knowledge | 14 October 2020 |

Liquidity Stress Testing and Material Risks – How do you break the news?

What should an AIFM, a UCITS ManCo or a self-managed AIF/UCITS (collectively “managers”) do when liquidity stress testing reveals a material risk to liquidity?  According to ESMA, it should notify the Central Bank of Ireland (as the relevant National Competent Authority), which has now published details on how this notification should be made and what should be included in it.

In essence, managers will need to file two ONR IF Regulatory Reports where liquidity stress testing reveals a material risk. The first report should be made immediately where the performance of a stress test reveals such a risk. The second report must also be made immediately, once the relevant manager has drawn up an extensive report with the results of the stress testing and a proposed action plan. The manager must include the extensive report and the action plan when filing the second report.

Overview

ESMA’s Guidelines on Liquidity Stress Testing in UCITS and AIFs seek to increase the standard, consistency and, in some cases, frequency of Liquidity Stress Testing (“LST”)1 and promote convergent supervision of LST by national competent authorities (“NCAs”). They have applied to managers2, depositaries and NCAs since 30 September 2020. On 13 July 2020, the Central Bank published a notice stating that it expected full compliance with the Guidelines from 30 September. See our related briefing (here).

Section V.3 of the Guidelines provides that “managers should notify NCAs of material risks and actions taken to address them”.  On 9 October 2020, the Central Bank published information regarding how managers should make this notification and what should be included in it. The information is set out, respectively, at ID1133 of the 35th edition of the Central Bank’s AIFMD Q&As and at ID1098 of the 30th edition of the Central Bank’s UCITS Q&As.  According to each of the Q&As, the relevant notifications should be make in two stages:

  • Stage 1: the manager should immediately inform the Central Bank via an ONR IF Regulatory Report if a stress test performed reveals a material risk;
  • Stage 2: the manager should draw up an extensive report with the results of the stress testing and a proposed action plan, including where necessary, action to strengthen the robustness of the AIF/UCITS including actions that reinforce the liquidity or the quality of the assets of the AIF/UCITS. The manager should again immediately inform the Central Bank via an ONR IF Regulatory Report of the measures taken, to include the extensive report and the action plan.

Comment

The Central Bank’s attempt to provide more clarity regarding the procedure for notifying the Central Bank where LST identifies a material risk to liquidity is to be welcomed. Nevertheless, it is not always easy for a regulated entity to determine the appropriate time to make a report to the Central Bank where one is required, and the term “immediately” gives little guidance in this regard.  With reference to the first report, a manager will need to consider whether “immediately” means when a material risk first comes to light, or whether it can, for example, further analyse the test result, and/or allow the board time to consider the risk identified, before making the report. Similarly, with regard to the second report, it is not clear whether the requirement to make the report “immediately” allows for time for the report and the action plan to be signed off by the board and, if so, whether this needs to take place in a specific time period once the relevant report and action plan have been drafted.


  1. The Guidelines define LST to mean “a risk management tool within the overall liquidity risk management framework of a manager which simulates a range of conditions, including: normal and stressed (i.e. extreme, unlikely or unfavourable) plausible conditions, to assess their potential impact on the funding (liability), assets, overall liquidity of a fund and, the necessary follow-up action.”
  2. Meaning in relation to (a) a UCITS, the UCITS management company or, in the case of a self-managed UCITS, the UCITS investment company; (b) an AIF, the AIFM or an internally-managed AIF; (c) an MMF, the manager of an MMF.

This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.

Key contacts