IOSCO - Guidance for Open-Ended Fund use of Anti-Dilution Liquidity Management Tools

In December 2023, IOSCO published its Final Report on Anti-dilution Liquidity Management Tools – Guidance for Effective Implementation of the Recommendations for Liquidity Risk Management for Collective Investment Schemes (FR/15/2023). 

After considering the feedback from its consultation in July 2023 (see below), IOSCO provided in the Final Report the following guidance to responsible entities:

1. Responsible entities should have appropriate internal systems, procedures and controls in place at all times in compliance with applicable regulatory requirements for the design and use of anti-dilution liquidity management tools (LMTs) as part of the everyday liquidity risk management of their Open Ended Funds (OEFs) to mitigate material investor dilution and potential first-mover advantage arising from structural liquidity mismatch in OEFs.
2. As part of their liquidity risk management framework, responsible entities should consider and use appropriate anti-dilution LMTs for OEFs under management (where appropriate) to mitigate material investor dilution and potential firstmover advantage arising from structural liquidity mismatch in OEFs.
3. Anti-dilution LMTs used by responsible entities should impose on subscribing and redeeming investors the estimated cost of liquidity, i.e., explicit and implicit transaction costs of subscriptions or redemptions, including any significant market impact of asset purchases or sales to meet those subscriptions or redemptions. Independently of the anti-dilution LMT used, responsible entities should be able to demonstrate to authorities (in line with the authorities’ supervisory approaches) that the calibration of the tool is appropriate and prudent for both normal and stressed market conditions.
4. If responsible entities set thresholds for the activation of anti-dilution LMTs, those thresholds should be appropriate and sufficiently prudent so as not to result in any material dilution impact on the fund.
5. Responsible entities should have adequate and appropriate governance arrangements in place for their liquidity risk management processes, including clear decision-making processes for the use of anti-dilution LMTs.
6. Responsible entities should publish clear disclosures of the objectives and operation (including design and use) of anti-dilution LMTs to improve awareness among investors and enable them to better incorporate the cost of liquidity into their investment decisions and mitigate potential adverse trigger effects

Alongside the IOSCO Guidance on Anti-Dilution Liquidity Management Tools, the FSB also published its Revised Policy Recommendations to Address Structural Vulnerabilities from Liquidity Mismatch in Open-Ended Funds.

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Background

On 5 July 2023 the International Organization of Securities Commissions (IOSCO) published a consultation report on Anti-dilution Liquidity Management Tools – Guidance for Effective Implementation of the Recommendations for Liquidity Risk Management for Collective Investment Schemes. The report provided detailed guidance to support greater and more consistent use of anti-dilution liquidity management tools (LMT) by responsible entities for open-ended funds – in both normal and stressed market conditions

IOSCO published this consultation report in coordination with the FSB’s consultation on Addressing Structural Vulnerabilities from Liquidity Mismatch in Open-Ended Funds – Revisions to the FSB’s 2017 Policy Recommendations.

The aim of the proposed LMT guidance was to add granularity to IOSCO’s existing open-ended funds liquidity risk management framework on the use of anti-dilution LMT, including the 2018 Recommendations for Liquidity Risk Management for Collective Investment Schemes and Good Practices for Open-ended Fund Liquidity and Risk Management.

The proposed guidance identified five anti-dilution liquidity management tools: swing pricing, valuation at bid or ask prices, dual pricing, anti-dilution levies, and subscription/redemption fees.

The proposed guidance covered the design and use of anti-dilution liquidity management tools by open-ended funds including calibration of liquidity costs and appropriate activation thresholds; oversight of liquidity management tools by fund boards, managers’ boards or depositories; disclosure to investors; and overcoming barriers to effective implementation.

AREF's Public Policy Committee had some profound concerns regarding some of the recommendations in both the IOSCO and FSB consultation reports. With the Committee's assistance, AREF submitted responses to both the consultation reports on 4 September 2023. The response to the IOSCO consultation report can be found here.