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Liquidity Stress Tests and Best Practice Guidelines for 2022


EU AIFs and UCITS funds have adapted to the ESMA’s Liquidity Stress Test Guidelines rules and regulations but there is still some way to go. For 2022 it is clear that liquidity risk management will become more holistic. Fund liquidity is a key topic for regulators and managers alike as we approach 2022. In implementing liquidity stress test frameworks firms are now at the stage of enhancing their ESMA’s 2020 liquidity solutions. To help those firms we have listed our top three best practice hints and tips for 2022 here.


1. Adopt a holistic approach to liquidity risk management

Best practices go beyond liquidity stress tests, too, with overall liquidity risk management becoming far more important for funds going forward. Having documented procedures and practices is important for overall governance. Firms that previously focused on implementing liquidity stress tests now realize that clear escalation paths; roles and responsibilities and automation of business operating workflows are required.


2. Add fund characteristics when assessing stress test frequency

According to ESMA, liquidity stress tests should be run at least annually, but there are clear best practices with many firms now performing liquidity stress testing on at least a quarterly basis. A one-size-fits-all does not work and firms are considering the fund characteristics when deriving the frequency of the liquidity stress testing.


3. Include forward and backwards-looking factors in redemption stress tests

Redemption stress testing is also key in light of the present global crisis. The approaches to redemption stress testing can vary from strict pro rata, or slicing to a more flexible approach. Slicing, or pro rata, has a minimal capability of generating cash. In normal conditions, slicing is far easier, but under stressed conditions, a compromise is needed. That is most certainly the case as we go into 2022. As a result, firms will be considering a mix of slicing and a maximum liquidity approach, or waterfall (which is often favoured where assets are bucketed according to their liquidity profile and the most liquid assets are sold first). When looking at redemptions, it’s well worth looking forward and backwards. The most important forward-looking factors are investor concentration. Firms have guidance from ESMA on how to group them, and retail and institutional investors act differently. Forward-looking indicators like performance, ratings, indices and volatility also help identify any potential deterioration of liquidity in the market, and are highly recommended as part of your best practice redemption stress framework.