Final Report
Guidelines on liquidity stress testing in UCITS and AIFs

02 September 2019 | ESMA34-39-882

Table of Contents
1

Executive Summary ....................................................................................................... 22

Overview ........................................................................................................................ 33

Annexes ......................................................................................................................... 5
Annex I: Feedback Statement ............................................................................................ 5
Annex II: Cost-benefit analysis ..........................................................................................23
Annex III: Guidelines on Liquidity Stress Testing in UCITS and AIFs ................................26

I Scope .................................................................................................................................27
II Legislative references, abbreviations and definitions .........................................................28
III Purpose ............................................................................................................................31
IV Compliance and reporting obligations ..............................................................................31
V Guidelines on Liquidity Stress Testing in UCITS and AIFs.............................................33
V.1 Guidelines applicable to managers .............................................................................33
V.1.1 The design of the LST models..............................................................................33
V.1.2 Understanding liquidity risks .................................................................................33
V.1.3 Governance principles for LST .............................................................................33
V.1.4 The LST policy .....................................................................................................34
V.1.5 Frequency of LST.................................................................................................35
V.1.6 The use of LST outcomes ....................................................................................36
V.1.7 Adapting the LST to each fund .............................................................................36
V.1.8 LST scenarios ......................................................................................................37
V.1.9 Data availability ....................................................................................................37
V.1.10 Product development .........................................................................................38
V.1.11 Stress testing fund assets to determine the effect on fund liquidity .....................38
V.1.12 Stress testing fund liabilities to determine the effect on fund liquidity..................40
V.1.13 LST on other types of liabilities ...........................................................................42
V.1.14 Funds investing in less liquid assets...................................................................43
V.1.15 Combined asset and liability LST .......................................................................44
V.1.16 Aggregating LST across funds ...........................................................................44
V.2 Guidelines applicable to depositaries..........................................................................45
V.3 Interaction with National Competent Authorities..........................................................45

1

1 Executive Summary
Reasons for publication
In April 2018, the European Systemic Risk Board (ESRB) published a set ofrecommendations to address liquidity and leverage risk in investment funds (the ESRB
recommendations1). The ESRB’s ‘Recommendation C’ requests that ESMA, in order topromote supervisory convergence, “develop guidance on the practice to be followed bymanagers for the stress testing of liquidity risk for individual AIFs and UCITS”.
On 5 February 2019, ESMA published a Consultation Paper (CP)2 on the draft Guidelines
on Liquidity Stress Testing in UCITS and AIFs in order to fulfil the ESRB recommendations
and gather input from stakeholders.
The consultation closed on 1 April 2019.
This Final Report provides an overview of the feedback received through the responses to
the CP and explains how ESMA took this feedback into account. It also contains the final
set of Guidelines on Liquidity Stress Testing in UCITS and AIFs.

Contents
Section 2 sets out an Overview of the document. Annex I provides the Feedback Statement
and Annex II includes the cost-benefit analysis which details the expected impact of the
Guidelines.
The Guidelines are set out in Annex III.

Next Steps
The Guidelines in Annex III of this report will be translated into the official EU languages andpublished on the ESMA website. The publication of the translations will trigger a two-month
period during which NCAs must notify ESMA whether they comply or intend to comply withthe guidelines. The Guidelines will apply from 30 September 2020.

1
2

Recommendation of The European Systemic Risk Board on liquidity and leverage risks in investment funds, (ESRB/2017/6)
ESMA Consultation Paper on Guidelines on stress testing in UCITS and AIFs ESMA34-39-784

2

2 Overview
Background
1. In April 2018, the European Systemic Risk Board (ESRB) published recommendations onaction to address systemic risks related to liquidity mismatches and the use of leverage ininvestment funds3. Amongst other measures, the ESRB recommended that ESMA develop
guidance on how asset managers carry out liquidity stress tests4, with a target delivery dateof 30 June 2019.
2. The ESRB requested that the Guidelines should be “based on the stress testing requirements
set out in Directive 2011/61/EU” setting out how managers should carry out stress testing. It
was also recommended that the guidance include, but not be limited to:-the design of liquidity stress testing scenarios5;
the liquidity stress test policy6, including internal use of liquidity stress test results7;
considerations for the asset8 and liability9 sides of investment fund balance sheets; andthe timing and frequency for individual funds to conduct the liquidity stress tests10.

Public consultation
3. On 5 February 2019, ESMA published a CP on the draft Guidelines on liquidity stress testingin UCITS and AIFs.
4. The consultation closed on 1 April 2019.
5. ESMA received 30 responses, 2 of which were confidential, mainly from asset management
industry associations and financial firms. Representatives from depositaries also commented
on the questions addressed to them. ESMA consulted the Securities and Markets
Stakeholders Group (SMSG), but the SMSG chose not to opine on these guidelines.
6. In general, respondents agreed with ESMA’s approach of introducing minimum standards forliquidity stress testing in AIFs and UCITS funds in Europe.
7. Many respondents stressed the need for a long implementation period due to the need tobring in new IT systems to cope with changed stress testing methodologies.
8. Most respondents said that the scope should exclude money market funds as they are alreadysubject to specific stress testing guidelines.
9. There were numerous requests for clarifications to the Guidelines and Explanatory
Considerations. The detailed content of the responses and ESMA feedback is outlined below
in the Feedback Statement.

3

ESRB/2017/6
ESRB/2017/6 Recommendation C – Stress testing read as follows: “In order to promote supervisory convergence ESMA isrecommended to develop guidance on the practice to be followed by managers for the stress testing of liquidity risk for individual
AIFs and UCITS”.
5
Covered in Section V.1.8 of Annex III of this Final Report
6
Covered in Section V.1.4 of Annex III of this Final Report
7
Covered in Section V.1.6 of Annex III of this Final Report
8
Covered in Section V.1.11 of Annex III of this Final Report
9
Covered in Sections V.1.12 and V.1.13 of Annex III of this Final Report
10
Covered in Section v.1.5 of Annex III of this Final Report43

Cost-benefit analysis
10. A cost-benefit analysis of the draft guidelines is included in Annex II of this Final Report. It
has been updated to reflect respondents’ feedback, particularly on initial and on-going costs
for managers.
Contents
11. This Final Report includes the Guidelines that ESMA intends to publish in Annex III. They
have been updated to reflect feedback from the public consultation.
Next steps
12. ESMA expects the Guidelines to be applied by 30 September 2020.

4

3 Annexes
Annex I: Feedback Statement
1. The responses to the public consultation included some general comments that aresummarised below.
2. There was a general agreement among respondents that Liquidity Stress Testing (LST) is
an important management tool for fund managers. It allows firms to assess the impact ofmarket stresses, to anticipate activity in stressed market conditions and to identify potential
vulnerabilities. In this context, respondents supported almost unanimously ESMA’s
proposed Guidelines that aim at achieving a common understanding of LST.
3. All respondents also agreed with ESMA’s principles-based approach allowing flexibility forfund managers. Given the heterogeneity of fund structures, respondents stressed that
there is no “one-size-fits-all” solution.
4. Several respondents also stressed that regulators should provide managers a wide arrayof appropriate tools to deal with potential liquidity crises when they arise. They invited
ESMA to assist with the wider availability of Liquidity Management Tools (LMT) across theEU.
5. Numerous concerns were raised regarding the difficulty of obtaining relevant and highquality data. Data scarcity remains a major obstacle to robust economic modelling.
ESMA response: ESMA notes the support from stakeholders for the creation of Guidelines on
LST and the proposed approach ESMA has adopted.
ESMA notes the support for a proportionate application of the Guidelines, requiring firms totake into account the nature, scale and complexity of the fund, which has been retained in the
Scope of the final Guidelines.
ESMA takes note of the general comment to widen the availability of LMT, but this would bebeyond the scope of the current exercise to create Guidelines on LST.
Finally, ESMA is aware of the challenges regarding availability of data, which was alreadyreflected in Guideline 9 in the CP. The wording of Guideline 9 has been retained in the final
Guidelines (Section V.1.9 of Annex III of this Final Report).
Q1 What additional costs and benefits would compliance with the proposed Guidelines
bring to the stakeholder(s) you represent? Please provide quantitative figures,
where available.
6. Many respondents noted that it was difficult to provide precise costs and benefits estimatesat this stage. They highlighted that the costs would be highly dependent on theprescriptiveness of the final requirements. Among these respondents, many supported aprinciples-based approach giving more flexibility to market participants and underlined that5

a “one-size-fits-all” solution would not be able to take specific fund’s characteristics into
account.
7. Nonetheless, a majority of respondents specified that a few provisions would entail
significant costs. Reverse stress testing was singled out, as it is not performed regularly
but rather on an ad-hoc basis and based on qualitative assessments. Concerns were also
expressed by respondents regarding the stress testing of “other liabilities” and historicalstress testing.
8. Many respondents noted that the proposed Guidelines will require fund managers to design
additional systems and to develop and implement IT solutions. They also pointed out thatgiven the scarcity of market data, in particular for some asset classes, the sourcing of goodquality data might represent a substantial cost increase. Several respondents also
indicated that a change in LST frequency and the obligation of validation of all estimatesby an independent expert would entail additional costs.
9. Most respondents were of the view that it is not possible to quantify the benefits of the
Guidelines.
ESMA response: ESMA takes note of the comments by stakeholders regarding the potential
cost of implementing new aspects of LST. In this regard, ESMA notes that LST already haveto be performed under the applicable legislation, which will reduce the cost impact of these
Guidelines. Furthermore, ESMA believes that a consistent application of LSTs will enhancefinancial stability and investor protection in the asset management sector, justifying theimplementation cost.
Q2 Do you agree with the scope of these Guidelines? Should certain types of funds be
explicitly excluded from these Guidelines? Should MMFs remain in-scope of these
Guidelines?
10. A significant majority of respondents agreed with ESMA’s approach and saw merit inhaving a broad scope to ensure that funds presenting a potential liquidity risk are coveredby the provisions.
11. Nonetheless, diverging comments were raised regarding which types of funds should be
included in the scope of the Guidelines.
12. Respondents were almost unanimously of the view that Money Market Funds (MMFs)
should be excluded from the Guidelines. They explained that MMFs already fall under the
MMF Regulation which includes more stringent provisions adjusted to their specificities interms of liquidity. Furthermore, they saw little rationale in applying two sets of rules to
MMFs considering that it could create the risk of conflicting regulation and operational
issues for firms.
13. There was also support for the inclusion of Exchange-Traded Funds (ETFs) in the scopeof the Guidelines, with respondents noting that most ETFs are UCITS funds. Several
respondents underlined the importance of adopting a flexible approach to allow asset

6managers to take account of the specificities of ETF structures, such as Authorised
Participants (APs), Other Liquidity Providers (OLPs) and redemption mechanisms.
14. Only one asset manager explicitly supported the exclusion of ETFs from the scope of the
Guidelines because of substantial differences between ETFs and mutual funds.
15. Different views were expressed by respondents regarding the inclusion of closed-ended
funds in the scope of the Guidelines. Numerous respondents supported the exclusion of
all closed-ended funds, both leveraged and unleveraged. They argued that forunleveraged funds there is no liquidity mismatch between investors’ expectations andunderlying assets if the fund does not allow for any redemption. For leveraged closedended funds, respondents agreed that liquidity risk exists, but the long investment horizon
negates the need for LST.
16. Nonetheless, many other respondents believed that leveraged closed-ended funds should
be in the scope. They pointed out that in case of leverage, it is key to assess the fund’sability to meet margin calls or provide collateral.
ESMA response: In order to reduce the potential for conflict, ESMA has decided to narrow
the scope of applicable provisions to MMFs, focusing on those parts of the Guidelines notalready covered in the MMFR rules. ESMA has also kept the provision that in case of conflict,the Money Market Funds Regulation (MMFR) rules apply. Regarding ETFs, ESMA has clarified
that these Guidelines apply in addition to requirements in the ESMA ETF Guidelines.
Leveraged closed ended alternative investment funds (AIFs) have also been retained in thescope of the Guidelines.
Q3 Is additional clarity required regarding the scope of these Guidelines? Is additional
clarity required regarding the meaning of ‘nature, scale and complexity’ of a fund?
Are there circumstances in which it would, in your view, be inappropriate for a UCITS
to undertake LST?
17. The majority of respondents welcomed the application of the proportionality principle,
arguing that the fund sector is very heterogeneous. They said it is important to tailor LST
to the funds’ investors and assets. The LST should also consider the fund’s specificinvestment strategy, additional LMT and the investors’ redemption processes.
ESMA response: ESMA takes note of the many contributions from stakeholders regarding
applying proportionality. ESMA believes the Guidelines already made sufficient reference toproportionality, noting the decision to keep a general reference in the scope section to adapting
the application of LST to the nature, scale and complexity of the fund.
Q4 What are your views on when the Guidelines should become applicable? How muchtime would managers require to operationalise the requirements of these
Guidelines?
18. Respondents highlighted the difficulty in providing a precise estimate at this stage asprovisions might be modified in the final version of the Guidelines. Nonetheless, there wasa broad agreement in favour of a long implementation period in order to adapt the current
processes, develop new IT systems and improve data quality.
719. A significant majority of respondents suggested an implementation period ranging from 18
to 24 months.
20. A minority of respondents were of the view that a shorter implementation would beappropriate.
ESMA response: ESMA believes that requiring the application of the Guidelines from 30
September 2020 grants a sufficient implementation period, bearing in mind the importance ofensuring convergence on how LSTs are performed by the asset management industry. ESMA
reminds stakeholders that, in any case, the requirements enshrined in AIFMD and the UCITS
Directive on, inter alia, liquidity stress testing are already applicable and continue to apply.
Q5 Do you agree with the proposed approach of setting out a list of Guidelines all funds
should follow, and the provision of explanatory considerations to help managers
comply with those overarching Guidelines? Do you see merit in including some ofthe explanatory considerations in the final Guidelines?
21. In general, most respondents agreed with ESMA’s approach that the Guidelines follow a
principles-based approach.
22. Some respondents were of the view that explanatory considerations should be presented
next to the Guideline they best fit. They said separating explanatory considerations fromthe Guidelines reduce their relevance and their effectiveness and might even be source ofconfusion.
23. Nevertheless, most respondents did not see any merit in including any explanatory
considerations in the final Guidelines as this would be too prescriptive.
24. Several respondents said it would be useful to include the explanatory considerations in
the final Guidelines. However, among those respondents a few expressed concerns
regarding the wording of the explanatory considerations and recommended ESMA clarify
that the explanatory considerations remain illustrative, rather than prescriptive, in order tobetter recognise the heterogeneity of strategies and investors.
ESMA response: ESMA acknowledges broad support for the CP approach. To illustrate theintent behind the Guidelines, ESMA has decided to include some of the explanatory
considerations next to the Guideline they best fit, also in line with the feedback provided bysome respondents. In order to further differentiate the Guidelines from the explanation on how
the expected outcome outlined in the Guidelines should be achieved, the Guidelines wereformatted in bold.
Furthermore, the final Guidelines have been changed to be in numbered paragraphs in distinct
sections with sub-headings as a presentational adaptation. To facilitate comparison between
the CP and the final Guidelines, a correlation table showing the paragraph numbers of the CP
Guidelines is provided below.

8Guideline number in the CP

New paragraph in the final Guidelines

1

20

2

24

3

18

4

25

5

28

6

29

7

30

8

31

9

37

10

42

11

49

12

50

13

67

14

72

15

74

Q6 Do you agree with the proposed Guidelines? What amendments, if any, should
ESMA make to its proposed Guidelines?
25. Respondents were generally supportive of the proposed Guidelines, arguing that they werein line with the existing industry practices and standard methodologies.
26. However, most respondents suggested a significant number of amendments to the
Guidelines. In most cases, respondents specified that some elements of the proposed
Guidelines were too burdensome, detailed and prescriptive.
27. Guideline 2: Industry respondents disagreed that LST should be documented twice. They
stressed that liquidity management is part of the general risk management process andshould be documented once.

9

ESMA response: The CP recommended that LST should be documented both in the LST
policy and within the UCITS Risk Management Process (RMP) and AIFM’s Documented Risk
Management Policy (AIF RMP). The final Guidelines recommend that LST should be
documented in an LST policy within the UCITS and AIF RMP.
28. Guideline 4: While respondents agreed that LST should be conducted annually since it isrequired by existing legislation, several respondents were of the view that recommending
a more specific frequency would not be in line with a principles-based approach.
ESMA response: ESMA notes that the minimum legal requirement to perform LST is annual
under the AIFMD. However, ESMA recommends a quarterly frequency for LST and recognisesthat there are situations where a higher or lower frequency is necessary.
29. Guideline 5: On point d) which obliges funds to set liquidity limits, numerous respondents
noted that firms should be free to set limits if they believe it appropriate for their funds,
having regard to the redemption commitments of the fund and the requirements ofinvestors, but should not be compelled to do so.
ESMA response: ESMA has clarified the language to highlight that the intention was that the
manager should set internal limits as an additional risk management tool.
30. Guideline 7: The comments focused on points b) (the types of scenarios) and c) (investor
behaviour assumption) of the Guideline. Several respondents questioned the added valueof taking into account gross redemptions since they were of the view that net figures are
sufficient. Concerns were also expressed regarding the availability of sufficiently granularinvestor behaviour data.
ESMA response: ESMA disagrees that gross redemptions may not be useful and has retained
the reference in the final Guidelines. The reference to the investment strategy has been
complemented by a reference to portfolio composition. Furthermore, an additional point in theliabilities section has been added to reflect ETF specificities.
31. Guideline 8: Many respondents opposed the inclusion of reverse stress testing (RST) on
a mandatory basis for all funds. These respondents stressed that RST is not required in
the UCITS Directive or AIFMD. The respondents were of the view that there is little value
in RST, while being very burdensome.
ESMA response: ESMA considers it beneficial to recommend the use of RST as this could
be an important tool to assess the potential sources of liquidity risks to which the fund is
exposed, enabling the assessment on the actions to be taken in order to ensure that the fundis adequately liquid.
32. Guideline 10: Several respondents were of the view that a manager or fund-specificapproach to asset liquidation scenarios would be more appropriate than the proposed time
and/or cost-related scenarios.

10ESMA response: ESMA remains of the view that time and/or cost-related asset liquidation
methods are commonly used tools in LST. ESMA has added text from the explanatory
considerations to complement the Guidelines.
33. Guideline 11: Three respondents invited ESMA to add some flexibility by using “whereappropriate”, instead of “where applicable”.
ESMA response: ESMA is of the view that funds have sufficiently diverse liabilities to warrant
retaining the original language of “where applicable”.
34. Guideline 14: The majority of respondents agreed that it should be up to the asset
manager to assess whether aggregate LST would be appropriate.
ESMA response: ESMA has clarified that a manager should aggregate LST across funds
where such an activity is appropriate for the fund. To specify that the Guideline is intended tocover scenarios of aggregate LST across funds, the words “across funds” have been added
after “Aggregate LST”.
Q7 Do you agree with the proposed explanatory considerations regarding LST of fundassets?
35. Respondents generally supported the proposed explanatory considerations regarding LSTof fund assets, considering them useful to improve LST standards across jurisdictions andmanagers.
36. However, many respondents highlighted the need to find the right balance between
standardisation and flexibility, to ensure that LST remains a useful risk management tool.
They expressed concern that some considerations are too prescriptive.
37. Moreover, several industry associations and firms suggested adding references to theequal treatment of investors and the preservation of market integrity as factors to consider.
38. Several respondents warned ESMA about the risks associated with data availability.
Indeed, they noted that the relevant Guidelines and explanatory considerations require
asset managers to ensure that any assumptions are adequately validated, documented
and justified, which would entail significant costs.
39. Finally, a few respondents suggested changing “prospectus” to “prospectus or fund rules”
since a prospectus is not the sole document that governs the contractual relationshipbetween fund and investors.
ESMA response: In line with the presentational adjustment, ESMA has incorporated
explanatory considerations on asset stress testing into the Guidelines on the basis that they
provide additional guidance.
The explanatory consideration in paragraph 32 of the CP (Section V.1.11 of Annex III of thisFinal Report) has been complemented by a bullet point noting that the manager should also
take into account the impact on other investors in the market and on market integrity when
considering liquidating assets.
11

The reference to “prospectus” has been amended to “prospectus or fund rules”.
Q8 What are your views on the requirement to undertake reverse stress testing, and theuse of this tool?
40. Respondents agreed that RST could be a useful tool in some cases but only one
respondent supported ESMA’s proposal to make it mandatory. Both financial industry
associations and asset management firms said mandatory RST would be burdensome formanagers while the benefits seem low and questionable. Respondents were also of theview that adding RST to historical and hypothetical stress testing would be redundant andunnecessary.
41. In this context, a clear majority of respondents invited ESMA to apply the principle ofproportionality. These respondents stressed that it should be left to the asset manager’s
discretion to decide whether RST would add value. Most suggested adding “whereappropriate” or “where applicable” to Guideline 8.
ESMA response: ESMA considers it beneficial to recommend the use of RST as this could
be an important tool to assess the potential sources of liquidity risks to which the fund is
exposed, enabling the assessment on the actions to be taken in order to ensure that the fundis adequately liquid. While not making the RST mandatory, the current text of the LST
Guidelines recognises the benefits of using RST, particularly for funds engaging in investment
strategies exposing them to low-probability risks with a potentially high impact. ESMA will keep
the issue of RSTs under review.
Q9 Do you see merit in providing further considerations for managers on the use of data
relevant to asset liquidity, particularly in circumstances when data is scarce?
42. Most respondents welcomed ESMA’s wording regarding the use of data relevant to asset
liquidity. However, the majority of respondents did not see merit in providing further
considerations in this area. They urged ESMA to maintain a principles-based approachthat offers more flexibility for fund managers to assess the existing available data and toadapt LST to circumstances.
43. Moreover, a significant number of concerns were raised regarding the requirement to havean independent validation of assumptions. Stakeholders’ feedback expressed concerns on
the potential costs deriving from a potential validation to be performed by an entity external
to the management company (although no explicit requirement to have such an external
validation was proposed in the consultation paper). According to these respondents, sucha requirement would entail substantial additional costs for managers. They invited ESMAto take proportionality into consideration especially if the expert is independent from theportfolio manager and no conflicts of interests are identified.
ESMA response: The CP did not provide any specific requirement on validation of LST models
and assumptions underpinning them, as this was only included in the explanatory
considerations which foresaw that LST models and assumptions underpinning them should beperiodically reviewed and validated, the results documented, and models amended as
appropriate. The final position adopted by the LST Guidelines expressly requires that the LST
policy should include the initial validation of LST models and assumptions underpinning them,12to be performed independently from portfolio management, though not necessarily by anentity/person external to the manager. Moreover, the Guidelines include an explicit
requirement for any assumptions used in the LST models to be adequately reviewed.
Q10 Do you agree with ESMA’s wording regarding the asset liquidation method usedin the LST model? How would you describe the asset liquidation method used by
you or the managers you represent?
44. Despite a few supportive responses, ESMA’s approach raised a significant number ofconcerns about over-prescription. Many respondents argued that it is not always possible
to predict, or model with a sufficient degree of accuracy, how a manager would liquidate
the fund in stressed conditions and under various stressed market scenarios.
45. Several respondents suggested amendments, including the deletion of “always
accurately”, and by replacing “would liquidate” with “could liquidate”.
ESMA response: ESMA believes that time and cost-related asset liquidation methods areuseful tools in LST.
Q11 Do you agree with ESMA’s wording regarding ‘second round effects’? What isyour current practice regarding modelling ‘second round effects’?
46. Respondents were generally supportive of ESMA’s approach and of the description of“second round effects” (SRE). A few respondents explicitly welcomed theacknowledgement that SRE require a more detailed understanding of how asset owners
will react to market liquidity events.
47. Most respondents focused on the practical consequences of SRE. Several respondents
pointed out that there is no or little evidence that fire sales by funds could have an impact
on other agents by triggering price spirals in the market where funds invest.
48. Nonetheless, the most common concern expressed by financial industry respondents was
the complexity to model SRE, especially in light of data scarcity.
49. Most respondents advised ESMA not to engage in the debate regarding second roundeffect, which is not without contention and implies the use of difficult risk modelling
techniques. Other respondents opted for a more balanced solution, inviting ESMA to soften
the wording to consider practical difficulties with SRE.
ESMA response: The CP did not include any specific recommendation on “second roundeffects”, which were mentioned in the explanatory considerations among the “difficult-to-model
parameters”. The Guidelines do not include any specific recommendation regarding themodelling of these effects either. However, they focus on the incorporation of these effects into
managers’ LST simulation, recommending that the method of liquidating assets in an LSTshould reflect how a manager would liquidate assets during normal and stressed conditions inaccordance with applicable rules. The recommendation to reflect how the manager would
liquidate assets during a period of exceptional market stress is also included in the context of
the use of RSTs.

13

Q12 What are your views on the considerations on difficult to model parameters, suchas price uncertainty? What is your current practice concerning this issue?
50. Many respondents agreed that price uncertainty is a key factor for LST (e.g. transaction
costs, liquidation period) that needs to be taken into consideration by fund managers whenmanaging liquidity risk. Most respondents also shared ESMA’s view regarding the difficultyof modelling price uncertainty.
51. On the one hand, several respondents, including trade associations and market
participants, recommended that price uncertainty should be included as one of theparameters in the liquidity modelling. They suggested considering it in the manager’s
contingency planning and when deciding to use a-LMT such as swing pricing.
52. On the other hand, a few respondents noted that the complexity of modelling priceuncertainty makes it useless. They were of the view that this highlights the need for asset
managers to have access to a well-diversified toolkit for liquidity management
ESMA response: The CP did not provide any specific recommendation on the need to take
into consideration price uncertainty when performing LST, as this was only included in the
explanatory considerations among the “difficult-to-model parameters”. However, theGuidelines cover price uncertainty considerations in the section on funds investing in less liquid
assets (Section V.1.14 of Annex III of this Final Report).
Q13 Do you agree with ESMA’s considerations on LST in funds investing in less liquid
assets? What amendments should be made to the proposed wording? Do you thinkthat ESMA should outline additional and/or specific Guidelines to be made in any
other fund or asset types, such as ETFs?
53. A significant number of respondents broadly agreed with ESMA’s considerations on LST
in funds investing in less liquid assets and recognised their usefulness.
54. A few respondents explicitly stated their opposition to ESMA’s considerations related tofunds holding less liquid assets.
55. Regarding the second part of the question, a large majority of respondents were of theview that ETFs should be included in the scope of the Guidelines, as ETFs fall in the scopeof the UCITS Directive. However, many respondents underlined that ETF structures’specificities should be fully acknowledged, e.g. the role of APs and other liquidity providers.
Some of the respondents pointed out that the Guidelines should recognise the role of thesecondary market for ETFs.
56. Only two respondents were of the view that ETFs should receive no specificconsiderations.
ESMA response: ESMA considered that the specificities of ETFs should be more explicitly
recognised in the Guidelines. Therefore, additional wording was added in order to take into
account ETFs’ specificities, including the role of AP, redemption models and replication models(Section V.1.7 of Annex III of this Final Report).

14

Q14 Do you agree with the considerations regarding LST on items on the liabilities
side of a fund’s balance sheet?
57. A significant majority of respondents broadly agreed with ESMA’s proposed considerations
regarding LST on items on the liability side of a fund’s balance sheet.
58. However, several respondents raised concern about the low availability of data on
underlying investors, noting that this is a key challenge for conducting LST on redemptions.
59. Some respondents suggested that ESMA should explore ways to encourageintermediaries or platforms to provide look-through data on underlying investors toinvestment funds, to enable firms to perform better LST.
60. Several respondents suggested that the “other liabilities” should only be considered if they
have a “material” or “significant” impact on a fund.
61. Some respondents stated wider concerns with ESMA’s approach regarding the status of
the explanatory considerations, noting that it would be helpful to specify that the
explanatory considerations should be considered illustrative and not individually binding.
ESMA response: ESMA acknowledges the comments regarding availability of data on
underlying investors, however, ESMA is not empowered to enforce such data availability fromintermediaries or platforms. The Guidelines recognise the difficulties regarding data
availability.
Q15 Do you agree with the considerations specifying the LST of redemptions andother types of liabilities may need to be considered distinctly, given a fund could
potentially limit redemptions but not other sources of liquidity drain?
62. The majority of respondents supported the distinct consideration of LST for redemptions
as opposed to other types of liabilities.
63. However, many respondents also stressed that the application of LST to other types of
liabilities should not be mandatory, calling for managers to be given flexibility.
ESMA response: ESMA recommends that the manager should include other types of liabilities
in its LST in normal and stressed conditions, where appropriate. Furthermore, all relevant itemson the liability side of the fund’s balance sheet, including items other than redemptions, should
be subject to LST.
Regarding the treatment of borrowing, ESMA intended this to be captured under “interest /credit payments” (Section V.1.13 of Annex III of this Final Report).
Q16 Do you agree with the requirement to reverse stress test items on the liabilities
side of the fund balance sheet?
64. A significant majority of respondents disagree with the requirement to RST liabilities, in linewith similar views on the earlier broader RST question (Question 8). A few respondents
noted the high costs involved for firms from introducing mandatory RST requirements.

15

65. While many respondents rejected the RST requirement outright, some respondents said
that there may be merit in RST liabilities for some funds, but the requirement should be
optional.
ESMA response: ESMA considers RST should take into account the treatment of remaining,as well as redeeming, unitholders. Therefore, use of RST could be beneficial also for liabilities
as this could be an important tool to assess the potential sources of liquidity risks to which thefund is exposed.
Q17 Do you agree with the requirement to incorporate investor behaviour
considerations into the LST model ‘where appropriate’? Are there cases which you
believe it would not be appropriate, and should these be detailed in these
Guidelines?
66. A significant majority of respondents agreed with the proportional approach ESMA has
suggested on incorporating investor behaviour considerations.
67. Several respondents suggested that ESMA should explore ways to encourageintermediaries or platforms to provide look-through data on underlying investors toinvestment funds, to enable firms to perform better LST.
68. A few respondents said that due to the difficulty of obtaining the underlying data on
investors, the language in the explanatory considerations should be amended to say not
only “where appropriate” but also “where available”.
ESMA response: ESMA acknowledges the concern regarding availability of data on
underlying investors, however, ESMA is not empowered to enforce such data availability fromintermediaries or platforms. The language on data in Guideline 9 of the CP was designed torequire managers to demonstrate how they overcome data shortcomings for LST (Section
V.1.9 of Annex III of this Final Report).
Q18 What do you think about ESMA’s Guideline stating that managers should
combine LST results on both sides of the balance sheet?
69. A significant majority of respondents agree with the ESMA Guideline recommending
combining the two sides of the balance sheet.
70. Several financial industry associations and asset management firms stressed, however,that ESMA should not be over-prescriptive or specify a single methodology, such as the
Redemption Coverage Ratio (RCR).
71. Several respondents noted that while combining asset and liability stress tests ismeaningful, comparing results from different funds is only useful where the funds are
pursuing similar strategies or managed by the same portfolio manager.
ESMA response: The Guideline has been amended to “after separately testing the asset andliabilities of the fund balance sheet, managers should combine appropriately the results of the
LST to determine an overall effect on fund liquidity” (Section V.1.15 of Annex III of this Final
Report).
16

Q19 What are your views on ESMA’s Guideline that aggregated LST should beundertaken where deemed appropriate by the manager?
72. Most respondents said there is little added value in aggregated LST across funds, asassets and liabilities are managed at individual fund level. An exception would be for funds
pursuing a similar strategy, exposed to similar assets and managed by the same portfolio
manager or portfolio management team.
73. Some respondents disagreed, noting that aggregated LST can be useful in all cases.
74. Many of the negative responses suggested that explanatory consideration in paragraph 56of the CP be amended to apply to a “range of investment funds with similar strategies or
exposures” which is already stated in paragraph 57 of the CP.
ESMA response: ESMA has clarified the language of Guideline 14 to stress that aggregate
LST should be undertaken “across funds” (Section V.1.16 of Annex III of this Final Report).
Furthermore, the explanatory consideration from paragraph 57 of the CP has been added in
the Guidelines.
Q20 What is your experience of performing aggregated LST and how useful are theresults?
75. Only a few respondents said they had experience of aggregated LST, and then only in thecase of funds with similar strategies or managed by the same portfolio manager or portfolio
management team.
76. In those cases, aggregated LST were found to be useful, including as a tool to inform risk
management in funds sharing the same investment strategy.
77. A clear majority of correspondents expressed a strong preference that aggregated LST
across funds should remain optional.
ESMA response: ESMA believes that clarified and additional language introduced in
Guideline 14 in the CP, as explained in the ESMA response to Question 19, should ensure
implementation of aggregate LST (Section V.1.16 of Annex III of this Final Report).
Q21 What are your views on ESMA’s considerations concerning the use of LST during
a fund’s lifecycle?
78. A clear majority of respondents agreed with ESMAs considerations on the use of LST
during a fund’s lifecycle, noting, however, that the use should be optional and proportional
to the risk involved at each stage.
79. Many respondents pointed out that, at the product development stage, LST, while
important, would be mostly qualitative and theoretical, limiting the potential insight thiswould give the firm.
80. Some respondents also stressed that where a fund is launched with very similar
characteristics to an existing fund, data from the existing fund could be used to inform theLST of the new fund.
1781. Several respondents also said that LST would have limited use immediately before theclosing of a fund. These respondents noted that as the fund has ceased trading, the fund’s
manager may make use of the available liquidity management tools, if necessary andappropriate, for the fair treatment of the remaining investors, without the need for LST.
ESMA response: ESMA believes that LST should be employed at all stages in the fund’s
lifecycle, where appropriate.
Q22 What is your experience of the use of LST in determining appropriate
investments of a fund?
82. A clear majority of respondents said LST does not play a significant role in determining theappropriate investments of a fund. Some respondents said that, inter alia, investment
policy, risk appetite and investment restrictions are more important than the result of an
LST in the investment process. Many respondents did concede that LST plays an importantpart of the product development phase, but not necessarily a central role in determining
the appropriate investments of the fund.
83. However, two respondents argued that LST does play an important role.
ESMA response: ESMA believes that LST can be useful in determining the investments inorder to maintain the appropriate liquidity level given the liability structure and investment
strategy of the fund.
Q23

In your view, has ESMA omitted any key uses of LST?

84. A clear majority of respondents said ESMA has not omitted any key uses of LST in thedraft guidelines.
ESMA response: ESMA takes note of the feedback on this issue and has not further amended
the Guidelines.
Q24 Do you agree with ESMA’s Guideline that LST should be undertaken in all cases
annually, but that it is recommended to undertake it at least quarterly, unless a
different frequency can be justified? What is the range of frequency of LST applied
on funds managed by stakeholder(s) you represent?
85. A significant majority of respondents agreed that LST should be undertaken at least
annually, but most respondents disagreed with the recommendation that LST be
undertaken quarterly.
86. Many said that while it may be necessary to conduct LST more frequently than once a year,
depending on the nature, scale and complexity of the fund, this should be left to thediscretion of the manager.
87. A financial industry association and an asset manager said that LST performed quarterly
should be the starting point, and one asset manager suggested monthly or even weekly.

18

88. Regarding factors requiring an increase in the frequency of LST, two financial industry
associations said that the use of derivatives does not necessarily increase the level of riskin the fund and would not require more frequent LST.
89. Two respondents also suggested that a diversified asset base or investor base could be afactor decreasing the frequency of regular LST.
ESMA response: ESMA notes that the minimum legal requirement to perform LST is annual
under AIFMD. However, ESMA recommends a quarterly frequency for LST and recognisesthat there are situations where a higher or lower frequency is necessary.
Q25 Should ESMA provide more prescriptive Guidelines on the circumstances which
can justify a more/less frequent employment of LST?
90. Almost all respondents said ESMA should not provide more prescriptive Guidelines on thecircumstances justifying more/less frequent LST.
91. Several respondents stressed, in line with previous responses that fund managers should
be given greater discretion on the frequency of conducting LST, taking into account thenature, scale and complexity of the fund.
92. One respondent did suggest that ESMA could include more scenarios in the explanatory
considerations when higher frequency of LST may be appropriate.
ESMA response: As ESMA noted in response to comments regarding Guideline 4 of the CP
in Question 6, ESMA notes that the minimum legal requirement to perform LST is annual in
the AIFMD. However, ESMA recommends a quarterly frequency for LST and recognises that
there are situations where a higher or lower frequency is necessary.
Q26 Do you agree that LST should be employed outside its scheduled frequency (adhoc) where justified by an emerging/imminent risk to fund liquidity?
93. A significant majority of respondents agree that LST should be employed outside thescheduled frequency if justified by an emerging/imminent risk to fund liquidity.
94. However, several asset managers and trade associations disagreed with the prescriptive
nature of the wording “emerging/imminent risk to fund liquidity” and expressed a preference
for something more flexible such as “where required”. These respondents said that itshould be up to the manager to decide the timing of more frequent LST where justified bycircumstances.
95. Several respondents said that in the case of “imminent” liquidity risks, the use of LSTshould be optional only, since an LST would not be very useful any more at that stage.
ESMA response: ESMA has included the explanatory considerations regarding factors to take
into account when determining the frequency of LST.
Q27

What are your views on the governance requirements regarding LST?

19

96. A majority of respondents agreed with ESMA’s proposed governance requirements for
LST. However, many financial industry respondents suggested paragraph 71 of the CP on
validation and back-testing is too prescriptive, suggesting the need for external validation
either be deleted, be made optional, or at least be made more proportional in how it isrequired to be applied by the firm.
97. Two respondents suggested that ESMA more clearly state that the risk management
function of the fund should be in charge of LST.
ESMA response: The CP did not provide any specific requirement on validation of LST models
and assumptions underpinning them, as this was only included in the explanatory
considerations which foresaw that LST models and assumptions underpinning them should beperiodically reviewed and validated, the results documented, and models amended as
appropriate. The final position adopted by the LST Guidelines expressly requires that the LST
policy should include the initial validation of LST models and assumptions underpinning them,
to be performed independently from portfolio management, though not necessarily by anentity/person external to the manager. Moreover, the Guidelines include an explicit
requirement for any assumptions used in the LST models to be adequately reviewed.
Q28

Should more information be included in the UCITS RMP and AIF RMP?

98. A clear majority of respondents did not think any more information should be included in
the UCITS and AIF RMPs.
99. One financial industry association noted that the AIFMD and UCITS implementing
legislation already contain a prescriptive list of items to be included in the RMPs, so nofurther specification was necessary.
ESMA response: ESMA believes that the information required by the Guidelines in Section
V.1.4 of Annex III of this Final Report is sufficient for implementing a robust documentation of
the LST policy.
Q29 Do you have any views on how managers which delegate portfolio management
can undertake robust LST, independently of the portfolio manager, particularly whenthe manager does not face the market?
100. Views were split on how managers who delegate portfolio management can undertake
robust LST. Most respondents said that the delegating entity should be able to conduct
effective LST, provided that the delegated portfolio manager collaborates sufficiently interms of providing enough information. They pointed out in several responses that LST
should be independent of portfolio management in any case, so delegating portfolio
management should not unduly impact the LST.
ESMA response: ESMA believes that the Guidelines already recommend that LST should be
performed robustly also in the case of delegation.
Q30 Do you agree with the proposed Guideline for depositaries on carrying out theirduties regarding LST?

20

101. A majority of respondents agreed with ESMA’s proposed Guideline and explanatory
considerations for depositaries.
102. A small minority of respondents disagreed that a Guideline was necessary at all, given
the existing requirements in the UCITS Directive and AIFMD. One asset manager said thisGuideline would increase depositary costs unnecessarily, which would be borne byunderlying investors eventually.
103. Most fund management companies and industry association responses stressed thatthe explanatory considerations should more explicitly limit the role of the depositary to
merely ensuring that an LST is in place and that an LST has been performed.
104. Many respondents stressed that the explanatory considerations should state inparagraph 78 of the CP that in addition to not re-performing or repeating an LST, it should
not be the role of the depositary to challenge an LST either.
ESMA response: ESMA takes note of the feedback with regard to depositaries, in particularwith regard to the variety of practices across Member States.
ESMA has incorporated the explanatory considerations and simplified the language.
ESMA also acknowledges that it is not the intention of Guideline 15 of the CP or the explanatory
considerations (Section V.2 of Annex III of this Final Report) to require depositaries to review
or challenge the LST.
Q31 In your experience do depositaries review the UCITS RMP and AIF RMP as amatter of course?
105. Views were split on current practices regarding depositaries’ review of RMPs. Half the
respondents said depositaries do not regularly review RMPs while a minority of
respondents said depositaries do regularly review RMPs.
106. However, some respondents said depositaries do review and challenge some aspectsof the RMP.
ESMA response: The Guidelines recommend that a depositary should verify that the manager
of a fund conducts LST. One way of verifying that LST is in place and carried out is to confirm
that the UCITS RMP or AIF RMP provides for the manager to carry out LST on the fund.
Q32 Do you see merit in ESMA publishing further guidance on the reporting of resultsof liquidity stress tests? If so, in your view how should ESMA require that results bereported?
107. A clear majority of respondents did not see merit in ESMA providing further guidanceon the reporting of results of liquidity stress tests.
108. A few respondents requested the deletion of explanatory considerations for interactions
with NCAs completely.

21

109. Most respondents urged ESMA to retain a principles-based approach and not toprescribe a more detailed reporting framework.
110. Some respondents pointed out that the MMF stress test reporting has been aburdensome exercise and suggested ESMA refrain from such a detailed approach for LST
reporting.
111. A small minority of respondents agreed that ESMA should provide more guidance onreporting to ensure comparability across EU Member States.
ESMA response: ESMA takes note of the feedback. Given the incorporation of a number of
explanatory considerations into the Guidelines, ESMA has also incorporated some of thelanguage on interaction with NCAs (Section V.3 of Annex III of this Final Report). Furthermore,
to address liquidity risk in the asset management sector, ESMA has strengthened the provision
regarding the interaction with NCAs by introducing a requirement for managers to notify NCAsof material risks and actions taken to address them.

22Annex II: Cost-benefit analysis
The following table summarises the potential costs and benefits resulting from theimplementation of these guidelines.
Policy objective

To achieve a set of minimum standards by which all managers
across Member States conduct LST in funds.

Technical proposal

To provide Guidelines on how managers can improve their LST
procedures, including by determining the appropriate use ofhaircuts, frequency and scenario design, and use of historical data.

Benefits

ESMA expects that these guidelines will benefit managers,
depositaries and NCAs by providing clarity and guidance on
expected practices.
The FSB and ESRB recommendations stem from the objective ofimproving liquidity management in funds more generally, with LST
being a key component of this.
There is evidence that improved LST standards and the improved
liquidity management that could flow from it would be beneficial tomanagers. For example, a stakeholder has stated that the FSB
recommendations were ‘positive’ for managers, due to the lower
reputation risk and increased earnings stability that may result frommanagers’ improved practices11. The ESRB stated that LST should
reduce liquidity risk at the investment fund level, this should leadto a lower risk of measures such as fund suspensions, which canbe a source of reputational risk for managers.
ESMA also expects that the proposed Guidelines will benefit abroader set of stakeholders. The ESRB explained in its
recommendation that ESMA should produce these Guidelines inorder to help:••“Lower liquidity risk at the financial system level”. By
reducing liquidity risk at the level of the investment fund, it
may reduce the likelihood of funds disposing of assets at
significant discounts in order to service redemptions (‘fire
sales’). Fire sales by a material proportion of funds would
be likely to move asset prices, potentially affecting financial
stability.
“Strengthen the ability of entities to manage liquidity in thebest interests of investors”. Investors in funds have

IPE: “FSB proposals ‘positive’ for asset manager, investors, says Moody’s”

1123

reasonable expectations that funds will be able to honour
redemption requests, as set out in fund documents such as
the prospectus. Improved liquidity management standards(via LST) could therefore reduce the likelihood thatinvestors’ redemptions will be restricted. Further, it may
also reduce the likelihood that funds will sell assets at firesale prices, which may not be in investors’ interests.
Costs for managers

Initialcosts
managers

The great majority of managers, 93% as measured by one
survey 12, already undertake LST and as such these Guidelines
may not add significant additional costs related to undertaking LST
for the first time. Given that LST is already required annually on inscope AIFs, ESMA anticipates that these Guidelines would lead tolimited costs for managers, focused on those UCITS managers
which do not already undertake LST.

for Within the group of managers already operating a programme of
LST (93%), ESMA anticipates that those managers which alreadyincorporate minimum standards would not incur significant initial,
ongoing or ad-hoc costs. Costs related to reading and responding
to this Consultation, and ensuring standards meet those specified
in the Guidelines are expected to be incurred.
For those managers who do not implement these minimum
standards, managers are likely to incur initial costs related to theadaptation of their LST practices. Those costs will mainly
correspond to the development and the implementation of therelevant IT tools.

Ongoing costs for The ESRB recognised in its recommendation that the minimum
managers
standards set out in these Guidelines could result in ‘extra’ stresstesting, and therefore higher costs13. Such higher costs may arise
from higher standards related to actions taken as result ofcomplying with minimum standards in this Guidelines. For
example, the incorporation of reverse stress testing into managers’
practices may require additional risk management resources.
According to the estimates provided by CP respondents, between
1 and 2 extra risk management resources would be needed.
However, as outlined above, this cost should be balanced by the
reputational and other benefits which arise from improved liquidity
management when minimum LST standards are met.

12
13

ESRB/2017/6 page 32
ESRB/2017/6 page 34

24

It is worth mentioning that given the current market data scarcity,
the sourcing of good quality data might entail additional costs,
particularly for some asset classes.
Based on the requirements set up in the Guidelines, managers
might be compelled to hire additional staff. Finally, the obligationof validation of all estimates and assumptions by an independent
expert might also be a source of potential new costs for managers.
Ad-hoc costs
managers

for Ad-hoc costs may decrease, as the need for corrections andenforcement by NCAs should be reduced, since clear standards
are set out in the Guidelines.

Costs
depositaries

for Depositaries may incur costs through complying with the Guideline
to verify managers have LST procedures in place. To mitigate this,the draft Guidelines draw on existing wording in UCITS and AIFMD
to highlight depositaries’ obligations in this area. Further, ESMA
believes that the proposed Guidelines are proportionate andlimited, particularly as documents such as the UCITS and AIF RMP
are already reviewed by many depositaries.

Costs to investors

Investors could conceivably incur costs from the implementation ofthese Guidelines. For example, if LST highlights that it may be
prudent to ensure additional liquid assets in a fund ahead of anevent which may materially impact fund liquidity, this can create
costs for investors in the fund. These costs could include costs
from liquidating positions in less liquid assets (such as transactions
costs). In both cases investors would hypothetically ‘pay’ thosecosts via lower fund performance. This however should bebalanced by the following: (a) UCITS are required to be able tomeet redemption demands at all times, as a result LST could be
one factor in enabling that outcome, however the overriding
requirement is set by the UCITS Directive, not these Guidelines (b)investors in AIFs may not be subject to the same increased costs,
as they may not be subject to the same obligation to provide
liquidity on-demand to investors.

Costs to ESMA & The Guidelines are not anticipated to add significant additional
national competent costs to ESMA and NCAs. The Guidelines could in fact lead toauthorities (NCAs)
lower resource requirements from NCAs, due to potential for a
reduced need to expend resource on requiring improvements instandards of LST.

25

Annex III: Guidelines on Liquidity Stress Testing in UCITS and
AIFs
Table of Contents
Scope ................................................................................................................................... 27
Legislative references, abbreviations and definitions ........................................................... 28
Purpose ................................................................................................................................ 31
Compliance and reporting obligations .................................................................................. 31
Guidelines on Liquidity Stress Testing in UCITS and AIFs ……………………………………..33

26

I ScopeWho?
1. These Guidelines apply to managers, depositaries and NCAs.
What?
2. These Guidelines relate to liquidity stress testing in UCITS and AIFs.
3. In particular, in respect of managers they apply primarily in relation to Article 16(1) of
the AIFMD, Articles 47 and 48 of the AIFMD Level 2 Regulation, Article 51 of the UCITS
Directive, Article 40(3) of the UCITS Level 2 Directive and Article 28 of the MMFR.
4. In respect of depositaries, these guidelines apply primarily in relation to Article 21 of
the AIFMD, Articles 92 of the AIFMD Level 2 Regulation, Article 22(3) of the UCITS
Directive and Article 3 of the UCITS Level 2 Regulation.
5. These Guidelines apply in respect of UCITS and AIFs, including:a) ETFs, whether they operate as UCITS or AIFs14;b) Leveraged closed ended AIFs.
6. The Guidelines in Sections V.1.1 (The design of LST models), V.1.2 (Understanding
liquidity risk), V.1.3 (Governance principles for LST), V.1.4 (The LST policy), V.2(Guidelines applicable to depositaries), and paragraphs 79 and 81 of Section V.3(Interaction with National Competent Authorities) apply to MMFs, without prejudice tothe MMFR and ESMA Guidelines exclusively applying to MMFs15, which prevail in theevent of any conflict.
7. These Guidelines should be adapted to the nature, scale and complexity of the fund.
Furthermore, the topic of LST naturally overlaps with other aspects of liquidity
management in funds, such as managing liquid and less liquid assets, diversificationand implementing measures such as ex post a-LMT. These Guidelines are notintended to provide comprehensive guidance regarding liquidity management issues
outside the scope of LST.
When?
8. These Guidelines apply from 30 September 2020.

For clarity, the existing guidelines on UCITS receiving collateral under the “ESMA ETF Guidelines of ETFs and other UCITS
issues” (ESMA 2014/937) apply. Paragraph 45 of the “ESMA ETF Guidelines on ETFs and other UCITS issues” provides that “A
UCITS receiving collateral for at least 30% of its assets should have an appropriate stress testing policy in place to ensure regularstress tests are carried out under normal and exceptional liquidity conditions to enable the UCITS to assess the liquidity risk
attached to the collateral”. This measure is specific to the circumstances involved for such UCITS whereas the LST Guidelines
are intended to provide guidance on the application of liquidity stress testing for investment funds generally and should be taken
into account by all UCITS.
15
Such as those ESMA Guidelines establishing common reference parameters of the stress test scenarios to be included in MMF
managers’ stress tests (currently referred to as ‘ESMA34-49-115’)
1427

II Legislative references, abbreviations and definitions
Legislative references
UCITS Directive

Directive 2009/65/EC on the coordination of laws,
regulations and administrative provisions relating toundertakings for collective investment in transferable
securities (UCITS)16.

UCITS Level 2 Directive

Commission Directive 2010/43/EU implementing Directive
2009/65/EC of the European Parliament and of the Council
as regards organisational requirements, conflicts of interest,
conduct of business, risk management and content of theagreement between a depositary and a managementcompany.17

AIFMD

Directive 2011/61/EU on Alternative Investment Fundmanagers and amending Directives 2003/41/EC and2009/65/EC and Regulations (EC) No 1060/2009 and (EU)No 1095/201018.

AIFMD Level 2 Regulation

Commission Delegated Regulation (EU) No 231/2013
supplementing Directive 2011/61/EU of the European
Parliament and of the Council with regard to exemptions,general operating conditions, depositaries, leverage,transparency and supervision.

CDR (EU) 2016/438

Commission Delegated Regulation (EU) 2016/438
supplementing Directive 2009/65/EC of the European
Parliament and of the Council with regard to obligations ofdepositaries19.

MMFR

Regulation (EU) 2017/1131 on money market funds20.

ESMA Regulation

Regulation (EU) No 1095/2010 of the European Parliamentand of the Council of 24 November 2010 establishing a
European Supervisory Authority (European Securities andMarkets Authority), amending Decision No 716/2009/EC
and repealing Commission Decision 2009/77/EC21.

16

OJ L 302, 17.11.2009, p. 32–96
OJ L 176, 10.7.2010, p. 42–61
18
OJ L 174, 1.7.2011, p.1
19
OJ L 78, 24.3.2016, p. 11–30
20
OJ L 169, 30.6.2017, p. 46–127
21
OJ L 331, 15.12.2010, p. 84.
1728

Abbreviations
AIF

Alternative Investment FundAIF RMP

AIFM’s Risk Management Policy

AIFM

Alternative Investment Fund Manager

a-LMT

Additional Liquidity Management Tool

ETF

Exchange Traded Fund

ESMA

European Securities and Markets Authority

ESRB

European Systemic Risk Board

EU

European Union

FoF

Fund of Funds

FSB

Financial Stability Board

FX

Foreign Exchange

LST

Liquidity Stress Testing

MMF

Money Market FundNCA

National Competent Authority

RCR

Redemption Coverage Ratio

RST

Reverse Stress Testing

UCITS

Undertaking for Collective Investments in Transferable
Securities

UCITS RMP

UCITS Risk Management Process29Definitions
closed ended AIF

an AIF other than an open ended AIF, which is an AIF
meeting the criteria of Article 1 (2) of Commission DelegatedRegulation (EU) No 694/201422

depositarydepositary of a UCITS or an AIF

ex post a-LMT

tools/measures applied by managers in exceptional
circumstances to control or limit dealing in fund units/sharesin the interests of investors, including but not limited tosuspension of dealing in units, deferral of dealing and sidepocketingfire sale priceliquidation of an asset at a material discount to its fair value

fund

a UCITS or an AIF

liquidation cost

the cost paid by the seller of an asset for the execution of agiven transaction in a timely manner for liquidity purposes

liquidity risk

the risk that a position in the fund cannot be sold, liquidated
or closed at limited cost to comply at any time with obligations
to redeem units/sharesliquidity stress testinga risk management tool within the overall liquidity risk
management framework of a manager which simulates arange of conditions, including: normal and stressed (i.e.
extreme, unlikely or unfavourable) plausible conditions, toassess their potential impact on the funding (liability), assets,
overall liquidity of a fund and, the necessary follow-up action

manager(a) in relation to a UCITS, the UCITS management company
or, in the case of a self-managed UCITS, the UCITS
investment company;(b) in relation to an AIF, the AIFM or an internally-managed
AIF;(c) in relation to an MMF, the manager of an MMF.

22

OJ L 183, 24.06.2014, p. 18.

30

redemption coverage ratio

a measurement of the ability of a fund’s assets to meetfunding obligations arising from the liabilities side of thebalance sheet, such as a redemption shock

reverse stress testinga fund-level stress test which starts from the identification of
the pre-defined outcome with regards to fund liquidity (e.g.
the point at which the fund would no longer be liquid enoughto honour requests to redeem units) and then explores
scenarios and circumstances that might cause this to occur

special arrangements

specific types of ex-post a-LMT measures available to some
AIFs and which impact investors’ redemption rights, such asside pockets or gatestime to liquidity

an approach, whereby the manager can estimate the amountof assets which could be liquidated at an acceptable cost, fora given time horizon

III Purpose
9. These Guidelines are based on Article 16(1) of the ESMA Regulation. The purpose of
these Guidelines is to establish consistent, efficient and effective supervisory practices
within the European System of Financial Supervision and to ensure the common,
uniform and consistent application of Union law. In particular, their purpose is toincrease the standard, consistency and, in some cases, frequency of LST alreadyundertaken and promote convergent supervision of LST by NCAs.

IV Compliance and reporting obligations
Status of these Guidelines
10. In accordance with Article 16(3) of the ESMA Regulation, NCAs and financial market
participants must make every effort to comply with these Guidelines.
11. Competent authorities to which these Guidelines apply should comply by incorporatingthem into their national legal and/or supervisory frameworks as appropriate, including
where particular Guidelines are directed primarily at financial market participants. In
this case, competent authorities should ensure through their supervision that financial
market participants comply with the Guidelines.
Reporting requirements
12. Within two months of the date of publication of the Guidelines on ESMA’s website in all
EU official languages, competent authorities to which these Guidelines apply must
notify ESMA whether they (i) comply, (ii) do not comply, but intend to comply, or (iii) do
not comply and do not intend to comply with the Guidelines.

31

13. In case of non-compliance, competent authorities must also notify ESMA within twomonths of the date of publication of the Guidelines on ESMA’s website in all EU official
languages of their reasons for not complying with the Guidelines.
14. A template for notifications is available on ESMA’s website. Once the template has
been filled in, it shall be transmitted to ESMA.
15. Financial market participants are not required to report whether they comply with these
Guidelines.

32

V Guidelines on Liquidity Stress Testing in UCITS and AIFs
V.1 Guidelines applicable to managers
V.1.1 The design of the LST models
16. In building LST models managers should determine:a. the risk factors that may impact the fund’s liquidity;b. the types of scenarios to use and their severity;c. different outputs and indicators to be monitored based on the results of
the LST;d. the reporting of LST results, outputs and indicators to management; ande. how the results of the LST are used by risk management, portfolio
management and by senior management.
17. A manager should ensure that LST provides information that enables follow-up
action.

V.1.2 Understanding liquidity risks
18. A manager should have a strong understanding of the liquidity risks arising fromthe assets and liabilities of the fund’s balance sheet, and its overall liquidity
profile, in order to employ LST that is appropriate for the fund it manages.
19. A manager should strike a balance by employing LST that:a. is adequately focused, specific to the fund and highlights the key liquidity
risk factors; andb. uses a wide enough range of scenarios to adequately represent thediversity of the fund’s risks.

V.1.3 Governance principles for LST
20. LST should be properly integrated and embedded into the fund’s risk
management framework supporting liquidity management. It should be subject
to appropriate governance and oversight, including appropriate reporting andescalation procedures.
21. LST should be performed under similar conditions to other risk management operations
that are subject to regulatory requirements on independence, including the requirement
for risk management staff to act independently from other functions such as portfolio
33management. Nevertheless, the governance structure should consider how theoutcome of LST is taken into consideration by the portfolio management function while
managing the fund.
22. Where the manager delegates portfolio management tasks to a third party, particularattention should be paid to the independence requirement, in order to avoid relianceon or influence by the third party’s own LST.
23. Organisational requirements include the requirement to effectively manage conflicts ofinterest arising from operationalising LST. These conflicts of interest include:a. allowing other parties, such as portfolio management staff (including portfolio
managers from separate legal entities), to exercise undue influence over the
execution of LST, including reliance on judgements relating to asset liquidity;
andb. management of information regarding results of stress tests. If information isshared with a client, it should be ensured that this would not be inconsistent
with the manager’s obligation to treat all investors fairly in the way it discloses
information regarding the fund.

V.1.4 The LST policy
24. LST should be documented in an LST policy within the UCITS and AIF RMP,
which should require the manager to periodically review and adapt, if necessary,
the LST as appropriate. The LST policy should at least include the following:a. a clear definition of the role of senior management in the process,including the governing body (e.g. Board of Directors or Trustees);b. its internal ownership and which management function(s) is/areresponsible for its performance;c. its interaction with other liquidity risk management procedures, including
the manager’s contingency plans and the portfolio management function;d. a requirement for regular internal reporting of LST results specifying thefrequency and recipients of the report;e. periodic review, documentation of the results and a procedure foramending the policy where required by the review;f.

the circumstances requiring escalation, including when liquidity
limits/thresholds are breached;g. the funds subject to LST;
h. initial validation of the LST models and assumptions underpinning them,which should be performed independently from portfolio management,
though not necessarily by an entity/person external to the manager;

34

i.

the types and severity of stress test scenarios used and the reasons forselecting those scenarios;j.

the assumptions used relating to data availability for the scenarios, theirrationale and how frequently they are revisited;k. the frequency at which LST is carried out and the reasons for selectingthat frequency; andl.

the methods for liquidating assets, including the limitations andassumptions used.

V.1.5 Frequency of LST
25. LST should be carried out at least annually and, where appropriate, employed at
all stages in a fund’s lifecycle. It is recommended to employ quarterly or more
frequent LST. The determination of a higher or lower frequency should be basedon the fund’s characteristics and the reasons for such a determination should
be recorded in the LST policy. Flexibility is allowed for on this issue dependingon the fund’s nature, scale and complexity and liquidity profile.
26. When deciding on the appropriate frequency, managers should take into account thefollowing:a. the liquidity of the fund determined by the manager and any change in theliquidity of assets;b. the frequency should be adapted to the fund rather than a ‘one-size-fits-all’approach being taken to all funds operated by the manager; andc. the nature of the vehicle (closed versus open ended), the redemption policy and
LMTs, such as gates or side pockets, may be additional factors to take into
consideration when determining the appropriate frequency of LST.
27. Managers should take into account the factors described in the table below when
determining the appropriate frequency of LST:
Recommended frequency of
LST

Factors which may increase
the frequency of regular LST•

Quarterly, unless a higher or lower frequency isjustified by the characteristics of the fund. The
justification should be recorded in the LST policy.

••

Higher unit dealing frequency.
Increased risks emanating from liabilities, such as aconcentrated investor base.
Complex investment strategy (e.g. extensive use ofderivatives).
Less liquid asset base.
Forthcoming event which could negatively affectfund liquidity.

•
•
•

35

Factors which may decrease
the frequency of regular LST

Recommended employmentof ad-hoc LST••

A highly liquid asset base.
Less frequent dealing in the fund’s units.

•

Ad-hoc LST should be undertaken as soon aspracticable if a material risk to fund liquidity isidentified by the manager and requires being
addressed in a timely manner.

V.1.6 The use of LST outcomes
28. LST should provide outcomes which:a. help ensure the fund is sufficiently liquid, as required by applicable rules
and redemption terms stipulated in fund documentation;b. strengthen the manager’s ability to manage fund liquidity in the bestinterests of investors, including in planning for periods of heightened
liquidity risk;c. help identify potential liquidity weaknesses of an investment strategy andassist in investment decision-making; andd. assist risk management monitoring and decision-making, including
setting relevant internal limits by the manager regarding fund liquidity as
an additional risk management tool. This may include ensuring the resultsof LST can be measured through a comparable metric, such as a key risk
indicator.
29. LST should assist a manager in preparing a fund for a crisis, and in its broader
contingency planning. This contingency planning may involve a manager’s plansto operationalise applying ex post a-LMT to a fund.

V.1.7 Adapting the LST to each fund
30. LST should be adapted appropriately to each fund, including by adapting:a. the frequency of LST;b. the types and severity of scenarios to employ to create stressed
conditions, which should always be sufficiently severe but plausible andshould be based on the liquidity risks arising from the assets andliabilities of the fund’s balance sheet as well as its overall liquidity profile;c. the assumptions regarding investor
redemptions) and asset liquidation;

behaviour(gross

and

net

36

d. the complexity of the LST model, which should account for the complexityof the fund’s investment strategy, portfolio composition, LMT and use of
efficient portfolio management techniques; ande. in the case of an ETF, the specificities of ETFs, for example, by taking into
account the role of authorised participants, redemption models andreplication models.

V.1.8 LST scenarios
31. LST should employ hypothetical and historical scenarios and, whereappropriate, RST. LST should not overly rely on historical data, particularly as
future stresses may differ from previous ones.
32. Historical scenarios for LST could include the global financial crisis 2008-2010 or theEuropean debt crisis 2010-2012. Hypothetical scenarios could include rising interest
rates, credit spread widening, or political events.
33. Managers using RST should simulate assets being liquidated in a way that reflects how
the manager would liquidate assets during a period of exceptional market stress. RST
should take into account the treatment of remaining, as well as redeeming, unitholders
as well as the role of transaction costs and whether or not fire sale prices would be
accepted.
34. Funds that engage in investment strategies exposing them to low-probability risks witha potentially high impact should pay particular regard to the use of RST to assess theconsequences of an extreme market event for their liquidity profile.
35. RST can be used to establish whether action needs to be taken to ensure the fund isadequately liquid or whether such a circumstance would be exceptional enough toenable suspension to be imposed in compliance with applicable rules. In the case of
UCITS, the ‘exceptional circumstances’ are those within the meaning of Article 84(2) of
the UCITS Directive, applicable national rules and the fund’s prospectus or fund rules.
36. An AIF may also use RST to simulate the level of assets that may be liquidated before
implementing ‘special arrangements’ allowed by its redemption policy and nationalrules.23

V.1.9 Data availability
37. LST should demonstrate a manager is able to overcome limitations related to theavailability of data, including by:
a. avoiding optimistic assumptions;23

Recital 59 of AIFMD Level 2 Regulation (EU) No 231/2013.

37

b. justifying reliance on third parties’ LST models, including where themodel is developed by a third party portfolio manager; andc. exercising expert qualitative judgement.
38. In particular, managers should adapt their approach where data is limited and any
assumptions used should be adequately reviewed.
39. Appropriate reductions in asset liquidity should be simulated in times of both normal
and stressed market conditions, particularly where historical data does not provide
sufficiently severe examples of stressed conditions. It should not be assumed that theportfolio can be liquidated at the full average daily traded volume of an asset unlesssuch an assumption can be justified based on empirical evidence.

V.1.10 Product development
40. During product development, a manager of a fund which requires authorisationfrom an NCA should:
a. be able to demonstrate to NCA that key elements of the fund, including its
strategy and dealing frequency enable it to remain sufficiently liquid
during normal and stressed circumstances; andb. where appropriate, undertake LST on the asset side (using a model
portfolio) as well as on the liability side, incorporating the expected
investor profile both from the early and late stages of the fund’s existence.
41. LST can also be used at fund launch to help identify factors material to the future risk
management of the fund. For example: quantifying the sensitivity of the fund’s liquidity
risk; identifying factors impacting liquidity risk; identifying metrics/key risk indicators tomonitor liquidity risk going forward; the frequency of risk management; and assessmentof any potential ex post a-LMT or special arrangements to be included in the prospectus
or fund rules.

V.1.11 Stress testing fund assets to determine the effect onfund liquidity
42. LST should enable a manager to assess not only the time and/or cost to liquidate
assets in a portfolio, but also whether such an activity would be permissible
taking into account:a. the objectives and investment policy of the fund;b. the obligation to manage the fund in the interests of investors;c. any applicable obligation to liquidate assets at limited cost; and38

d. the obligation to maintain the risk profile of the fund following liquidationof a portion of its assets.
43. Liquidation cost and time to liquidity are the two principal approaches typically
employed by managers to simulate asset liquidity under normal and stressed
conditions. Managers should apply the appropriate method for the individual fund.
Other approaches may be adopted to the fund.
44. Liquidation cost depends on asset type, liquidation horizon and the size of the
trade/order. Managers should consider these three factors when assessing liquidation
cost of their assets under normal and stressed conditions.
45. Managers should reflect a significant number and variety of market stresses in theestimation of the liquidation cost and time to liquidation under stressed conditions,which are typically characterised by higher volatility, lower liquidity (e.g. higher bid-ask
spread) and longer time to liquidate (depending on asset class). In this context,
managers should not only refer to historical observations of stressed markets.
46. A manager should choose the method of liquidating assets in LST taking into accountthe assets and liabilities, as well as the redemption terms of the fund. The manager
should also be aware of the method’s limitations and make conservative adjustments
to its broader liquidity risk management to mitigate these limitations.
47. The method of liquidating assets in an LST should:
a. reflect how a manager would liquidate assets during normal and stressed
conditions in accordance with applicable rules, either legal requirements(according to the UCITS Directive), or limitations specific to the fund that are
imposed in the prospectus or fund rules;
b. ensure the model used for the fund is and stays in compliance with its objectives
and investment policy and fund rules;
c. reflect the fund being managed in the interests of all investors, both thoseredeeming and remaining;d. comply with applicable obligations for the fund to maintain the risk profile
envisaged by fund documentation;e. be reflected in the LST policy;f.

take into account, where relevant, the potential negative effects on otherinvestors or on overall market integrity.

48.
Managers should pay particular regard to low probability, high impact scenarios,
including the potential difficulty of reliably pricing less liquid assets during a period ofmarket stress.

39V.1.12 Stress testing fund liabilities to determine the effect onfund liquidity
49. LST should incorporate scenarios relating to the liabilities of the fund, including
both redemptions and other potential sources of risk to liquidity emanating fromthe liability side of the fund balance sheet.
50. LST should incorporate risk factors related to investor type and concentrationaccording to the nature, scale and complexity of the fund.
51. Redemption requests are the most common and typically most important source ofliquidity risk for investment funds. Additionally, different types of liabilities on a fund’sbalance sheet and their potential impact on fund liquidity varies according to the fund.
Special arrangements or a-LMTs could also be considered when managing liability risk.
52. For normal conditions, managers could monitor the historical outflows (average andtrends over time), average redemptions of peer funds and information from any
distribution network regarding forecast redemptions. Managers should ensure that thetime series is long enough to fairly reflect ‘normal’ conditions.
53. For stressed conditions, example scenarios are historical trends, historical events,
contemporary trends in peer funds, hypothetical/event-driven scenarios and reverse
stress testing.
54. Depending on the availability of granular historical data covering redemptions for each
investor type and other information relative to a fund’s specific distribution, managers
could also simulate redemption requests for different types of investors.
55. The manager should take into account the extent to which variables arising fromadditional factors such as investor behaviour can or should be incorporated into theirscenarios in the LST model. The decision on the granularity, depth of analysis and useof data is subject to necessity and proportionality. Managers should understand thepotential risks associated with the fund’s investor base and be able to demonstrate thatthose risks play a material factor in the ongoing liquidity risk management of a fund.
56. The table below provides examples of factors regarding investor behaviour which may
be incorporated into the LST model:
FactorExamples of potential liquidity risk

Examplesofpotential
incorporation into LST

Investor
category

Redemption risk may vary by type ofinvestor. For example, the likelihood ofredeeming during stressed conditions
could be categorised according towhether investors are wealth managers,

Based on the manager’s
knowledge and experience of
their clients, the LST model
may simulate, for example,
funds of funds posing more
redemption risk than other40

pension schemes, direct retail investors, types of investors, andor other UCITS or AIFs.
simulate their withdrawal fromthe fund first

Investor
One or more investors may own aconcentration materially larger proportion of the fundthan others, leading to a particular risk tofund liquidity from the investor(s)redeeming.

The manager may model one
or a number of the largest
investors
redeeming
simultaneously from the fundover a given period of time24.

Investor
location

Investors located in different regions orcountries may pose distinct redemption
risk due to idiosyncratic factors linked tothe political, economic or other factors
relating to their location. For example,
investors in a region subject to different
monetary policy may pose distinct
redemption risks during periods ofchanges in FX and/or interest rates.
Political and/or economic risks may also
lead investors in other regions orcountries to redeem.

The manager may simulate amaterial
proportionofinvestors located in a specificcountry redeeming over agiven time period first.

Investor
strategy

Whilst many investors’ strategies are
long-term and, in any case, challenging to
unpick, some investors follow formulaic or
pre-defined strategies that may pose
particular redemption risk in changing
market conditions. For example, somefunds explicitly seek to target a level ofrisk, as measured by volatility, and are
identifiable as such via their fund names
and stated investment objectives. Suchfunds often seek to de-risk during volatile
periods and may pose heightened
redemption risk during periods of volatility
in given asset classes. Where funds withformulaic or pre-defined strategies areinvestors, the manager may need to pay
due regard to the liquidity risk such funds

The manager may simulate
redemptions from investors
following similar strategies instressed and normal market
conditions.

24

This exercise may have limited utility where the fund has only one institutional investor that cooperates with the manager
concerning intentions to subscribe and redeem units.

41

pose during stressed and normal market
conditions.

V.1.13 LST on other types of liabilities
57. A manager should include other types of liabilities in its LST in normal andstressed conditions, where appropriate. All relevant items on the liability side of
the fund’s balance sheet, including items other than redemptions, should be
subject to LST.
58. Net redemptions may not be the only relevant risk to liquidity coming from the liability
side of a fund’s balance sheet and which therefore should be subject to LST. In somecases, LST should determine the circumstances in which liquidity risk cannot be
mitigated, for example a level of margin calls the fund would not be able to fund.
Contingency planning should adequately reflect this and help to mitigate the liquidity
risk in such circumstances.
59. The table below provides examples of factors which may affect liquidity risk:
Liability type

Examples of factors which may
affect liquidity risk

Potential events
simulated

which

may

be

Derivatives

Changes in the value of theunderlying may lead to derivative
margincalls,
affectingtheavailable liquidity of the fundSimulation of a change in thevalue of the underlying of thederivative leading to a larger
than anticipated margin callCommitted capitalFunds investing in real or
immovable assets are often
required to commit capital toservice the investment, such as
maintenance or refurbishment
costs

Simulation of unexpected
event causing new/higher
outlay of capital to a realestate investment

Securities Financing
Transactions/
Efficient
Portfolio
Management

Funds lending out assets are
exposed to the counterparty risk ofthe borrower and the associatedliquidity risk arising from potential
default. Whilst this can be
mitigated by the collateral posted,liquidity risk is not eliminated(bearing in mind the liquidity of thecollateral).

Simulation of default of thecounterparty to a securities
lending operation. Simulationof
cash
collateralreinvestment risk

42

Interest/credit
payments

Funds which incorporate leverage Simulationofincreased
into their investment strategy are interest rates on the payment
subject to liquidity risk arising from obligations of the fundfactors such as interest ratesensitivity

V.1.14 Funds investing in less liquid assets
60. Risks arising from less liquid assets and liabilities risks should be reflected in
the LST.
61. Many funds invested in less liquid assets have distinct risks emanating from both assets
and liabilities, compared to funds investing in more liquid securities. For example, many
AIFs investing in real estate have less frequent dealing periods and notice periods
which reduce liabilities risk from redemptions. However, such funds are also exposed
to distinct liabilities risk arising from servicing and maintaining real estate assets(including hard to simulate risks such as legal risks).
62. Furthermore, funds investing in less liquid assets have inherently less flexibility to
improve overall liquidity by selling assets at a limited discount during periods ofstressed market conditions. Therefore, the outputs from LST by managers of less liquid
assets may have some distinctive features.
63. Low probability, but high impact scenarios, including the potential difficulty of reliably
pricing less liquid assets during a period of market stress, will be important in respectof less liquid assets. Those assets may be particularly vulnerable to an absence ofliquidity in times of market stress, affecting time to liquidity, liquidation cost, and also
whether or not assets would be liquidated at all when taking investors’ best interests
into consideration. RST may be a particularly valuable tool in this context, helping to
identify scenarios which could lead to significant fund liquidity risk (e.g. identifying
scenarios which would lead to the imposition of special arrangements or suspensions).
64. The nature of a less liquid asset base can place even more emphasis on the importanceof managers ensuring that investors are treated impartially during stressed market
conditions. LST could therefore help a manager to establish a governance framework
seeking to support fair outcomes for all investors, by helping to model a fair method ofliquidating assets.
65. One way in which a manager could consider the liquidity of the fund is to prioritise
undertaking ad-hoc LST on funds investing in less liquid assets where a forthcoming
event has been identified which could negatively impact fund liquidity. Thus, managers
should pay particular regard to the appropriateness of the frequency of LST in funds
investing in less liquid assets.
66. FoFs which gain indirect exposure to less liquid assets via their target funds should pay
due regard to considerations relating to less liquid assets. This is because the43underlying exposure of those target funds may lead to the suspension of the target
investment vehicle or other measures. This may have an impact on the FoFs so its LST
model should take this risk into account.

V.1.15 Combined asset and liability LST
67. After separately stress testing the assets and the liabilities of the fund balance
sheet, the manager should combine the results of the LST appropriately todetermine the overall effect on fund liquidity.
68. Combined asset and liability LST can assist in the assessment of which funds present
the largest liquidity risk at a given moment, considering liquidity risk on both the assets
and liabilities sides. This can have a material role in a manager’s contingency planning
for a crisis, such as in the planning for the impact of crystallised liquidity risk in one ormore funds at firm-level.25
69. Managers should incorporate risk scoring into the LST where it enables an enhanced
view of liquidity across the funds they manage, including in contingency planning andthe operational preparation for a liquidity crisis.
70. An outcome of combined asset and liability LST may be a comparable metric or score,for example based on the RCR. The manager’s chosen approach should be explainedand documented in the LST policy, particularly if it does not require the assessment of
the time and/or cost to liquidate assets in a portfolio as outlined in paragraph 42. Where
one fund operated by the manager can be compared to another using such a metric, it
can be a meaningful risk indicator for senior management.26
71. In cases where fund scores/metrics change materially in a given timeframe, combined
asset and liability LST can assist in the set-up of an alert system to assess whether
action on a fund’s liquidity is required.

V.1.16 Aggregating LST across funds
72. A manager should aggregate LST across funds under its management where it
assesses such an activity to be appropriate for those funds.
73. Aggregating LST across funds involves utilising the same liquidity stress test on morethan one fund with similar strategies or exposures. It may be useful when considering
the ability of a less liquid market to absorb asset sales were they to occur concurrently
in funds operated by the manager. This may be particularly pertinent when funds
operated by the manager own a material level of assets in a given market. Aggregationof LST may allow the manager to better ascertain the liquidation cost or time to liquidity

25

ESRB/2017/6 page 31
For more information, see Guide to the use of stress tests as part of risk management within asset management companies,
AMF, page 18 and Liquidity stress testing in German asset management companies, BaFin, pages 29-31.
2644

of each security, by considering the trade size, stressed market conditions andcounterparty risk.

V.2 Guidelines applicable to depositaries
74. A depositary should set up appropriate verification procedures to check that the
manager of a fund has in place documented procedures for its LST programme.
75. The verification does not require the depositary to assess the adequacy of the LST. For
example, one way of verifying that LST is in place and carried out is to confirm that the
UCITS RMP or AIF RMP provides for the manager to carry out LST on the fund.
76. Under both the UCITS Directive and the AIFMD, depositaries are required to implement
procedures to verify that the fund is acting in compliance with obligations under those
Directives.27
77. Where the depositary is not satisfied that LST is in place, it should take action as per
any other evidence of a potential breach of rules by a manager. Depending on thenational regime, this may require a depositary to inform (or require a manager to inform)
the applicable NCA of the manager’s failure to comply with applicable rules.
78. The depositary does not need to replicate or challenge the LST undertaken by amanager.

V.3 Interaction with National Competent Authorities
79. NCAs may at their discretion request submission of a manager’s LST to help
demonstrate that a fund will be likely to comply with applicable rules, including
regarding the ability of the fund to meet redemption requests in normal and stressed
conditions.
80. Furthermore, managers should notify NCAs of material risks and actions taken toaddress them.
81. NCAs may at their discretion request managers to notify them of other information
relating to the LST, including liquidity stress test models and their results. This may beparticularly the case during a period of large redemptions across the market.

27

In the case of UCITS, under Article 3(2) of Commission Delegated Regulation (EU) 2016/438. In the case of AIFMD, under
Article 95 of Commission Delegated Regulation (EU) 231/201345