September 18, Via Re: CIS Liquidity Risk Management Recommendations. Dear Dr. Worner:

Transcription

1 State Street Financial Center One Lincoln Street Boston, MA T F September 18, 2017 Shane Worner IOSCO General Secretariat International Organization of Securities Commissions (IOSCO) Calle Oquendo Madrid Spain Via consultation @iosco.org Re: CIS Liquidity Risk Management Recommendations Dear Dr. Worner: State Street Corporation ( State Street ) appreciates the opportunity to comment on the International Organization of Securities Commissions ( IOSCO ) consultation ( Consultation ) on the quality of regulation and industry practices concerning liquidity risk management of collective investment schemes ( CIS ) 1, including mutual funds and exchange-traded funds ( ETFs ). The Consultation includes recommendations related to disclosures to investors, alignment between asset portfolio and redemption terms, availability and effectiveness of liquidity risk management tools, fund level stress testing and contingency planning. Additionally, it consults on issues related to ETFs. Specifically, IOSCO poses questions related to the potential significance of ETFs to determine whether there are additional matters to be dealt with, such as whether liquidity requirements should be different for ETFs versus other CIS, and whether ETFs have unique liquidity-related issues. Headquartered in Boston, Massachusetts, State Street specializes in providing institutional investors with investment servicing, investment management, data and analytics, and investment research and trading. With $ trillion in assets under custody and administration and $2.606 trillion in assets under management as of June 30, 2017, State Street 1 IOSCO Consultation on CIS Liquidity Risk Management Recommendations (July 2017) available at

2 operates in more than 100 geographic markets worldwide. State Street is organized as a United States ( U.S. ) bank holding company, with operations conducted through several entities, including ( SSGA ), its asset management division. SSGA is the third largest global manager of ETFs with $584.5 billion in total global ETF assets as of June 30, SSGA SPDR ETFs represent 269 global offerings including 150 U.S. listed ETFs and 119 non-u.s. listed ETFs. Overall, State Street generally supports the proposed recommendations in the Consultation but suggests some clarifications and slight modifications. More detail follows in our response, but in summary State Street: Believes that the proposed recommendations in the Consultation should relate to the same range of CIS but that CIS set-up for single investors should be treated differently or even excluded from these requirements, or in the alternative, IOSCO should confirm that CIS do not include CIS set-up for single investors. Supports the general considerations around liquidity risk management articulated in IOSCO s Open-ended Fund Liquidity and Risk Management - Good Practices and Issues for Consideration Consultation Report 3 ( Good Practices Consultation ) but believes that the availability of data should be considered as regulatory bodies develop robust and defensible liquidity risk measurement and monitoring regulatory requirements. Believes greater harmonization should be sought between regulators in the utilization of liquidity risk management tools. Supports general considerations related to stress testing but strongly discourages the adoption of bank-like stress testing. Given the diversity of funds, we advise against a onesize-fits-all approach when it relates to asset management stress testing. Believes that ETFs have different liquidity characteristics than other types of open-ended funds and recommends that the final 2017 liquidity recommendations highlight the: (1) in-kind creation and redemption features of ETFs and the effect of the composition of baskets on the overall liquidity of the ETF s portfolio; (2) secondary market liquidity relationship between the ETF s portfolio liquidity and the way in which ETF shares trade, including the efficiency of the arbitrage function and the level of active participation by market participants; and (3) daily transparency of ETFs as a key differentiator in aiding investors to know what they own and understand the liquidity of the underlying holdings of a fund. Supports guidance for suitable dealing frequency and arrangements (Recommendations 3 and 4). 2 This AUM reflects approximately $34.03 billion (as of June 30, 2017) with respect to which Funds Distributors, LLC ( SSGA FD ) serves as marketing agent; SSGA FD and SSGA are affiliated. These figures also include the assets under management of SPDR S&P MidCap 400 ETF (approximately $19.03 billion as of June 30, 2017). 3 IOSCO Open-ended Fund Liquidity and Risk Management - Good Practices and Issues for Consideration (July 2017) available at State Street Corporation Page 2 of 11

3 Supports disclosures generally but does not support disclosing in offering documents the specific approach CIS will take when under liquidity pressure due to a heightened level of net redemption requests (Recommendation 7). Suggests adding language related to how responsible entities should proceed when faced with the need to sell assets to the extent that might lead the CIS to vary from its investment strategy (Recommendation 12). Believes the proposed approach for CIS to assess its redemption obligations and liabilities will be difficult to practically implement, as the current marketplace lacks such granular data on investor base characteristics and therefore should qualify the language in Recommendation 13 by including to the extent reasonably practicable (Recommendation 13). Supports stress testing at the fund level but believes that guidance should be principlesbased and not overly prescriptive (Recommendation 14). Supports periodic testing of contingency plans (Recommendation 16). Supports additional liquidity management tools (Recommendation 17) but notes that some additional liquidity management tools (e.g. swing pricing) may not be operationally feasible in the current market environment. General CIS Liquidity Recommendations (Question 1) IOSCO s 2013 Principles of Liquidity Risk Management for Collective Investment Schemes Final Report ( 2013 Liquidity Report ) 4 included fifteen principles that should be considered in the design phase of CIS and principles that should form part of the day-to-day liquidity risk management process. The Consultation proposes to re-affirm and enhance this guidance. Question 1 in the Consultation generally asks whether the proposed 2017 liquidity recommendations should relate to the same range of CIS that the 2013 Liquidity Report related to and also if certain CIS or types of CIS should be excluded from any particular requirements. State Street believes that the proposed text in the Consultation should apply to the same range of CIS. Additionally, State Street believes that CIS set-up for a single investor should be treated differently or even excluded from these liquidity requirements or in the alternative, IOSCO should confirm that CIS do not include CIS set-up for a single investor. State Street notes that for a number of reasons single investors may choose to invest in CIS. In these circumstances, there is no concern related to first-mover advantage, etc. As such, these single investors should not be subject to the same liquidity rules proposed in the Consultation. State Street Recommendation: Clarify that CIS set-up for single investors should be treated differently than other CIS. 4 IOSCO Principles of Liquidity Risk Management for Collective Investment Schemes (March 2013) available at State Street Corporation Page 3 of 11

4 Good Practices Consultation (Questions 2-4) In conjunction with the Consultation, IOSCO issued its Good Practices Consultation, which contains a series of examples and good practices related to liquidity risk management. Specifically, the Good Practices Consultation includes how the measures to address liquidity risk management should take into consideration the specificities of the fund (i.e. investment objectives and the implementation of its investment strategy; dealing frequency; investor base; the nature of assets under management; and liquidity needs under applicable market conditions); how asset managers are primarily responsible for proper liquidity risk management; and the role regulators play in protecting investors, maintaining fair, efficient and transparent markets and addressing systemic risks. Overall, State Street agrees with the general considerations around liquidity risk management articulated in the Good Practices Consultation and believes it covers the key considerations regarding liquidity risk management tools, including their use in normal and stressed scenarios. However, one of the biggest challenges industry is facing is the lack of available and reliable information in the marketplace. We believe that the availability of data should be considered as regulatory bodies develop robust and defensible liquidity risk measurement and monitoring regulatory requirements. Additionally, greater harmonization should be sought between regulators in the utilization of liquidity risk management tools and regulators should be careful to avoid conflicting or disparate mandates. As a global institution, State Street operates in many jurisdictions with various and sometimes conflicting regulatory regimes. Global harmonization of the regulatory regime related to liquidity risk management would be extremely beneficial in managing liquidity risk. In regards to the general considerations regarding stress testing, State Street agrees with the stress testing considerations articulated in the Good Practices Consultation. However, although we believe that fund level stress testing carried out by asset managers is good practice, we strongly discourage the adoption of bank-like stress testing. Unlike a bank, which conducts financial activity on its balance sheet, our global asset manager, SSGA, is in the business of managing risk for clients in a fiduciary capacity. The resulting profit and loss belongs to the investor and not SSGA and therefore, a crucial difference exists between SSGA s fiduciary responsibility and bank-like activities. Additionally, in a vast majority of cases there is no leverage in SSGA funds and therefore the objective is to measure and monitor liquidity risk and not to protect capital. Moreover, SSGA manages over 1,000 funds globally and conducting a bank-like stress testing would be unmanageable and offers little benefit. State Street Recommendations: Clarify that regulatory bodies should consider the availability of data as they develop robust and defensible liquidity risk measurement and monitoring regulatory requirements. Seek greater harmonization between regulators in the utilization of liquidity risk management tools. Discourage bank-like stress testing and advise against a one-size-fits-all approach when it relates to asset management stress testing. State Street Corporation Page 4 of 11

5 Exchange-traded Funds (Questions 5-6) The Consultation discusses whether additional issues arise as to whether measures to mitigate liquidity mismatch may require tailoring to address the specific characteristics of ETFs. Potential issues that were identified included: A liquidity cost to Authorized Participants ( APs ) or other market participants for in-kind redemptions, as transferring illiquid or less liquid instruments to redeeming APs leads to increased participation costs and interference with their role in the ETF arbitrage mechanism; Significant selling of ETF shares by investors on secondary markets leads to significant redemptions from the underlying fund via the operation of the AP mechanism; Potential significant discrepancies between ETF share prices and the value of the underlying securities due to the cessation, even temporarily, of APs arbitrage operation; and The lack of contingency arrangements to provide liquidity to the secondary market in the event of market stress. Overall, State Street believes that ETFs have different liquidity characteristics than other types of open-ended funds. Issues such as on-demand liquidity, first-mover advantage and the imposition of transaction costs on non-redeeming shareholders do not exist for ETFs which redeem creation units in-kind for APs. We believe that in making recommendations, it is important to consider the difference in the roles of APs and market makers. APs are principally responsible for managing the creation and redemption of shares in the primary market and are those participants that are able to engage directly with the fund. Through the efficiency of the arbitrage function, market makers reliably keep a fund s secondary market price (bid/ask) tied closely to the fund s intrinsic value. Through the lens of activities of APs and market makers, the liquidity risk of ETFs is linked to both the ETF s underlying asset liquidity and the ETF secondary market volume. ETF providers implement AP oversight processes and procedures towards an overall effort to provide end-toend oversight of the ETF primary and secondary markets. We believe that the daily transparency of ETFs is a key differentiator that aids the ability for investors to know what they own and understand the liquidity of the underlying holdings of a fund. Therefore, ETFs should be treated differently and their unique aspects should be highlighted in IOSCO s 2017 Liquidity Recommendations. Specifically, State Street believes that IOSCO should highlight the following in its final 2017 Liquidity Recommendations related to ETFs: The in-kind creation and redemption features of ETFs and the effect of the composition of baskets on the overall liquidity of the ETF s portfolio; The secondary market liquidity relationship between the ETF s portfolio liquidity and the way in which ETF shares trade, including the efficiency of the arbitrage function and the level of active participation by market participants; and State Street Corporation Page 5 of 11

6 The daily transparency of ETFs as a key differentiator for investors in understanding what they own and the liquidity of the underlying holdings of the fund. State Street Recommendation: Highlight that ETFs have different liquidity characteristics than other types of open-ended funds and highlight in-kind creation and redemption features and their effect on the composition of baskets; secondary market liquidity relationship between the ETF s portfolio liquidity and the way in which ETF shares trade; and daily transparency of ETFs. Suitable Dealing Frequency and Arrangements (Recommendations 3 and 4) (Question 7) The Consultation seeks to add additional guidance to Recommendation 3 related to dealing frequency which generally articulates that responsible entities should give due consideration to fund structure and the appropriateness of dealing frequency. The Consultation states that Recommendation 4 is being modified as follows with related guidance: The responsible entity should ensure that the CIS dealing (subscription and redemption) arrangements are appropriate for its investment strategy and underlying assets throughout the entire product life cycle, starting at the product design phase. State Street supports both the additional guidance in Recommendation 3 and the modified Recommendation 4 with its related guidance. We believe that the guidance on the design phase process captures current good practices in the design of CIS. Disclosures to Investors and Prospective Investors (Recommendation 7) (Question 8) The Consultation proposes an amended Recommendation 7 which states: The responsible entity should ensure that liquidity risk and its liquidity risk management process are effectively disclosed to investors and prospective investors. It then provides some additional guidance related to this recommendation including additional disclosure requirements to investors such as a clear liquidity risk assessment in initial offering documentation; a commitment to provide periodic and aggregate information regarding the investment portfolios that may allow the assessment of liquidity risk; and disclosure in offering documents on how to deal with situations where it is under liquidity pressure from a heightened level of net redemption requests. While State Street generally supports adequate liquidity risk disclosures, we believe the disclosure regime should be proportionate to the benefits gained by investors. State Street agrees that transparency is important to educate investors and some hypothetical scenarios are appropriate for disclosure. However, the guidance associated with Recommendation 7 is too prescriptive and does not achieve this goal. For example, we do not support disclosing in the State Street Corporation Page 6 of 11

7 offering documents the specific approach that CIS will take when under liquidity pressure from a heightened level of net redemption requests. Much of this information should remain confidential and should not be detailed in offering documents. In many circumstances, heightened levels of net redemption requests are complex matters and experienced professionals should be provided some flexibility and latitude during their decision making process. State Street therefore recommends that disclosures in offering documents describe potential liquidity options and approaches during heightened levels of net redemption requests but not prescribe the exact steps to be taken. Allowing necessary flexibility through less prescriptive guidance protects confidentially and the unintended disclosure of too much information. State Street Recommendation: Clarify that disclosures should not be too prescriptive and that disclosures in offering documents specifically should describe potential liquidity options and approaches during heightened levels of net redemption requests but not prescribe the exact steps to be taken. Identifying Emerging Liquidity Shortage (Recommendation 12) (Question 9) The Consultation proposes additional guidance related to identifying emerging liquidity shortage. Specifically, the Consultation proposes to add the following additional text to the guidance: During stressed market conditions, the responsible entity should ensure that the interests of investors are safeguarded and CIS investors are being treated fairly. As such, the responsible entity should seek to maintain the investment strategy and attempt to maintain alignment between the funds investment strategy and its liquidity profile taking into account investors best interests, including ensuring that remaining investors are not left with a disproportionate share of potentially illiquid assets. One such step could involve the monitoring and management of large redemptions by investors to the extent reasonably practicable. Question 9 asks whether this additional wording should be included in Recommendation 12 concerning how responsible entities should proceed when faced with the need to sell assets to the extent that might lead CIS to vary from its investment strategy. State Street agrees that the additional wording should be included as it provides a reasonable approach to identifying emerging liquidity shortage and permits some flexibility by recognizing that the responsible entity should monitor and manage large redemptions by investors only to the extent reasonably practicable. State Street Corporation Page 7 of 11

8 Incorporating Relevant Data and Factors into the Liquidity Risk Management Process (Recommendation 13) (Question 10) Recommendation 13 relates to the incorporation of relevant data and factors into the liquidity risk management process in order to create a robust and holistic view of the possible risks. The Consultation seeks to enhance the related guidance by requiring entities to make reasonable efforts to understand the investor base by considering CIS marketing and distribution channels; analyzing historical redemption patterns by different types of investors; analyzing investor profiles and the potential impact these characteristics have on the level of redemptions under different scenarios; analyzing data on liabilities such a collateral needs and potential margin calls; and also analyzing potential redemption demands. State Street believes that although theoretically the proposed guidance for Recommendation 13 may be the appropriate approach for CIS to assess its redemption obligations and liabilities, it will be difficult to implement practically. As discussed previously, one of the biggest challenges industry faces is the lack of information in the marketplace. Currently, the marketplace lacks such granular data on investor base characteristics. There exists uncertainty in future investor behavior both in normal market conditions and more significantly, in stressed market conditions. Therefore, State Street recommends that Recommendation 13 be modified to state: The responsible entity should be able to incorporate, to the extent reasonably practicable, relevant data and factors into its liquidity risk management process in order to create a robust and holistic view of the possible risks. This modification to Recommendation 13 will allow institutions the necessary flexibility to take into account data on investor base characteristics, if it is reasonably available. State Street Recommendation: Modify Recommendation 13 to state that The responsible entity should be able to incorporate, to the extent reasonably practicable, relevant data and factors into its liquidity risk management process in order to create a robust and holistic view of the possible risks. Fund Level Stress Testing (Recommendation 14) (Questions 11-15) The Consultation proposes to replace existing Recommendation 14 that [t]he responsible entity should conduct assessments of liquidity in different scenarios, including stressed situations 5 with the following: 5 IOSCO Principles of Liquidity Risk Management for Collective Investment Schemes (March 2013) (Page 10) available at State Street Corporation Page 8 of 11

9 The responsible entity should conduct ongoing liquidity assessments in different scenarios which could include fund level stress testing, in line with regulatory guidance. The additional guidance for Recommendation 14 in the Consultation provides: requirements for stress testing related to strong and effective governance; appropriate documentation; appropriate stress testing based on normal and stress scenarios, reliable and up-to-date information, and other market risks and factors; implementing additional liquidity management tools; utilizing feedback from back-testing; utilizing stress testing results in all stages of the CIS product life cycle; and carrying out stress testing in a frequency relevant to the specific CIS. State Street supports the use of fund level stress testing and supports a more principles-based approach which will allow the necessary flexibility for funds conducting their fund level stress testing. Additionally, regulators need to be mindful that investors benefit from accessing securities such as high yield, bank loans and small cap equities, which although are known as less liquid strategies, market liquidity still exists with these securities. Regulators should be careful not to design regulation that will make these attractive investment options unavailable to investors that do not have access to separate accounts. State Street Recommendation: Supports a more principles-based approach for fund level stress testing. Periodic Testing of Contingency Plans (Recommendation 16) (Questions 16-17) The Consultation proposes to include a new Recommendation 16 which states: The responsible entity should put in place and periodically test contingency plans with an aim to ensure that any applicable liquidity management tools can be used where necessary, and if being activated, can be exercised in a prompt and orderly manner. It then provides guidance which lists the events that responsible entities should plan for during contingency planning. State Street generally agrees that Recommendation 16 adds up to an effective testing procedure which will lead to the smooth triggering of applicable liquidity management tools when appropriate. Additionally, we believe that the guidance provides a comprehensive list of examples that are necessary and appropriate to be included as part of the contingency plan for the effective implementation of liquidity management tools by CIS/responsible entities. State Street Corporation Page 9 of 11

10 Implementation of Additional Liquidity Management Tools (Recommendation 17) (Question 18) The Consultation also proposes to include a new recommendation related to the implementation of additional liquidity management tools. Specifically, newly proposed Recommendation 17 states: The responsible entity should consider the implementation of additional liquidity management tools to the extent allowed by local law and regulation, in order to protect investors from unfair treatment, amongst other things, or prevent the CIS from diverging significantly from its investment strategy. State Street supports the use of additional liquidity management tools, as we believe that all possible liquidity management tools should be available to managers. As noted throughout our response, State Street supports greater harmonization in the utilization of liquidity risk management tools and supports the development of robust liquidity risk frameworks that are applied consistently on a global basis. We are against prescriptive regulatory mandates that force the adoption of multiple, different liquidity frameworks across various jurisdictions. Although we believe that all possible liquidity management tools should be available to managers, we note that not all liquidity management tools are necessary or appropriate in all markets, or for all fund types. For example, SSGA has had a positive experience with swing pricing in the European markets, and believe it could be beneficial to U.S. investors in open-end funds. However, current U.S. market practices differ from those in Europe and swing pricing is challenging to implement due to the timing of information flows. The current U.S. open-end funds regime fund flow information operates on a timetable which does not permit the adjustment of net asset values based on a swing factor. State Street Recommendation: Clarify that not all liquidity risk management tools are necessary or appropriate in all markets, or for all fund types. Conclusion In conclusion, State Street appreciates the opportunity to comment on IOSCO s proposed enhancements to its 2013 liquidity recommendations in the Consultation. As noted above, State Street generally supports the recommendations in the Consultation but suggests some clarifications. Specifically, we believe that the proposed text in the Consultation should apply to the same range of CIS as the 2013 Liquidity Report; believe the Good Practices Consultation covers the key considerations regarding liquidity risk management tools, including in normal and stressed scenarios; support the suitable dealing frequency and arrangements recommendations; support adequate liquidity risk disclosures; support the additional guidance related to identifying emerging liquidity shortage; support periodic testing of contingency plans; and support the implementation of additional liquidity management tools. State Street Corporation Page 10 of 11

11 However, we believe IOSCO should: Clarify that CIS set-up for single investors should be treated differently than other CIS; Clarify that regulatory bodies should consider the availability of data as they develop robust and defensible liquidity risk measurement and monitoring regulatory requirements; Seek greater harmonization between regulators in the utilization of liquidity risk management tools; Strongly discourage bank-like stress testing and advise against a one-size-fits-all approach when it relates to asset management stress testing; Highlight that ETFs have different liquidity characteristics than other types of openended funds and highlight in-kind creation and redemption features and their effect on the composition of baskets; secondary market liquidity relationship between the ETF s portfolio liquidity and the way in which ETF shares trade; and daily transparency of ETFs; Clarify that disclosures should not be too prescriptive and that disclosures in offering documents specifically should describe potential liquidity options and approaches during heightened levels of net redemption requests but not prescribe the exact steps to be taken; Modify Recommendation 13 to state that The responsible entity should be able to incorporate, to the extent reasonably practicable, relevant data and factors into its liquidity risk management process in order to create a robust and holistic view of the possible risks. Support a more principles-based approach for fund level stress testing; and Clarify that not all liquidity risk management tools are necessary or appropriate in all markets, or for all fund types. Please feel free to contact Stefan Gavell at smgavell@statestreet.com or Phil Gillespie at Phillip_Gillespie@ssga.com should you wish to discuss State Street s submission in further detail. Sincerely, Stefan Gavell State Street Corporation Executive Vice President and Head of Regulatory, Industry & Government Affairs Phil Gillespie Executive Vice President and General Counsel State Street Corporation Page 11 of 11