ESMA warns money managers to prepare for future liquidity shocks

Money managers must prepare corporate debt and real estate strategies for future adverse liquidity and valuation shocks, Europe's top supervisory authority warned.

The European Securities and Markets Authority published a report Friday on how prepared investment strategies that have significant exposures to corporate fixed-income and real estate assets are for future shocks, such as the impact of the COVID-19 pandemic.

ESMA conducted a supervisory exercise with national securities regulators by analyzing strategy data for the period Feb. 17 to March 31, the report said.

The strategies in the sample "managed to respond adequately to redemption pressures" associated with the pandemic, said Steven Maijoor, chairman of ESMA, in a statement accompanying the report. "However, the work also revealed shortcomings that must be addressed in order to enhance funds' preparedness to future shocks, and we have identified a number of priority areas that funds and supervisors should focus on to address potential liquidity risks in the fund sector."

Despite the findings that most strategies coped well, ESMA urged caution in interpreting the results since the shock linked to the pandemic was concentrated over a short period of time and against a backdrop of significant government and central bank intervention.

ESMA said concerns have emerged around the valuation of portfolio assets, particularly for real estate strategies, "for which the crisis could have a more significant impact over the longer term," the report said.

The report outlined five priority areas to enhance the preparedness of strategies and managers. These relate to the ongoing supervision of the alignment of the funds' investment strategy, liquidity profile and redemption policy; ongoing supervision of liquidity risk assessment; reporting on fund liquidity profiles; an increase in the availability and use of liquidity management tools; and the supervision of valuation processes in the context of uncertainty over such valuations.

Addressing these priority areas should reduce the risk and impact of "collective selling" from these strategies for the financial system. ESMA said it will continue to monitor liquidity and valuation risks "through regular assessments of the resilience of the fund sector."