The hedge find industry has
expressed general and overall support for the IOSCO principles on liquidity
risk management for collective investment funds, but at the same times urges
IOSCO to make a number of modifications to accommodate hedge fund practices and
structures. In a letter to IOSCO, the Managed Funds Association totally agreed with
the principle that a fund’s liquidity risk management must be supported by
effective governance, including an appropriate degree of independent oversight.
Since it is unclear what independent oversight means in this context, the MFA
urged IOSCO to clarify that the proper degree of independent oversight will
vary for investment funds based on differences in business models and size.
Importantly, the MFA agrees
with the principle that material information about liquidity risk and the
management of such risk should be disclosed to investors. But, noted the MFA, IOSCO’s
recommendation that day-to-day liquidity information should be readily
accessible would be overly burdensome for funds without providing significant
value to investors, particularly with regard to funds with limited redemption
rights. The MFA asked IOSCO to modify the recommendation to provide that
investment funds disclose material liquidity risk in light of the redemption
rights of investors in the fund. IOSCO also provides that
responsible entities should not provide preferential disclosure to select
investors.
But sophisticated investors often negotiate investment terms, noted
the MFA, including the type of reporting the investor will receive, through
side letter arrangements, which are permitted in many jurisdictions. To the
extent permitted by law, investment funds should be permitted to negotiate
terms with individual investors. Thus, the hedge fund association urged IOSCO
to clarify that such negotiated terms may be limited in certain jurisdictions
and permitted in other jurisdictions and that investment funds and their
responsible entities should only provide such disclosure to the extent
permitted under applicable law.
While agreeing with the
IOSCO principle that investment funds and their responsible entities should
develop a liquidity risk management process that creates a robust view of
possible risks, the hedge fund group is concerned with the recommendation that
the responsible entity should consider quantitative and qualitative factors to
ensure that in all but exceptional circumstances the investment fund can always
meet its liabilities as they fall due. Investment funds and their responsible
entities can develop reasonable policies, reasoned the MFA, but they cannot
ensure outcomes. Thus, the MFA encouraged IOSCO to modify this recommendation
to provide that investment funds and their responsible entities should
reasonably design processes intended to achieve the desired outcomes.
The IOSCO principles provide
that responsible entities should avoid using tools or exceptional measures that
may affect redemption rights. The MFA asked IOSCO to distinguish between the
use of liquidity tools and extraordinary measures so as not to discourage the
use of liquidity risk management tools. Tools such as notice periods, limited
periods for redemption, and gates are used by many investment funds and their
responsible entities as part of the normal liquidity risk management process.
More broadly, while agreeing
with the principle that liquidity risk management plays an important role in
the investment activities of an investment fund, the MFA is concerned that the
recommendations following the principle would be unworkable for many funds.
Specifically, there is concern about the recommendation that the responsible
entity should consider the liquidity of instruments it intends to purchase and
the impact on the investment fund’s liquidity before transacting. The MFA noted
that it is not practical for fund managers to consider the impact on overall
liquidity on a trade-by-trade basis prior to executing every investment transaction.
The hedge fund group urged IOSCO to provide that an investment fund’s liquidity
risk management process should contain provisions reasonably designed to ensure
that investment decisions are consistent with the overall liquidity profile
established for the fund.
The MFA also agrees that the
party responsible for the liquidity risk management process should regularly
monitor and assess the liquidity of the portfolio. But the discussion following
this principle provides that the liquidity risk management process should
enable the responsible entity to continuously measure, monitor and manage the
investment fund’s liquidity. The MFA is concerned that this recommendation
would be difficult, if not impossible, to meet for many hedge funds,
particularly if continuous measurement is interpreted to require real-time
measurement. Thus, the MFA asked IOSCO to provide that the appropriate timing
and frequency of the review of the portfolio will vary from fund to fund based
on a variety of factors, including the strategy, type of assets, and overall
liquidity profile of a fund’s portfolio.