In July 2024, the European Securities and Markets Authority (ESMA) released a consultation paper detailing proposed Regulatory Technical Standards (RTS) on Liquidity Management Tools (LMTs) under the Alternative Investment Fund Managers Directive (AIFMD) and the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive. This initiative aims to enhance the resilience of investment funds during periods of market stress by standardizing the characteristics and application of LMTs across the European Union (EU).
Background and Rationale
The 2024 amendments to the AIFMD and UCITS Directive introduced a harmonized framework for LMTs, mandating that managers of open-ended Alternative Investment Funds (AIFs) and UCITS select at least two appropriate LMTs from a specified list. This requirement seeks to ensure that fund managers are better equipped to manage liquidity risks, thereby safeguarding investors and maintaining financial stability.
Key Provisions of the Draft RTS
The draft RTS outline the specific characteristics of each LMT available to fund managers, providing clarity on their implementation and operationalization. The LMTs addressed include:
- Suspension of Subscriptions, Repurchases, and Redemptions: Temporarily halting these activities to prevent disorderly market conditions and protect investors’ interests.
- Redemption Gates: Limiting the amount that can be redeemed on a given redemption day to manage large outflows and ensure equitable treatment of investors.
- Extension of Notice Periods: Increasing the time between a redemption request and its fulfillment, allowing fund managers to better align asset liquidation with redemption demands.
- Redemption Fees: Charging fees to investors upon redemption to deter short-term trading and cover the costs associated with asset liquidation.
- Swing Pricing: Adjusting a fund’s net asset value to pass on the costs of trading activity to the investors responsible for it, thereby protecting existing investors from dilution.
- Dual Pricing: Establishing separate prices for buying and selling fund units to reflect the costs of entering and exiting the fund.
- Anti-Dilution Levy: Imposing a charge on transactions to offset the costs incurred by the fund due to investor activity, ensuring that remaining investors are not disadvantaged.
- Redemptions in Kind: Fulfilling redemption requests by delivering assets from the fund’s portfolio instead of cash, which can be beneficial in illiquid markets.
- Side Pockets: Segregating illiquid or hard-to-value assets into a separate sub-fund to isolate them from the main portfolio, allowing for fair treatment of investors.
Implementation and Compliance
Fund managers are required to assess the suitability of each LMT in relation to their fund’s investment strategy, liquidity profile, and redemption policy. They must select at least two LMTs (one for Money Market Funds) and incorporate them into the fund’s rules or instruments of incorporation. Detailed policies and procedures for the activation and deactivation of selected LMTs must be established and communicated to the competent authorities of the home Member State.
Stakeholder Engagement and Feedback
ESMA invited stakeholders to provide feedback on the consultation paper by October 8, 2024. This collaborative approach ensures that the final RTS will be informed by industry insights and practical considerations, promoting effective and proportionate regulation.
Next Steps
Following the consultation period, ESMA plans to finalize the RTS and submit them to the European Commission for endorsement by April 16, 2025. Once adopted, these standards will become binding, and fund managers will be expected to comply by integrating the specified LMTs into their liquidity risk management frameworks.
Conclusion
ESMA’s proposed RTS on LMTs represent a significant advancement in the EU’s efforts to strengthen the resilience of investment funds. By standardizing the characteristics and application of LMTs, the RTS aim to enhance investor protection and maintain financial stability across the EU’s investment fund sector. Fund managers are encouraged to familiarize themselves with these developments and prepare for their implementation to ensure compliance and effective liquidity risk management.
At Christy’s we advise on all aspects of fund formation, including: advice to determine the most appropriate structure that will best fit the investment strategy, investor base and requirements of the management team; the CySec authorisation process; AIFMD considerations, including relating to operational requirements and marketing in the EU; regulatory capital requirements; and negotiating fund terms with investors.
