Updated expectations on liquidity risk management

Under the new LRM guidance which replaces the 2020 version, the FMA recommends that fund managers have a range of appropriate liquidity management tools (LMTs) for specific circumstances, including where redemption obligations can’t be met in the ordinary course of business.

The guidance says in extreme circumstances managers, including KiwiSaver providers, should be able to temporarily suspend redemptions and this must be disclosed to investors through the PDS or other material information.

For voluntary transfers between KiwiSaver providers, managers of schemes involved in the transfer may agree to any longer period than the default 10 working days as expressly provided in section 56(4) of the KiwiSaver Act 2006.

The guidance says, “We expect managers, exercising care, diligence and skill, would make such agreements in good faith to appropriately manage fund liquidity in situations such as extreme market conditions or scheme-specific liquidity issues.”

Effective LRM

Key improvements the FMA would like to see overall are better frameworks, policies and procedures covering LRM, more regular stress testing and more tailored LMTs.

It has set out 11 features of effective LRM, based on international frameworks adapted to New Zealand’s markets. These are: having an overarching framework and strategy; governance; contingency plans; product design (a survey from 2021 revealed 45% of managers had not undertaken stress testing during the product design phase); disclosure and communication to investors so they understand how the fund manages liquidity and the effect of their investment; a monitoring framework; liquidity management tools; stress testing; use of leverage to adjust risk and return; record keeping, data and systems; and regular evaluation and review.

The FMA says managers must consider how these features apply to their operations and each of their funds but retain discretion about how they manage liquidity in the context and scale of their own business.​ 

FMA director of markets, investors and reporting, John Horner, says effective LRM is a fundamental capability managers need to implement, maintain and enhance, and failure to do so may breach the law.

He says the guide doesn’t impose additional burden and on the contrary, it explains how the FMA views liquidity risk management as an essential component of professional standards.

“In doing so, it recognizes the diverse range of MIS manager businesses and funds on offer. We do not expect all managers to implement the guide word for word, but we do want firms to review their systems against the guide and tailor their LRM approach to suit their specific funds.”