ESMA introduces new rules for fund liquidity management tools

At a glance
 

The European Securities and Markets Authority (ESMA) has issued on 15 April 2025 two texts related to Liquidity Management Tools (LMTs); level 2 Draft Regulatory Technical Standards (RTS) and level 3 Guidelines on Liquidity Management Tools as per requirements from “Directive (EU) 2024/927 of the European Parliament and of the Council of 13 March 2024 amending Directives 2011/61/EU and 2009/65/EC” issued on 26 March 2024.

The Guidelines on Liquidity Management Tools (LMTs) for Undertakings for Collective Investments in Transferable Securities (UCITS) and open-ended Alternative Investment Funds (AIFs) are established to guide fund managers in effectively managing liquidity risks under both normal and stressed market conditions. Fund managers are required to select at least two LMTs from those outlined in Annex IIA of the UCITS Directive and Annex V of the Alternative Investment Fund Managers Directive (AIFMD), considering factors such as the fund’s structure, investment strategy, and liquidity profile. The guidelines focus on ensuring fair treatment, while seeking to prevent first mover advantage.

The ESMA has developed Draft Regulatory Technical Standards (RTS) regarding liquidity management tools under both the AIFMD and the UCITS Directive. These standards aim to enhance the effectiveness of liquidity management in investment funds, ensuring consistent application across the European Union. The regulatory framework provides options for fund managers to use a combination of liquidity management tools and anti-dilution mechanisms to address specific challenges. 

A closer look

In the Draft Regulatory Technical Standards (RTS) and Guidelines on Liquidity Management Tools issued on 15 April 2025, ESMA has outlined policies and guidelines to assess the suitability of LMTs based on the fund's legal structure, investment strategy, redemption policy, liquidity profile, investor base, and distribution policy. These LMTs include redemption gates, suspension of subscription, redemptions or repurchases, notice period extensions, redemption fees, swing pricing, dual pricing, anti-dilution levies, side pockets and redemptions in kind. Managers are expected to demonstrate that the calibrations of the LMT are in the best interest of investors.

Each mechanism is subject to specific characteristics and application conditions:

• Suspension of subscriptions, repurchases, and redemptions: The mechanism should be applicable to all investors and share classes simultaneously, ensuring temporary cessation of all transactions to manage liquidity during stress.
• Redemption gates: Partial restrictions should limit the volume or proportion of shares that can be redeemed within a given period, leading to a control on fund outflows.
• Extension of notice periods: Additional time can be added to the standard notice periods for redemption requests, allowing fund managers to better plan liquidity needs without altering redemption frequency.
• Redemption fees: Charges can be applied to redemption of shares, reflecting both explicit and implicit costs, including market impact. These charges can be set as a percentage or a monetary amount and are useful to discourage excessive withdrawals.
• Swing pricing: Adjustment of the net asset value performed to reflect transaction costs associated with buying or selling shares of the fund including any significant market impact, mitigating the potentially adverse impact of frequent or large transactions on fund valuation and its long term performance.
• Side pockets: Creation of a separate share class or fund isolates assets with other economic or legal features due to exceptional circumstances, preventing subscriptions and redemptions from affecting the main fund.
• Anti-dilution levies: Fees can be charged directly to investors entering or leaving the fund, aimed at safeguarding existing investors from the transaction costs associated with other investors' capital activities including any significant market impact.

These tools are designed to enhance the liquidity management capabilities of fund managers, ensuring stability and investor protection during market fluctuations.
 

Potential impact for the fund industry

The guidelines on LMTs for funds are expected to clarify the required operational and governance framework for fund managers to ensure the consistent application of selected LMTs under the UCITS and AIFMD Directives.

The draft RTS would impose more stringent liquidity management practices. Fund managers will need to strategically select at least two tools from the regulatory standards, thus introducing a greater level of oversight on the management of liquidity risks. This approach is expected to enhance investor protection and maintain market stability, especially under stressful conditions.

Although many fund manager already have such mechanisms in place, the implementation of these new standards could lead to increased administrative efforts and potential costs for fund managers as they adapt their systems and processes to align with the new regulation. However, this may be offset by the longer-term gains in investor confidence and the resilience of funds under varying market conditions.

The draft RTS outline the following requirements:

With regards to the new guidelines, here are the main requirements:

Next steps

The draft RTS are now with the European Commission (EC) for approval. The EC has three months from submission to decide on adoption, extendable by an additional month.

The RTS will take effect 20 days after its publication in the Official Journal of the European Union. The Guidelines will become effective upon the RTS taking effect, with existing funds given twelve months to comply.

How Deloitte can help

With more than 10 years of experience on LMTs, Deloitte developed a deep knowledge and understanding of the techniques used in Europe, but also globally.

We can provide assistance in:

1. Designing new LMT for your funds, including:

• Benchmarking market practices to define the most suitable solution based on each setup.
• Defining applicable governance, roles and responsibilities.
• Executing quantitative analysis of the funds in scope to define the computation methodology.
• Performing project management assistance with regard to the implementation.

2. Reviewing your current LMT model, including:

• Benchmarking market practices to identify potential competitive gaps.
• Operating a gap analysis of the governance currently in place to identify risks of non-compliance.
• Analyzing the current calculation methodology to improve the accuracy of the parameters computed.
• Back-testing the values historically used to assess the dilution avoided.

3. Providing ongoing assistance to help your clients operate LMT programs, including:

• Periodically compiling the dilution adjustment.
• Periodically compiling the dilution threshold.
• Conducting periodic back-testing reviews to assess the effectiveness of the LMT used.