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UCITS IV – Liquidity risk measurement

The Issue – understanding liquidity risk for investment fundsUCITS IV – Liquidity risk measurement

The European Directive defines ‘liquidity risk’ as “the risk that a position in the UCITS portfolio cannot be sold, liquidated or closed at limited cost in an adequately short time frame and that the ability of the UCITS to [repurchase or redeem its units at the request of any unit-holder] is thereby compromised;

Under UCITS IV, for the first time, UCITS must explicitly address liquidity risk, going beyond the cover rules set forth in previous UCITS regulation. However, neither detailed regulatory guidelines nor meaningful and recognized market practices have emerged.

Concepts like mean traded volumes, bid/ask spread or liquidity coverage ratio can be useful, but they are usually not reconcilable across different instrument categories (e.g. structured products, OTC derivatives, high yield bonds, etc.) or the necessary information is just not available. Furthermore, while in some cases asset liquidity risk is well discussed and apprehended, liquidity risk triggered by liabilities, such as large redemptions or other cash outflows, may be more difficult to estimate. As a result, a general and comprehensive framework accounting for asset and liability liquidity risk, both in normal and stressed conditions, may be difficult to design and implement.

In order to help our clients address these new challenges, Deloitte’s risk management experts have conducted empirical research and have built on market experience to set the basis of our proprietary liquidity risk measurement framework.

Our approach – asset and liability liquidity risk reporting

We have translated the UCITS IV regulatory expectations into a liquidity risk measurement framework anchored around the following steps:

  1. Assets’ liquidity risk profile, considering the following dimensions:
    • market depth,
    • liquidation time, and
    • liquidation cost (i.e. market risk, execution costs, bid/ask spread, currency conversion risk).

Assets’ liquidity risk profile

  1. Net future liability liquidity risk obligations arising from
    • Financial Derivatives Instruments (listed or OTC),
    • subscription / redemption activity, and
    • other known or unknown cash flows.

Net future liability liquidity risk obligations

  1. Design of stress scenarios, considering potential
    • drying up of liquidity conditions and/or widening in liquidation costs;
    • large redemptions; and also
    • liquidity contingency plans (e.g. overdraft facilities, etc.)

Design of stress scenarios

  1. Aggregation at the fund level
    • Liquidity coverage ratio up to the next trading days
    • Liquidity generating capacity
    • Breakdown and overall liquidity profile
    • Liquidity buffer level (cash + high-quality liquid assets)
    • Assets under liquidity watch
    • Under normal and stressed conditions

Aggregation at the fund level

Our services and solutions for liquidity risk

We believe an appropriate liquidity risk measurement framework can be a valuable tool in order to

  • Achieve regulatory risk compliance, and
  • Improve portfolio and risk management day-to-day activities.

Our value proposition for liquidity risk measurement framework covers the following areas:

  • UCITS IV liquidity risk management review, gap analysis and development;
  • Design and implementation of internal measurement framework for liquidity risk;
  • Assistance in specific areas such as: key liquidity risk indicators development, asset or liability risk qualitative and/or quantitative modelling, liquidity risk reporting design, stress testing design and implementation, vendor selection, etc.;
  • Outsourcing of liquidity risk measurement & reporting.

services and solutions for liquidity risk

 

Contacts

  • Xavier Zaegel
    Partner - Capital Markets/Financial Risk Leader
  • Marco Lichtfous
    Partner - Capital Markets/Financial Risk
  • Ruth Bültmann
    Partner - Strategy & Corporate Finance
  • ExternalURL
    Sylvain Crépin
    Senior Manager - Capital Markets/Financial Risk

Related links

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Learn more

  • UCITS IV: liquidity risk reporting - Understanding the liquidity of financial instruments | Brochure
    Under UCITS IV, funds must explicitly address liquidity risk. But regulatory guidelines, or meaningful and recognised market practices do not really exist.
  • Risk management services UCITS IV | Deloitte solution
    Adapting to the investment funds industry evolution, the recent UCITS IV Directive introduced several substantial new requirements for risk management.
  • ESMA's Q&A on ETFs and other UCITS issues (ESMA/2013/1547) - 10/12/2013
    On 27 November 2013, the ESMA published an updated version of the Q&A on ETFs and other UCITS issues. Compared to the previous versions dated of 15 March 2013 and 11 July 2013, this new version adds two Q&A’s.

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