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In our view, the LRM guidance is one of the more important guidance notes for MIS managers released by the FMA. It aligns well with FMA’s purpose of promoting the confident and informed participation of businesses, investors, and consumers in the financial markets.
Let’s face it: There’s not much more that hinders confident and informed participation in financial markets than investors being unable to access their investments when they would ordinarily expect to do so.
New Zealand's experience during the global financial crisis highlighted this, and arguably, given that most New Zealanders are now investors in an open-ended managed investment scheme (e.g., KiwiSaver), the LRM stakes are getting higher.
The LRM guidance remains essentially unchanged from the consultation draft released in September 2023. However, there are subtle changes in emphasis to clearly put the onus on MIS managers, as prudent professional investment managers, to effectively manage the liquidity risks associated with each of their funds rather than the FMA prescribing specific LRM methods or approaches.
In essence, the LRM guidance is pitched as, just that, a helpful tool and guide for MIS managers to use when considering and implementing LRM for each of their funds.
It is unarguable that managing liquidity risk in a manner consistent with a fund’s investment objective and expected redemption terms is one of the most critical fiduciary duties of any MIS manager (i.e., it is what their customers (their beneficiaries) would expect — it is why they pay fees to a professional MIS Manager).
It is unarguable that supervisors, who also have fiduciary duties to the MIS manager’s customers, should hold MIS managers to account for their management of each fund’s liquidity risks (i.e., it is what the customers (the beneficiaries) would expect and it is why they pay fees to a professional supervisor).
If a customer is unable to access their investment when they expect to, the customer, or the regulator on their behalf, will be minded to question how the MIS manager and supervisor were discharging their fiduciary duties. This underscores the importance of managing liquidity risks effectively to mitigate customer harm, regulatory scrutiny and, from a commercial perspective, reputational damage.
So, with the above in mind, we think the LRM guidance is useful in that it contains a sensible overview of the features to be considered as part of any LRM framework.
It would also be sensible ‘risk management’ and a helpful demonstration of how an MIS manager is discharging their fiduciary obligations to benchmark and, where appropriate, adjust their LRM framework and underlying policies and processes having reference to the LRM guidance.
The exact LRM approaches implemented will depend on each funds terms and features.
In this regard, the FMA appears to have been relatively (and perhaps deliberately) neutral by not calling out any particular MIS product type or underlying liquidity risk factors as requiring greater consideration or more specific LRM guidance.
If we had to critique the LRM guidance (which we have), given KiwiSaver's increasing systemic importance and impact on New Zealanders' financial well-being and confidence in financial markets, perhaps the FMA could have given specific emphasis to the liquidity risks in KiwiSaver and how they may manifest and be mitigated by KiwiSaver MIS managers.
The legislative design of KiwiSaver presents challenges for MIS managers in that it is a long-term savings scheme where (most of the time) member contributions are locked until age 65. This means that from an investment fiduciary perspective, a KiwiSaver MIS manager might consider it appropriate to have some exposure to more illiquid and private market assets.
However, this must be balanced against the legislative setting, which requires KiwiSaver members balance to be transferred to another KiwiSaver scheme on request (within 10 business days), and member contributions and permitted withdrawals are (generally) processed each business day necessitating the underlying assets to be valued and unit prices to be calculated regularly.
While redemption requests for KiwiSaver funds might be easier to forecast and meet out of liquid assets than other MIS products, we do not think the liquidity risks associated with KiwiSaver Schemes are necessarily lower than those associated with other open-ended MIS.
We are particularly mindful that in open-ended MIS (such as KiwiSaver) all you need is material unit pricing uncertainty due to factors such as an inability value of an underlying asset or asset class independently, objectively, and in a timely manner, as a potential need to suspend a fund to maintain KiwiSaver member fairness and equity regardless of whether there is a material increase in unit holder redemptions.
Perhaps the FMA views these factors as obvious, that any prudent professional MIS manager would consider in designing and implementing and appropriate LRM Framework for a KiwiSaver Scheme.
In any event, we suspect that they (and impacted investors) will likely hold this view in the, hopefully, rare event that investors are unable to access their money from a fund when they would ordinarily expect to do so.
In the meantime, if you would like to help to pragmatically review your LRM approach in response to the LRM guidance, we would be happy to help.
