The European Securities and Markets Authority has rolled out stress tests for investment funds.
The EU regulatory body issued guidelines this week for probing Ucits and money market funds (mainly for retail investors) and alternative funds (for professional and savvier investors).
“EU-based funds need to regularly test the resilience of their funds to different types of market risks, including for liquidity risk,” Esma stated on Monday. “The guidelines will become applicable on 30 September 2020.”
“… in the period between 2007 and 2018 the total net assets managed by EU-domiciled Ucits funds have increased significantly from €6.2trn to €9.3trn. Therefore, it is crucial to ensure that the fund industry is resilient and is able to absorb economic shocks.”
Ucits are the type of investment fund that forms the backbone of Luxembourg’s fund industry.
Esma published a case study as part of its documents package simulating an investor run on Ucits bond funds. “The results show that overall, most funds are able to cope with such extreme but plausible shocks, as they have enough liquid assets to meet investors’ redemption requests,” according to the financial markets regulator. But “up to 40% of high yield bond funds could experience a liquidity shortfall” under its hypothetical scenario.
A second test, on “the impact of the funds’ liquidation on financial markets”, found that “that the overall price impact is limited for most asset classes”, aside from high yield bonds and emerging markets bonds, where a selloff “could have a material impact” on values.
ESMA publishes a framework to be used for stress simulations for the investment fund sector.