With redemption waves, tough market conditions and high interest rates, the last year tested especially the resilience of real estate funds in the Finnish market. Highlighting the importance of a robust liquidity management, it remains one of the top priorities this year in fund management.
As the market continues its recovery and we eagerly await pending interest rate cuts, here are some valuable insights on effective liquidity management. These insights draw from the recent recommendations by the regulator, market news, our extensive experience in client engagements and the upcoming AIFMD II regulation.
In late 2023, the FIN-FSA published a comprehensive thematic review focusing on liquidity stress tests for alternative investment funds, particularly those investing in real estate.
Here are the key highlights from the report that we believe are crucial for fund managers to consider:
- Fund management companies are mandated to establish robust arrangements for liquidity management, aligning the investment strategy, liquidity profile, and redemption policy of the fund.
- Stress tests should be conducted regularly, considering factors such as the fund’s investment strategy, liquidity profile, investor type, and redemption policy. Quarterly or more frequent tests are recommended, tailored to each fund’s characteristics.
- Transparent reporting of stress test results to the board of directors and senior management is essential for effective risk management, including proposed actions in case of breaches of set limits.
- Consideration of liquidation costs, the time required for liquidation, market risks, and the potential impact of declining property values on fund liquidity are also essential in stress test scenarios. It is essential to classify fund’s assets based on liquidity.
- Liquidity buffer: Last, but not least, the FIN-FSA recommends that real estate funds should allocate certain portions of the fund’s investments into assets with a shorter liquidation period than the notice period for redeeming the unit. According to the FIN-FSA, a share of less than 10 % of the fund’s GAV can easily lead to problems.
Our recommendations:
- We advise fund managers to prepare their liquidity management and stress testing policies in accordance with relevant regulations and guidelines. The key in effective liquidity management lies in aligning investment strategies, liquidity profiles, and redemption policies, forming the foundation for resilience in the face of market uncertainties.
- In light of the unpredictable future market conditions, we recommend fund managers to explore and familiarize themselves with all liquidity management tools outlined in the AIFMD II text – different tools may be suitable for varying scenarios. However, given that the Commission has not yet adopted regulatory technical standards (RTS) to specify the characteristics of the liquidity management tools, the actual implementation of the upcoming liquidity management regulation is not timely until next year.
- We emphasize the importance of ongoing assessment and adjustment of stress testing policies to adapt to evolving market conditions and regulatory requirements.
- We recommend fund managers to assess their current operational structures and reporting channels to ensure they are generating accurate and sufficient information to meet the requirements of an effective and reliable liquidity management.
In conclusion, adherence to the FIN-FSA’s guidance ensures more effective liquidity management, essential for real estate funds to withstand various market conditions.