For fund management companies in Singapore, liquidity risk refers to the risk that the Fund vehicles they manage may not have sufficient cash or liquid assets to meet obligations when they arise and it represents a key challenge to financial stability, investor protection and the seamless operation of funds. As global financial markets become increasingly complex and interconnected, managing liquidity risk requires a more sophisticated and proactive approach.
According to a study on liquidity risk management, fund management companies must regularly check their liquidity and create strategies to keep adequate liquid reserves. Fund management companies should consider adopting the standards and best practices issued by the International Organisation of Securities Commissions, alongside the MAS’ Guidelines on Liquidity Risk Management Practices for Fund Management Companies (Guideline). Enhancing liquidity risk management practices is critical and fund management companies should focus on certain key areas.
- Conduct Comprehensive and Dynamic Liquidity Gap Analysis
Liquidity gap analyses should be an ongoing, adaptive process that involves regularly evaluating mismatches between expected cash inflows and outflows across multiple time horizons. This evaluation must encompass a wide range of factors, such as expected fund redemptions, projected investment income, operational costs and potential market changes. To anticipate and mitigate risks, companies should incorporate multi-layered stress testing and scenario analysis, simulating both predictable and unexpected events, including extreme market volatility, sudden shifts in investor sentiment, regulatory changes, geopolitical events, global financial crisis, Covid-19 and economic downturns.
In addition to traditional stress scenarios, companies should identify circumstances under which liquidity buffers could become inadequate, to pre-emptively develop mitigation strategies.
- Maintain Robust and Flexible Liquidity Buffers
Liquidity buffers are essential safeguards against significant redemptions and their adequacy must be evaluated based on a comprehensive assessment of the fund’s size, investment strategy, underlying assets, investor profile and broader market conditions. Liquidity reserves should be dynamically managed with the ability to quickly adjust levels in response to real-time market developments or changes in investor behavior. This approach may include the adoption of liquidity risk management tools, allowing for early warning signals when liquidity thresholds approach critical levels. As highlighted in the Investopedia article on liquidity risk, developing contingency funding plans is vital for organisations to ensure they can access liquidity during crisis.
Moreover, firms should consider tiered liquidity buffer structures, wherein a portion of the buffer is dedicated to high-probability events, while additional reserves are allocated to more severe or low-probability scenarios. These reserves should consist of high-quality, liquid assets that can be easily converted to cash without significant loss in value.
- Enhance Strategic Diversification and Asset Allocation
Strategic diversification should not only address the allocation of assets across different classes and regions but also consider the liquidity profiles of specific investments. Companies must evaluate the liquidity characteristics of each asset, such as daily trading volumes, bid-offer spreads and market depth to avoid concentrating holdings in assets that may become illiquid under heightened market volatility/stress. Diversification should also extend to investment time horizons, staggering maturities to ensure a continuous stream of liquid assets becomes available over time.
Where appropriate, fund managers can utilise liquidity tranching, creating different tiers of the portfolio based on asset liquidity to better manage redemptions and maintain flexibility during periods of heightened market volatility/stress. Active rebalancing strategies should be employed to continually optimise the portfolio’s liquidity profile. Therefore, fund management companies must prioritise effective liquidity management to avoid high-interest borrowing or forced asset sales during financial distress, as highlighted in the RisingWave blog on liquidity management tools.
- Integrate Advanced Liquidity Management Tools and Analytics
Incorporating state-of-the-art liquidity management tools, such as artificial intelligence and machine learning models, can significantly enhance the predictive accuracy of liquidity forecasting and stress testing. These technologies enable the identification of liquidity trends, early detection of stress signals, and forecasting of investor behaviors with higher precision. Advanced analytics can also facilitate real-time monitoring of liquidity metrics like the liquidity coverage ratio allowing for more dynamic risk management.
Companies should also develop robust contingency funding plans, which detail specific actions to be taken under different stress conditions. These plans should be regularly tested and updated to reflect changes in the market environment to ensure the availability of alternative funding sources during periods of heightened market volatility/stress.
- Stay Ahead of Regulatory Requirements and Industry Best Practices
Adherence to the Guidelines is the baseline for effective liquidity risk management, but leading firms should strive to go beyond just compliance. Staying informed about the latest regulatory developments and industry best practices allows companies to anticipate changes and adapt their strategies accordingly. Proactive engagement with regulators and participation in industry working groups can provide insights into future trends and emerging risks.
Moreover, companies should consider voluntary alignment with MAS guidance, supervisory expectations and observations, which can serve as benchmarks for internal practices.
- Elevate Staff Competence Through Ongoing Training and Knowledge Development
An effective liquidity risk management framework depends on highly skilled and knowledgeable personnel. Fund management companies should invest in continuous professional development programs for their staff, covering the latest liquidity risk management techniques, regulatory updates, and analytical tools. Staff should also be encouraged to participate in cross-disciplinary training, combining expertise in finance, risk management, data science and technology to broaden their skills and improve decision-making capabilities.
Creating a culture where liquidity risk awareness is embedded across the relevant levels of the organisation ensures that teams remain vigilant and responsive to potential risks.
- Strengthen Governance Frameworks and Oversight Mechanisms
Strong governance structures and oversight mechanisms are vital for effective liquidity risk management. The board and senior management should actively set the firm’s risk appetite, define liquidity risk limits and oversee the implementation of liquidity management policies. There should be a clear governance framework detailing the roles and responsibilities of all stakeholders involved in liquidity risk management.
To enhance accountability, firms can establish liquidity risk committees that report regularly to senior management and the board on liquidity conditions, stress testing outcomes and adherence to risk limits. This structured approach ensures that liquidity risk management remains a core focus of strategic decision-making.
- Leverage Technology While Managing Associated Risks
Technological advancements can transform liquidity risk management by improving efficiency, accuracy and agility. Fund managers should use automation for routine monitoring of tasks, data analytics for deeper insights and blockchain technology for transparent and secure reporting. However, technology introduces new risks, such as cybersecurity threats and system failures , which must be addressed through robust cyber risk management programs and contingency planning for technology-related disruptions.
Regular technology audits and stress tests of systems used for liquidity management can help ensure reliability, resilience and compliance with regulatory standards.
- Foster Transparent and Proactive Engagement with Stakeholders
Open and transparent communication with investors, regulators, and other key stakeholders is essential to maintaining confidence, especially during times of heightened market volatility/stress. Fund management companies should provide regular updates on liquidity positions, stress testing outcomes and risk management strategies. Being proactive in disclosing changes in risk factors or liquidity buffers enhances trust and can prevent panic during turbulent periods.
Engaging with industry associations and participating in collaborative initiatives for developing industry-wide liquidity management standards can also yield valuable insights and best practices.
- Monitor, Review and Innovate Continuously
Liquidity risk management is not a static process but requires continuous improvement. Fund management companies should establish a routine schedule for reviewing liquidity risk management practices, incorporating feedback from audits, internal assessments and real-world liquidity events. This approach facilitates the identification of gaps, inefficiencies or emerging threats.
Innovation should also be encouraged, with exploration of new tools, techniques and frameworks such as incorporating behavioral finance insights into liquidity forecasting or using Environmental, Social and Governance (ESG) factors to adjust liquidity management strategies.
By embracing these enhanced liquidity risk management practices, fund management companies in Singapore can better position themselves to navigate uncertain market conditions, protect investor interests and contribute to the stability of the broader financial system. The ability to effectively manage liquidity risks is not only a regulatory requirement but also a competitive advantage that enhances the resilience and long-term sustainability of funds.
What does this mean for you?
Understanding and implementing the Guideline is essential for ensuring your business’s reliability and regulatory compliance.
Curia Regis offers a dedicated team in Singapore to provide invaluable regulatory and compliance support. We can help you understand your liquidity risk management obligations under the Guideline, adapt your existing framework to meet these requirements and develop a tailored compliance solution that considers your specific business model and complexity.
Contact us at [email protected] to know more and follow our LinkedIn page https://uk.linkedin.com/company/curiaregis for updates in the regulatory space.
