Risk Liquidity and Capital Management

What is Liquidity Risk?

Liquidity generally describes the ability to pay debts when they are due. If you can’t raise enough cash to pay your bills, regardless of the assets you own, you will become insolvent. In the context of investment funds, liquidity is generally seen as the ability to fulfill redemption orders when requested.

Mutual funds can face a mismatch between the assets they own and the demand of investors to redeem their capital. The majority of Undertakings for the Collective Investment in Transferable Securities (UCITS) funds offer their shareholders the ability to subscribe or redeem their capital daily.  If the assets held within the fund cannot be sold quickly to meet redemption requests, there could be severe issues in paying redeeming investors.  This can be exacerbated in times of stress when investors may look to redeem en masse whilst the market for the assets is drying up.

Canj and Company, LLC  has formulated Sound Practices for Managing Liquidity in Financial Organizations. 

Principles for Sound Liquidity Risk Management and Supervision has been significantly expanded in a number of key areas.  In particular, more detailed guidance is provided regarding:

The importance of establishing a liquidity risk tolerance

The maintenance of an adequate level of liquidity, including through a cushion of

liquid assets

The necessity of allocating liquidity costs, benefits and risks to all significant business

activities

The identification and measurement of the full range of liquidity risks, including

contingent liquidity risks

The design and use of severe stress test scenarios

The need for a robust and operational contingency funding plan

The management of intraday liquidity risk and collateral

Public disclosure in promoting market discipline