IOSCO gives fund managers guidance on handling liquidity crises

Fund managers should have to tell prospective investors clearly exactly what they would do if illiquidity hit their fund and outline circumstances under which they would limit redemption rights of clients, according to proposals made today by the umbrella organisation for securities watchdogs, IOSCO.

The clear recommendations on greater disclosure by managers in regards liquidity come after en-masse fund lockdowns during the credit crisis angered investors.

Up to 35% of hedge funds curbed withdrawals at the height of the 2008/2009 crisis, for example, angering many investors.

IOSCO noted in its consultation on fund liquidity, published today, that liquidity tools – such as gates, exit and dilution fees, in specie transfers and individual agreements with certain investors – should only be used after making full disclosure of their existence.

And this disclosure alone “should not replace the need for an effective liquidity risk management process”, it said.

A fund should “explain liquidity risk, why and in what circumstances it might arise, and its significance and potential impact on the [fund] and its unit-holders, as well as an appropriate summary of the process by which the responsible entity aims to mitigate the risk,” IOSCO said.

The fund should also explain any tools or exceptional measures that could affect redemption rights “and examples of when the tool might be applied, if it is of a contingent nature. A responsible entity must take care to ensure that these descriptions are clear and comprehensible to investors.”

The memory of managers limiting withdrawals still riles some allocators.
Allesandro Mauceri, a Swiss allocator who faced redemption curbs in some chosen funds, estimated only 30% of those managers that gated funds during the recent global crisis did so for legitimate reasons, and not just saving their own skin.

“Managers argued they had to control outflows from the fund to protect investors in it, but the reality was that in many cases, if they had honoured redemptions they would have lost their business,” he said.

“With suspensions of NAV managers effectively said, ‘I am keeping you hostage, and if you want to do something about it, good luck’.”

Mauceri’s former employer tried to act, by going so far as to advertise publicly in the Neue Zuercher Zeitung for co-investors in one portfolio to identify themselves, and overthrow the fund’s board to liberate their cash. But few were willing to come forward, fearing the spotlight.

Now heading the Genevan multi-family office Palaedino Asset Management, Mauceri has turned to more liquid, ‘unlockable’ Ucits products, which he says are “the sensible path” for anything other than the most illiquid hedge fund strategies.

He is also board chairman of the Axiom Fund of Ucits funds, which recently totally eliminated its management fee.

In its consultation today, IOSCO also made nodded at the practice of curbing fund redemptions, by stating that “the responsible entity should fully consider the liquidity of the types of instruments in which the [fund’s] assets will be invested, and should ensure that these are consistent with the [fund’s] ability to comply with its redemption obligations or other liabilities”.

IOSCO added managers needed to treat all investors – redeeming and remaining – equitably when facing various liquidity conditions, and be mindful that margin requirements can also call on the liquidity of a fund.

Of utmost importance is making the liquidity offered by the fund commensurate with what it is offered by the underlying securities in which it invests, IOSCO said.

And the ability to gain “certain tax treatment for a [fund], or to access a wider market for distribution, should not lead responsible entities to set a more frequent dealing frequency for units in the [fund] than is appropriate,” IOSCO said.

The body added managers should take into account the interests of all its unitholders when deciding whether to take exceptional measures to handle liquidity.

People interested in commenting on IOSCO’s recommendations should do so by 2 August.

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