Comments. Anlage. On IOSCO s consultation on CIS Liquidity Risk Management: CIS Liquidity Risk Management Recommendations and

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1 Anlage Comments On IOSCO s consultation on CIS Liquidity Risk Management: CIS Liquidity Risk Management Recommendations and Consultation report on Open-ended Fund Liquidity and Risk Management Good Practices and Issues for Consideration Position Paper of the German Insurance Association CR04/2017 German Insurance Association Wilhelmstraße 43 / 43 G, Berlin Postfach , Berlin Tel.: Fax: , rue Montoyer B Brüssel Tel.: Fax: Contact person: Tim Ockenga Head of Investments t.ockenga@gdv.de Sandra Blösser Investments Head of Unit Investment Funds s.bloesser@gdv.de

2 General comment The German Insurance Association (GDV) is the association of insurers in Germany. Its more than 450 members are representing over 95% of the insurance market in Germany with total investments of 1,509 bn EUR. GDV gladly takes the opportunity to present its views on IOSCO s (supplemented) recommendations on open-ended funds liquidity risk management as well as its respective considerations with regard to good practices. German insurers have invested around a third of their total investments in investment funds. Thus, from an institutional investor s perspective, a functioning and robust system of investment funds is of utmost importance. In this context, the Liquidity Risk Management of funds is of substantial relevance. IOSCO s Principles of Liquidity Risk Management for Collective Investment Schemes, published in March 2013, in our opinion, already sets high standards for the Liquidity Risk Management of funds as well as the legal and regulatory requirements on investments funds and its Managers, which have been established in the European Union. GDV welcomes the review of IOSCO s recommendation and especially supports its expressed intention to improve investor protection, to safeguard the interest and fair treatment of investors and to maintain the robustness of funds and market integrity. In particular, we support an extension of available liquidity management tools, to broaden the possibilities to manage the liquidity of the fund and to handle stressed situations. We also welcome IOSCO s confirmation that its recommendations, as before, have to be subject to the different jurisdictions and have to be transposed within the context of the specific legal structures prevailing in each jurisdiction. Here we would welcome a harmonisation of the availability of these tools across jurisdictions. Thereby from an investor s perspective it is of high importance that any regulations or guidelines on the use of such instruments take into account a fair treatment of fund investors. page 2 / 9

3 Comments Q1: The 2013 Liquidity Report related to open-ended CIS and where determined by the responsible entity, to some closed-ended CIS. Should the proposed text laid out below apply also to the same range of CIS? Should certain CIS or types of CISs be excluded from any particular requirements, or be subject to a different requirement, because of their investment strategies, ownership concentrations, redemption policies, or some other factor that makes them more or less prone to liquidity risk? Answer Q1: A general transfer of the IOSCO recommendations to closed-ended funds does not appear to be justified. Unlike open-ended investment funds they do not offer regular redemptions to their unit holders, so that the requirements on the liquidity management for structural reasons are completely different. The FSB, too, has highlighted in its Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities of January 2017, that its recommendations for liquidity mismatch focus on open-ended funds. Thus, IOSCO s supplemented liquidity risk recommendations should be limited to open-ended investment funds. With regard to the good practice document : Q2: Do respondents agree with the general considerations around liquidity risk management? Are there other issues that should be included? Answer Q2: GDV in general agrees with IOSCO s considerations around liquidity management of open-ended funds laid down in the Good-practice Document. A functioning and robust system of investment funds is of utmost importance from an institutional investor s perspective. In this context an effective Liquidity Risk Management of funds is of substantial relevance. The described tools in the Good-Practices Document hereby in general seem to be suitable to improve the management of liquidity of open ended funds by broadening the possibilities to manage fund liquidity and to handle stressed situations. We therefore support an extension of available liquidity management tools. Regarding the general availability of possible liquidity management tools GDV would welcome a harmonisation across jurisdictions. Subject to the type of funds allowed in the different jurisdictions and the existing specific legal structures, generally all liquidity risk management tools set out and described in the Good Practice document should be made available for investment funds. Thereby from an investor s perspective it is of high importance that any regulations or guidelines on the use of such instruments, take into account the fair treatment of fund investors. In any case it has to be ensured that the responsible entity is only allowed to use these tools in the best interest of investors. page 3 / 9

4 In addition, though, it should be allowed that both sides at any time can mutual agree on the application of appropriate liquidity management tools or respective solutions, regardless of whether they were already stipulated in the relevant fund documentation or not. This kind of flexibility appears appropriate to provide effective and successful solutions in particular in case of specialized-aif s (who are marketed solely to professional investors) with only one or a few investors. Q3: Does the Good Practices Document cover the key considerations regarding liquidity risk management tools, including their use in normal and stressed scenarios? Are there other issues that should be considered? Are there other key tools that should be included? Do you agree with the pros and cons in regards to the use of each tool? Are there other pros and cons that should be considered? Answer Q3: The extension of possible liquidity management tools is in our opinion a suitable approach to handle stressed situations. As shown in recommendation 17 and in detail explained in IOSCO s Good practice Document there are a number of potential additional liquidity-management-tools. Thereby the Good Practice Document covers in our opinion the key considerations regarding such tools. GDV especially welcomes IOSCO s approach of a balanced analysis of pros and cons of the respective tools in the Good-Practices Document. We share the view that not all of these tools seem equally suitable for all types of funds. Thus, for example, the agreement on extended notice periods is considered in particular for real estate and hedge funds. Also the nature of the investors (retail or professional) in the fund is important when assessing the use of these tools, e.g. in-kind redemptions an in-specie redemptions may not be practical or appropriate for retail investors, but could be for certain institutional investors. As noted by IOSCO in its recommendation 17 there are a number of considerations to be taken into account when assessing whether and to what extend use liquidity management tools. In any case it has to be ensured that the responsible entity is only allowed to use these tools in the best interest of investors. Whereby GDV in general supports an extension of possible liquidity management tools as well as IOSCO s considerations regarding the tools described, in the following we would like to make some comments and point out some further relevant aspects from an investor s perspective: Tools like suspension of redemption, anti-dilution levies and extended notice periods are already established in Germany and are in our opinion useful mechanisms for liquidity management. page 4 / 9

5 With regard to swing pricing which aim to ensure that remaining investors do not incur the transaction costs triggered by large cash flows, we would like to note, that in our opinion, transaction costs do not appear the actual problem in such movements. It should be born in mind that instruments like for example swing pricing or anti-dilution levies cannot eliminate a possible liquidity problem in the case of a crisis, in particular not if the shareholders are willing to accept respective charges. As a negative effect of swing pricing we see that there is an adjustment to the valuation of the value of the fund. Funds are usually measured at the fair values of the funds, i.e. market price or in exceptional cases at model prices. The consideration of in- and outflows is a deviation from this rule. This valuation method also increases the volatility of the fund, because not only the value of the fund fluctuates but also the swing factor. Nevertheless swing pricing would be supported by us as an additional optional tool, which provider and investor should be allowed to agree on. Bid or Ask Prices could be a suitable approach in particular for bond funds. Redemption Gates appear particularly interesting as they restrict investor s redemption orders in the same proportion, thus limiting first mover advantages. They can also be used under normal market conditions in order to maintain and control liquidity in the fund at a sufficient high level. In times of crisis, however, they may not be able to solve the liquidity problem because investors are nevertheless able to redeem their shares and accept longer periods of time. Depending on the design of such tools, however, redemption gates can also restrict the possibilities for investors to redeem too much, for example if the redemption of shares is excluded for an extended period of time. With Side Pockets, illiquid assets can be separated and they allow access to liquid assets of the portfolio without affecting the integrity of the overall portfolio. For example, funds can be settled and investors can get back their investments for the liquid shares in the fund and have to wait until illiquid shares held in Side Pockets are sold. Investors are, however, limited in terms of time when they receive parts of their investments. Redemptions in-kind seem to be an interesting way to sell assets out of the fund to certain investors. However, account should be taken of the fact that existing liquidity problems are only transferred to the respective investor, so that they remain in the relevant market. In addition redemptions in kind are not suitable for every investor category. In addition of these tools, further measures could be envisaged that contribute to the management of liquidity, like the sale of non-cashable assets to interested investors or third parties; if necessary, with a debtor warrant (a) or the admission of share classes with different possibility of redemptions (b). page 5 / 9

6 Ad (a) The idea behind this is that assets which cannot be liquidated are sold to interested investors or third parties so that the fund can be settled in extreme cases. The adequate valuation of these assets is addressed by returning later profits on further disposal for a certain period of time to the original investors by issuing a warrant. Ad (b) The idea behind this is to create different share classes for a fund with different possibilities of redemptions. For example, daily possibility of redemption could be agreed for retail investors, while for institutional investors, for example only a monthly or quarterly possibility of redemption is agreed. Institutional investors would then receive an illiquidity advantage, for example in the form of a lower management fee. In some jurisdictions the possibility to establish respective share classes already exists. Q 4: Do you agree with the general considerations regarding stress testing? Are there other issues that should be included? Answer Q4: We consider it as important, that stress testing results do not automatically trigger specific actions, like an adjustment of the liquidity of the relevant fund portfolio, in cases when there is the possibility to mutual agree on subsequent actions. Such individual agreements should be in particular possible in case of specialized-aif s with only one professional investor or professional investors with similar targets. ETFs Issues and Questions Q5: Should ETFs be subject to different liquidity requirements than other CIS? a) If not, should ETFs be included within the scope of the 2017 Liquidity Recommendations? (i) If yes, are changes needed to be brought to the 2017 Liquidity Recommendations to reflect ETFs specificities? Which ones? (ii) If not, please explain why ETFs should not be included within the scope of the 2017 Liquidity Recommendations if they have partly similar liquidity issues as other CIS. b) If ETFs should be subject to different liquidity requirements than other CIS, what should they be? Answer Q5: Q6: Are there key liquidity related issues specifically regarding ETFs? Answer Q6: page 6 / 9

7 The proposed additional guidance and recommendations: Q 7: Recommendation 3 and 4: Does this guidance on the design phase process capture the best of current good practices in the design of CIS? Answer Q7 Recommendation 3: GDV supports the approach, that responsible entities give due considerations to the structures of the fund and the appropriateness of the dealing frequency under consideration of the targeted investor base. With regard to the recommendation that the investment strategy and objectives should be designed to give strong assurance, that redemptions can be met in both normal and reasonably foreseeable stressed market conditions it should be taken into account, that a fund cannot be reasonably designed to cope with all stress situations. It appears not possible to give ex ante assurance that redemptions can be met under an extreme scenario like e.g. Lehman. Therefore within the respective recommendation extreme scenarios should be excluded; the recommendation should only cover reasonably foreseeable stressed market situations as seasonal effects like end of year periods, where liquidity is usually poor. Answer Q7 Recommendation 4: Liquidity Risk Management Practices Assets: GDV believes that setting limits on illiquid assets is not always a practicable approach because liquidity changes over time. An asset class seen as reliable liquid can turn illiquid at some point in time (e. g. EU peripheral debt). Therefore we consider that any definition of such limits, where applicable, should remain at the discretion of each asset management company and not be externally provided, because it would be based on individual and case-by-case considerations. Liquidity Risk Redemption-constraining Additional Liquidity management Tools : As stated above, GDV supports an extension of possible liquidity management tools to broaden the possibilities to manage liquidity of the fund and to handle stressed situations in the best interest of the unit-holders within the fund. As such tools are subject to applicable law and national regulation we would welcome a harmonisation of the availability of these tools across jurisdictions. Q8: Recommendation 7: Does Recommendation 7 capture appropriate additional liquidity disclosures? Answer Q8: GDV supports a comprehensive disclosure of the liquidity assets to investors and the operating principle of included additional management tools and the circumstances of their usage. A proper description of these details page 7 / 9

8 in the prospectus is not only necessary to make investors aware of material liquidity risk. Since the use of respective management tools can significantly influence an investor in its freedom to exercise its investor s rights in relation to the fund shares held comprehensive information about these aspects is also necessary to make investors aware of these possible limitations. Q9: Recommendation 12: Should additional wording 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 the CIS to vary from its investment strategy? Answer Q9: Q10: Recommendation 13: Does the proposed additional guidance under Recommendation 13 constitute the appropriate approach for a CIS to assess its redemption obligations and liabilities? If not, what else would you suggest? Answer Q10: Recommendation 14: Q11: Are there procedures or practices that responsible entities currently use to implement their stress tests which have been found to be particularly informative to responsible entities and which are not consistent with or included in the approach set out here? If so, please provide examples. Q12: Are there procedures or practices that responsible entities have not found to be particularly useful which the proposed approach to liquidity stress testing would encourage and why? Q13: Is the proposed approach to the design and operation of stress testing processes realistic and does it deal with the key issues? Q14: Does the proposed additional guidance under Recommendations 3, 7 and 12 add effectively to the available guidance? Q15: Does Recommendation 14 capture the best of current good practices in stress testing? Answers Q11 - Q15: Additional recommendations and chapters: Q16: Recommendation 16: page 8 / 9

9 Does the recommendation add up to an effective testing procedure which will lead to the smooth triggering of applicable liquidity management tools when appropriate? Answer Q16: Q17: Recommendation 16: Other than those examples listed above, are there any additional scope and/or aspect that you consider necessary and appropriate to be included as part of the contingency plan for an effective implementation of liquidity management tools by CIS/responsible entities? Answer Q17: Q18: Recommendation 17: How do existing CIS envision transitioning to Recommendation 17? Answer Q18: As stated above, GDV supports an extension of possible liquidity management tools. However the subsequent introduction of such instruments to already existing funds can be disadvantageous for investors. So in our view it is important to ensure that rights of investors are not unreasonable prejudiced by such subsequently introduced tools. In any case, though, it should be possible that both sides subsequently mutual agree on an application of appropriate instruments. page 9 / 9