The FCA has set out key areas that investment firms must focus on after it was instructed to assess risks posed by open-ended funds investing in the fixed income sector.

The regulator has today published material to show good practice in the sector.

The FCA has been working with the Bank of England, at the request of the Financial Policy Committee.

The FCA said it engaged with a number of large investment management firms to understand how they manage liquidity in their funds.

The FCA highlighted the following key points for firms in the investment fund management sector to address:

1. Tools, processes and underlying assumptions – these require continuous re-assessment and updating to ensure they remain suitable for market conditions.

2. Operational preparedness – a high degree of reassurance that tools, particularly extraordinary measures, can be implemented smoothly when required.

3. Disclosure – clear and full disclosure to fund investors on liquidity risks and the tools available to the fund to manage those risks, such as swing pricing, deferred redemption and suspension.

The FCA report stated: “Current market conditions make it particularly timely to reassess liquidity management. Our description of the good practices we have observed at leading investment management firms may help firms to improve their own liquidity management.”

Good practices contributing to strong management of liquidity risk identified by FCA officials in their review included:

• Processes to ensure that the fund dealing (subscriptions and redemptions) arrangements are appropriate for the investment strategy of the fund.

• A regular assessment of liquidity demands. This assessment includes, but is not limited to, the development of a range of potential redemption scenarios and risks, on the basis of an analysis of the composition of fund investors; the historic pattern of net fund flows; and other factors, such as the experience of similar funds.

• An ongoing assessment of the liquidity of portfolio positions.

• The use of liquidity buckets. These buckets indicate whether the liquidity of the securities is ‘high’, ‘medium’ or ‘low’. Limits are then applied, indicating the allowed ranges of total portfolio exposure to each bucket. These limits are adjusted over time to take into account changes in market conditions.

• An independent risk function that monitors portfolio bucket exposures regularly and reports breaches to the set limits.

• Stress testing used by fund managers to assess the impact of extreme but plausible scenarios on their funds. This tool supplements other elements of the liquidity risk management process.