying investments and redemption policy must be mutually consistent. In practice, the investments of a fund open for redemptions on a daily basis must be very liquid, such as publicly traded financial instruments, whereas a fund paying redemptions on a quarterly basis may also invest in less liquid assets, such as real estate. In order to secure and ensure the liquidity of the fund, the manager must conduct appropriate stress tests and simulate how the fund’s liquidity can also be secured in the most challenging market conditions, for example where concurrent large redemptions are directed at the fund and the liquidity of its investments is impaired. Fund managers must therefore make advance preparations to ensure that they are able to fulfil assurances given to investors also in the most challenging circumstances.

Liquidity problems in European funds

As a result of the Brexit referendum of 2016, many real estate funds in the United Kingdom were forced to temporarily suspend fund redemptions to ensure the equal treatment of investors. Many funds which had professed to be open for redemptions even on a daily basis were unable to pay exceptionally large redemptions to investors at a predetermined date. The backdrop of the large redemptions was concern about the development of the value of the real estate market due to the Brexit vote. In summer 2019, there was a liquidity scandal in the United Kingdom when the redemptions of a UCITS fund1 managed by Woodford Investment Management had to be suspended, and the fund was liquidated later in the autumn. In the Woodford case, the underlying cause of the problems was too large investments in illiquid non-listed equities and large redemption orders made to the fund, in combination with the daily dealing of the fund. There were also other individual European funds facing similar liquidity problems during 2019.

Authorities concerned about fund liquidity

Funds’ liquidity problems witnessed in 2019 have led to increasing concerns about fund liquidity both among securities supervisors and other financial sector authorities. Liquidity problems in the fund sectors could have a more extensive impact on financial stability and the functioning of the markets. Problems concerning funds’ liquidity have been the subject of global debate. Both the FSB (Financial Stability Board), IOSCO (International Organisation of Securities Commissions) and the ESBR (European Systemic Risk Board) have highlighted the issue. The European Securities and Markets Authority (ESMA) has launched a pan-European supervisory initiative on liquidity management by UCITS funds, in which the FIN-FSA also participates. ESMA has also published guidelines on more detailed requirements on stress testing related to funds’ liquidity management, which will enter into force in autumn 2020.

The FIN-FSA found shortcomings in liquidity management by non-UCITS investing in real estate

In the review year, the FIN-FSA made a thematic review of the valuation practices and liquidity management of non-UCITS funds investing in real estate. The thematic review concerned 13 companies and their 21 real estate funds. The capital and assets under management of open-ended Finnish real estate funds have risen significantly over the past five years, and in the review year, Finnish households held approximately 65 percent of the capital invested in them. In total, open-ended real estate funds had over EUR 6.5 billion of capital.

The thematic review found that real estate funds must prepare more thoroughly both in their valuationpractices and liquidity management for challenges posed by market developments, and that the operators continue to have room for development in this area. The FIN-FSA found that many real estate funds had shortcomings in their stress tests. Since the net subscriptions in open-ended real estate funds have almost always been positive, Finnish managers do not yet have experience of situations where they have been unable to pay fund redemptions to investors.

The FIN-FSA will monitor follow-up measures concerning fund operators’ valuation practices and liquidity management in 2020.

1 UCITS = Undertakings for Collective Investment in Transferable Securities.