Summary of ESMA Consultation Papers on the Draft RTS and Guidelines on Liquidity Management Tools for AIFMS and UCITS Management Companies

Background

• Directive (EU) 2024/927 amended the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive and the Alternative Investment Fund Managers Directive (AIFMD) by, among other things, providing that an AIFM (of an open-ended AIF) or a UCITS ManCo shall select at least two appropriate Liquidity Management Tools (LMTs) from a list of LMTs specified after assessing the suitability of the LMTs in light of the investment strategy, liquidity profile and the redemption policy of the relevant fund.
• The LMTs selected shall be incorporated in the fund rules/incorporation documents to be used in the best interests of investors.
• The selection of LMTs and the accompanying policies and procedures shall be communicated to the relevant regulator.
• In addition, AIFMs and UCITS ManCos shall implement detailed policies and procedures for the activation/deactivation of the LMTs.
• Draft RTS does not seek to introduce conditions on when the LMTs may be used but rather a definition of what characteristics each type of LMT has.
• The proposed rules do not preclude the ability of the AIFM/UCITS ManCo to deploy LMTs other than those described in the draft Regulatory Technical Standards (RTS).
• Other than suspensions and side pockets, the LMTs below can be activated by the AIFM/UCITS ManCo only if they have been selected and included in the fund rules and instruments of incorporation.

Questions

The questions from the European Securities and Markets Authority (ESMA) Consultation Papers are below.

The questions largely ask for feedback from market participants as to whether:

• The LMTs are correctly described.
• There are other features the definitions should include.
• Any LMTs should be defined for UCITS and alternative investment funds (AIFs) differently.
• In a fund with multiple share classes the LMTs should be applied differently to different share classes.
• In each instance, the reasons for the same.

Liquidity Management Tools

The LMTs concerned are:

• Suspension of subscriptions, repurchases and redemptions (“suspension”)
• Redemption gates
• Extension of notice periods
• Redemption fees
• Swing pricing
• Dual pricing
• Anti-dilution levy
• Redemptions in kind
• Side pockets.

Selection of LMTs

In selecting the LMTs, an AIFM/UCITS ManCo should have regard to:

• The fund’s investment strategy and investment policy.
• Fund structure, including notice period, lock up period, settlement period and dealing frequency.
• Liquidity profile and all liquidity risks, reflecting results of liquidity stress testing.
• Redemption policy and characteristics of investor base.
• Distribution policy, including any anti-dilution levies (including if applied by platform).

Suspension

• No requests for subscriptions, repurchases and redemptions may be processed during the suspension, including requests submitted before the suspension was effected.
• It is not permissible to process subscriptions while suspending redemptions.
• Fund must be reopened simultaneously for subscriptions, repurchases and redemptions.
• Any decision to suspend must be accompanied by a plan “for the future of the fund” in light of possible outcome(s) for the fund (e.g. temporary suspension followed by reverting to normal operation, creation of a side pocket or liquidation of the fund).
• Only available in exceptional circumstances and when in the best interests of the investors.
• Suspension always available as an option, without the need to pre-select it.
• Exceptional circumstances include asset valuation difficulties, severe liquidity issues, critical cyber incident that affects the fund, unforeseen market closures, significant fraud, natural disaster and severe financial/political crisis.

Redemption Gates

• Temporary and partial restriction to investors’ redemption rights.
• May apply to redemption rights only while permitting subscriptions.
• Activation thresholds set ither at % of NAV–activation thresholds applied to individual redemptions disallowed.
• Gates may be activated at a higher level than set in the fund documents.
• Gates to be applied to all redeeming investors at the level of the threshold, applied pro rata.
• Unredeemed portion of a redemption request may be carried over to the next redemption/dealing date, but any priority given to the requests carried over must be pre-determined.

Extension of Notice Periods

• If notice period is extended, dealing frequency and settlement period should be unaffected.
• Extended notice means the standard notice period plus additional notice period.
• If notice period extended, the extension shall be the same for all investors, and shall apply to all share classes.

Redemption Fees

• A fee within a predetermined range that reflects the cost of liquidity, paid to the fund by redeeming investors to ensure remaining investors are not unduly affected.
• When applying the redemption fee, the impact of other redemptions or subscriptions on the NAV will not be taken into account (in contrast to anti-dilution levies and swing pricing).
• Redemption fees correspond to transaction-based costs which are fixed or have low variation. Redemption fees are deducted from the money received by redeeming investors.
• Redemption fees are paid to the fund to the benefit of remaining investors.
• Redemption fees shall impose on redeeming shareholders or unit-holders the explicit and implicit estimated costs of portfolio transactions caused by redemptions, including any estimated significant market impact of assets sales to meet those redemptions.
• Redemption fees may apply to all redemption orders or only to redemption orders that exceed a certain threshold which can be expressed as a percentage of the NAV of the fund or as a number of shares/units redeemed by investors or both.
• Investors placing redemptions orders that correspond to a certain redemption fee level shall all be charged the same redemption fee.
• Although available to all funds, most applicable to funds with fixed/foreseeable transaction costs, allowing for transparent pre-investment disclosure to investors.

Swing Pricing

• A predetermined mechanism by which NAV is adjusted by the application of a factor (the swing factor) that reflects the cost of liquidity.
• All subscribing and redeeming investors will transact on the basis of the same adjusted (“swung”) NAV.
• May be applied to all subscription/redemption activity or only when such activity exceeds a specific threshold.
• Swing factor may be static or be tiered to reflect the greater impact on NAV of higher subscriptions/redemptions and associated costs.
• Same swing factor must be applied to all share classes.
• Less appropriate for hard to value assets, best suited for funds with majority of assets in liquid public markets.
• Investor disclosure of adequate swing pricing information, including thresholds, both under normal and stressed market conditions.
• By design, swing pricing should always ensure NAV is adjusted to market conditions; estimated liquidity costs must be based on justifiable data.
• Changes to swing factor beyond maximum range disclosed must be objectively justifiable and evidenced.

Dual Pricing

• Dual pricing refers to the calculation of two NAVs per valuation point and there can be two ways to implement it.
• Calculating one NAV which incorporates assets’ ask prices and the other NAV which incorporates assets’ bid prices.
• Subscribing investors pay the NAV calculated using ask asset prices and redeeming investors receive the NAV calculated using bid asset prices.
• Alternatively, establishing an ‘adjustable spread’ around the fund’s NAV under which assets are priced on a mid-market basis, with a bid price at which the fund redeems shares and an offer price at which the fund issues new shares.
• The difference between these two prices is known the spread as estimated by the fund manager, which could be dynamic to reflect the liquidity costs in prevailing market conditions.

Anti-dilution Levy

• The level of the levy is expressed as a percentage of the redemption/subscription order.
• There can be a pre-determined activation threshold.
• For a given dealing date, if the net difference between redemptions and subscriptions results in net subscriptions, an anti-dilution levy will be charged to subscribing investors.
• Conversely, for a given dealing date, if the net difference between redemptions and subscriptions results in net redemptions, an anti-dilution levy will be charged to redeeming investors.
• When activated, all redeeming (or subscribing) investors shall be charged an antidilution levy. The amount of the levy charged to investors may be the same for all subscribing/redeeming investors or tailored to the exact transaction costs of the redeeming/subscribing investors if the AIMF/UCITS ManCo is able to quantify them exactly for each investor.

Redemptions in Kind

• Redemptions in kind allow funds to avoid the sale of sizable blocks of securities in response to redemption requests and avoid significant transaction costs.
• Redemptions in kind shall only be used to meet redemption requests from professional investors.
• If the fund is solely marketed to professional investors or if the investment policy of the fund is to replicate the composition of a certain stock or debt securities index and that fund is an exchange-traded fund (ETF), fund managers are not required to transfer assets to professional investors on a pro rata basis of the assets held by the fund.
• The same type of transfer of assets (i.e pro rata share or not) shall apply to all redeeming investors.

Side Pockets

• Side pockets allow for the separation of certain assets, whose economic or legal features have changed significantly or become uncertain due to exceptional circumstances, from other fund assets.
• Side pockets should only be employed in the best interests of the investors in “exceptional circumstances”, i.e. in unforeseen circumstances that materially affect the fund’s ability to continue its normal investment activities, including:
  • Significant valuation uncertainty and/or illiquidity of a specific portion of the portfolio for which there is no active market and/or for which trading is prohibited (e.g. due to sanctions) and/or for which fair valuation is temporarily unavailable with the view of segregating it from the rest of the fund to not compromise liquidity for the fund overall.
  • In case of fraud, financial crisis or war affecting a particular sector or geopolitical region.
• Side pockets may be operated by way of balance sheet segregation, e.g. by creating a separate share class, or by physical segregation by placing the assets in a separate fund.
• Side pockets need not be separately selected by the AIFM/UCITS ManCo may be used without a specific election.
• Side pockets shall be closed-ended.
• Investors shall receive shares/units of the side pockets on a pro rata-basis of their holdings in the original fund.
• The AIFM/UCITS ManCo shall manage the side pockets with the sole objective of it being liquidated.
• Cash resulting from the sale of assets located in the side pocket shall not be reinvested and shall be paid to investors.
• The fund manager shall allocate a proportion of liquid assets to the side pocket in order to fulfil any possible liabilities arising from the management of the side pocket.
• The fund manager shall manage the rest of the fund in accordance with the fund’s investment strategy.
• New subscriptions and redemptions in the fund shall be executed on the basis of assets excluding the assets in the side pocket.