Services

UCITS IV – Liquidity risk measurement

Under UCITS IV, for the first time, UCITS must explicitly address liquidity risk, going beyond the cover rules set forth in previous UCITS regulation. However, neither detailed regulatory guidelines nor meaningful and recognised market practices have emerged.

Understanding liquidity risk for investment funds

The European Directive defines ‘liquidity risk’ as “the risk that a position in the UCITS portfolio cannot be sold, liquidated or closed at limited cost in an adequately short time frame and that the ability of the UCITS to [repurchase or redeem its units at the request of any unit-holder] is thereby compromised;”

Concepts like mean traded volumes, bid/ask spread or liquidity coverage ratio can be useful, but they are usually not reconcilable across different instrument categories or the necessary information is just not available.

Furthermore, while in some cases asset liquidity risk is well discussed and apprehended, liquidity risk triggered by liabilities, such as large redemptions or other cash outflows, may be more difficult to estimate.

As a result, a general and comprehensive framework accounting for asset and liability liquidity risk, both in normal and stressed conditions, may be difficult to design and implement.

In order to help our clients address these new challenges, Deloitte’s risk management experts have built on market experience to set the basis of our proprietary liquidity risk measurement framework. 

Our approach – asset and liability liquidity risk reporting

We have translated the UCITS IV regulatory expectations into a liquidity risk measurement framework anchored around the following steps:

1. Assets’ liquidity risk profile, considering the following dimensions:

  • market depth,
  • liquidation time, and
  • liquidation cost (i.e. market risk, execution costs, bid/ask spread, currency conversion risk).

2. Net future liability liquidity risk obligations arising from:

  • Financial Derivatives Instruments (listed or OTC),
  • subscription / redemption activity, and
  • other known or unknown cash flows.

3. Design of stress scenarios, considering potential

  • drying up of liquidity conditions and/or widening in liquidation costs;
  • large redemptions; and also
  • liquidity contingency plans (e.g. overdraft facilities, etc.)

4. Aggregation at the fund level

  • Liquidity coverage ratio up to the next trading days
  • Liquidity generating capacity
  • Breakdown and overall liquidity profile
  • Liquidity buffer level (cash + high-quality liquid assets)
  • Assets under liquidity watch
  • Under normal and stressed conditions

Our services and solutions for liquidity risk

We believe an appropriate liquidity risk measurement framework can be a valuable tool in order to

  • Achieve regulatory risk compliance, and
  • Improve portfolio and risk management day-to-day activities.

Our value proposition for liquidity risk measurement framework covers the following areas:

  • UCITS IV liquidity risk management review, gap analysis and development;
  • Design and implementation of internal measurement framework for liquidity risk;
  • Assistance in specific areas such as: key liquidity risk indicators development, asset or liability risk qualitative and/or quantitative modelling, liquidity risk reporting design, stress testing design and implementation, vendor selection, etc.;
  • Outsourcing of liquidity risk measurement & reporting.

Contacts

Xavier Zaegel, FRM

Xavier Zaegel, FRM

Partner | Capital Markets/Financial Risk Leader

Xavier is a partner within the advisory and consulting department and is the head of the Capital Markets practice in Luxembourg. As a market and credit risk specialist, he has been leading various ass... More

Marco Lichtfous

Marco Lichtfous

Partner | Capital Markets/Financial Risk

Marco is a partner within the advisory and consulting department and has over 20 years of professional experience. He is specialised in risk management, turnaround management, M&A, corporate finance, ... More

Jan van Delden

Jan van Delden

Partner | Audit & Assurance

Jan is a partner within the audit department with over 20 years’ experience. He has specialised in the audit of investments fund and real estate structures. He is part of the investment fund and real ... More