1 Comment 1 Commentby Andrea Malcolm
Simon Haines, chair of BIG which represents most of the non-bank fund managers, says the new guidance which updates the 2020 version reflects a step forward in what will undoubtedly be an ongoing conversation between the FMA and industry as to the best way to consider liquidity.
“What was good about the guidance was the combination of the FMA providing a clear list of tangible matters that fund managers should be thinking about when deciding their approach to liquidity (which is preferable to asking us to give effect to subjective concepts like “fairness”, for example), and recognition that it is not right to expect fund managers to apply an extensive one size fits all approach to managing risk, when the inherent risks of liquidity as a potential source of problems will be much greater for some funds than for others.”
One of the ideas BIG advocated for was that the priority given to managing liquidity risk should turn on the level of liquidity a customer would normally expect from the kind of investment that they were going into (e.g. a customer would go into a forestry scheme clearly understanding that it may not be easy to liquidate their investment, but they would have a very different expectation if they went into a general equities fund), and the level of liquidity risk that would inherently sit in the fund, relative to other kinds of risk.
“We think that was well received,” says Haines. “Of course there will be a few areas where there could be a need to go back and revisit at some point. For example, the stress testing expectations may not be practical in a smaller fund manager where there may be no group of people independent of the portfolio managers with the right skills to review the results of stress testing.”
Haines says New Zealand has unique issues around fund liquidity. The first is that when our funds invest into major international markets e.g. they are buying Microsoft and Amazon, it is extremely unlikely that they will be unable to sell those kinds of stocks because our funds are so small relative to their global counterparts.
“Therefore a New Zealand fund manager would not need the same level of liquidity oversight when it buys amazon, than say BlackRock does.”
“On the other hand our domestic markets do not trade much outside of the NZX top 10 and our Government is signalling a desire for funds to invest more into potentially illiquid direct assets. Therefore we definitely do have areas where liquidity needs to be considered carefully but our regulatory policy needs to be calibrated in such a way as to avoid having a chilling effect.”
The FMA updated guidance lays out 11 “factors” for effective liquidity management. These are: having an overarching framework and strategy; governance; contingency plans; product design (a survey from 2021 revealed 45% of managers had not undertaken stress testing during the product design phase); disclosure and communication to investors so they understand how the fund manages liquidity and the effect of their investment; a monitoring framework; liquidity management tools; stress testing; use of leverage to adjust risk and return; record keeping, data and systems; and regular evaluation and review.
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Extreme but plausible... let me think. Is a global pandemic plausible, a share market crash plausible, sovereign default, hyperinflation, Middle East conflict expanding, wider European war, need I go on?
NZ shares are, in normal market conditions, virtually illiquid past the top 15 shares. KiwiSaver managers should be actively seeing private equity and infrastructure assets befitting a long-term investment strategy, applying an "extreme but plausible" hindsight test limits managers to investing in cash under the mattress, because you never know what's around the corner. Most markets provide the illusion of liquidity until the extreme but plausible occurs.
Well-intentioned guidance, but just another reason to prevent KiwiSaver managers from doing their job.