Developments in relation to risk management for European investment funds

Abstract

This paper gives an overview of the recent developments in liquidity risk management for investment funds through the example of measures applicable to funds domiciled in Luxembourg. The paper first outlines the current context regarding risk management, with a focus on liquidity risk management. It then presents risk-management requirements to the undertakings for collective investment in transferable securities (UCITS) and alternative funds. Next, the paper discusses liquidity risk management with consideration of its legal definition and management practices and the need to address such risks at each stage of the life of the fund (design stage, postlaunch stage and stress testing through the funds’ activity). This study is based on the frame set by EU (European Union) law provisions, such as the UCITS Directive or The Alternative Investment Fund Managers Directive, and national Luxembourg legislation, including Luxembourg’s regulatory implementation of international standards such as The International Organization of Securities Commissions (IOSCO) Recommendations on liquidity risk management. This paper further outlines the important role of the Luxembourg regulator, the Commission de Surveillance du Secteur Financier (the CSSF), which has been proactively developing at a very early stage a strong administrative practice to ensure that liquidity risk-management processes meet the required standards in order to promote a sound and prudent fund financial situation. Therefore, the authors recommend strongly that the risk-management system of each relevant market player be checked for compatibility with the IOSCO recommendations and, where appropriate, with the CSSF Circular 19/733. They also stress the importance of adequate stress testing on risks related to liquidity to prepare for volatile times such as the current situation with the global pandemic coronavirus disease-2019 (COVID-19).