Categories
Monthly Update

2021: Liquidity, resiliency and ESG

To say that 2020 was a shock to the system would be an understatement, although the financial services sector has largely held its own during the crisis. Despite this, a number of regulatory changes aimed at the asset management industry are likely to be unveiled over the next 12 months. The New City Initiative (NCI) looks at some of the potential developments that could unfold in 2021.

Liquidity risk management – expect new rules

Liquidity risk management was an area of concern for the UK’s Financial Conduct Authority (FCA) long before COVID-19 struck. The preceding summer had seen Neil Woodford’s Equity Income Fund forced to suspend redemptions after investing into difficult-to-dispose of assets. The FCA and Bank of England are currently reviewing liquidity risk management practices at managers with one possibility being that redemption notice periods be lengthened to reduce the risk of panic selling, particularly at daily dealing funds whose portfolios contain difficult to sell assets. In 2020, the FCA sent a survey to asset managers asking them about their financial resilience during COVID-19, the findings of which are likely to feed into any future policies concerning liquidity risk management.

COVID-19 did cause a handful of short-term liquidity issues, especially for entities exposed to real estate assets and corporate debt. The European Securities and Markets Authority (ESMA) subsequently issued a report in November 2020 urging AIFMs and UCITS to implement changes to ensure they are better prepared for future shocks, including improved liquidity profile reporting and ongoing supervision checking there is alignment between the fund’s investment strategy, liquidity profile and redemption policy.

Operational resiliency will continue to be a priority

While the FCA has applauded the asset management industry’s response to COVID-19, it is likely to continue focusing forensically on the sector’s operational resilience. Rather fortuitously, the FCA published a guide to operational resiliency in 2019 just ahead of COVID-19. Among some of its main requirements are that financial institutions consider how disruption to their business services can have an impact beyond their own commercial interests; that firms set a tolerance for disruption for each important business service and ensure they can continue to deliver these critical services during serious crises; and a requirement for financial institutions to map out and test important business services so as to identify vulnerabilities in their operational resilience.

ESG and a new era of regulation

The absence of regulation and a litany of different standards has meant that investing into ESG (environment, social, governance) assets can be a complicated activity. The EU – conscious of the challenges facing investors when allocating into ESG funds – has sought to make the process more straightforward through the passage of the Sustainable Finance Disclosure Regulation (SFDR), which will oblige fund managers to disclose on their websites how they incorporate sustainability risks into their investment decision-making and remuneration policies. A template specific to sustainability funds will need to be produced from next year, while it is expected the taxonomy will also be published in 2021. Although the UK has yet to introduce its own equivalent ESG rules, few expect the country will deviate too much from the EU. Furthermore, many existing non-EU AIFMs leveraging the national private placement regimes will still need to comply with SFRD and the taxonomy rules.