Hong Kong SFC Set to Publish Guidance on Liquidity Risk

Hong Kong's securities regulator will soon publish guidance on liquidity risk management for authorised funds in the territory, building upon recent international developments in the field, the regulator's head of investment products said. 

The Securities and Futures Commission ("SFC") has been concerned about the impact on funds' liquidity and valuation in the event of a significant market downturn, and has as a result conducted a review of the local industry and international best practices in order to come up with guidance on liquidity risk management, said Julia Leung, the SFC's executive director of investment products. The guidance, which will be principles-based and non-prescriptive, will cover five key areas, she said. 

First, it cover governance at the firm level, she said; essentially ensuring that firms have proper and up-to-date policies and procedures, as well as effective and independent personnel and oversight. The second area is product design, where the SFC wants fund managers to understand investors' redemption behaviour and balance it against the fund's investment strategy. 

Liquidity forms the third area of focus, with the SFC requiring firms to monitor funds' liquidity on an ongoing basis. However, the SFC will not set hard liquidity targets or mandatory cash buffers for funds, she said. 

Stress testing will be the fourth area of focus, where the SFC will want firms to understand how liquidity positions may change under duress. 

"We believe managers should regularly perform stress testing to assess the impact of plausible adverse changes in market conditions as well as the adequacy of the funds' action plan and risk management tools," she said. 

The final area of guidance will cover liquidity risk management tools. Here, the SFC recommends that managers make sure they have the necessary tools in place, have clear procedures and clearly demarcated responsibilities surrounding the tools' implementation, and that they appropriately disclose these tools to investors. 

Speaking at the ASIFMA-GFMA Market Liquidity Conference in Hong Kongon Tuesday, 14 June, Leung said a growing proportion of asset holdings were now in less liquid markets that are ill-equipped to absorb market or liquidity shocks. 

"As open-ended funds venture into more exotic and less liquid assets, the gap has continued to widen between the liquidity that these funds promise investors on the one hand, and the liquidity that they can obtain from their underlying investments on the other," she said. "At a micro level, failing to manage this risk properly could mean that funds cannot meet redemption requests or can only do so in a way that may be prejudicial to the interests of remaining investors. At a macro level, some are concerned that mismanagement of liquidity risk associated with open-ended funds could lead to fire sales in the underlying asset markets, potentially causing market volatility or making it worse."

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North Asia editor for Thomson Reuters Regulatory Intelligence. He is based in Hong Kong.