Liquidity Management Under AIFMD2: RTS for Open-Ended Funds

A predetermined fixed fee that imposes on those redeeming (on an individual basis and to be deducted from amounts paid for the benefit of the fund) the estimated explicit and implicit costs of portfolio transactions caused by redemptions, including any estimated significant market impact of asset sales to meet the redemptions.

To be expressed as a percentage of the redemption orders of investors (can be done as a range with a minimum and maximum percentage).

Fees may vary depending on size of redemption orders, but investors that fall within the same order/level are to bear the same fee.

Most applicable to funds: (i) that invest in assets with fixed/transparent/foreseeable transaction costs (e.g., agency or notary fees); (ii) that are invested in assets that are less liquid and for which other tools such as swing pricing might be challenging to implement due to infrequent and limited pricing sources; (iii) that invest in assets with low-variation transaction costs; and (iv) whose underlying assets do not have very frequent and reliable pricing sources.

AIFM may set activation thresholds that could be expressed as the size of redemption orders above which fees are charged to redeeming investors.

AIFM to calibrate as either a single fee or an adjusted fee that is based on a tiered approach and applies a methodology (that is disclosed in fund docs) that ensures coverage of cost of liquidity and allows for adjustment when required to reflect higher-cost/stressed market conditions.

The purpose of the swing factor (expressed as a percentage of the AIF’s NAV) is to impose on redeeming or subscribing investors the estimated explicit and implicit costs of portfolio transactions caused by redemptions and subscriptions, including any significant market impact of asset purchases of sales to meet them.

When activated, the NAV of the AIF is to be adjusted: AIFM to choose if this is on every dealing day when there is net activity of any size between redemptions or subscriptions (full swing) or when the net redemptions/subscriptions are greater than a predetermined trigger threshold (partial swing). If net capital activity on a given dealing day is more subscriptions, NAV is adjusted upward by the swing factor (and vice versa).

AIFM to choose a single swing or a progressively increasing tiered approach (which accounts for more redemption/subscription activities that generate higher transaction costs when transaction costs increase more rapidly than net capital activity of the AIF). An AIFM can have different swing factors corresponding to different trigger thresholds, but for AIFs with multiple share classes, these should be the same for all investors.

Most applicable for funds whose underlying assets are actively traded/information on trading costs is available and frequently updated (less appropriate if there is valuation uncertainty).

Activation and calibration are dynamic and reflective of market conditions, based on the AIFM’s methodology that is set out in its LMT policy.

AIFM should disclose a maximum swing-pricing factor for normal market conditions that it can recalibrate for stressed conditions, with reference to a clear framework. The activation threshold for swing pricing should not be disclosed in order to avoid first-mover advantage.

AIFM can choose between 2 mechanisms (with the same objective of imposing transaction costs on investors):

(i) calculating one NAV that incorporates assets’ ask prices (for subscribing investors) and another NAV that incorporates assets’ bid prices (for redeeming investors); and (ii) setting an adjustable spread to one NAV, in which assets are priced on a midmarket basis (bid price for redemption and offer price for subscription), with the difference being the ‘spread’ to reflect liquidity costs in prevailing market conditions.

The same calculation method shall apply to all investors.

Most applicable for funds that invest mainly in assets with liquidity costs that consist primarily of the bid-ask spread (less appropriate where there is valuation uncertainty).

Any significant market impact or explicit transaction costs should be accounted for separately by additional adjustment to NAV.

Impose on subscribers and redeemers the estimated explicit and implicit costs of portfolio transactions caused by subscriptions and redemptions, including any estimated significant market impact of asset sales/purchases used to meet them. Charged to those subscribing or redeeming when the number of redemptions exceeds the number of subscriptions (or vice versa), resulting in a change in the net assets or liabilities of the funds.

If net redemptions, anti-dilution levy to be deducted from amount paid to redeeming investors; if net subscriptions, anti-dilution levy is charged to subscribing investors.

AIFM may use a trigger threshold when the levy is applied only if net difference between redemption and suspension orders exceeds the trigger.

AIFM can apply same levy to transacting investors or charge them exact transaction costs resulting from their orders.

Most applicable for funds that invest mainly in assets with market-contingent liquidity costs. In particular for funds with a small number of investors (to address the impact of redemption at short notice); with significant levels of subscription and/or redemption activity that could negatively affect the fund’s existing investors (e.g., smaller funds suffer higher liquidity costs when affected by large redemptions); and funds that invest in assets that are less liquid.

Can be activated on an ongoing or dynamic basis based on predefined thresholds.

Calibrated on same factors as for swing, including all estimated explicit and implicit transaction costs.

AIFM to disclose the reason for applying the levy and how it differs from an exit fee.

AIFM to have flexibility to determine: (i) whether gates are automatically activated when a threshold is exceeded (threshold is predefined as the net redemption orders for a given dealing date in proportion to the NAV of the AIF); or (ii) when threshold exceeded, if all redemption orders are executed in full (if compatible with AIF liquidity structure, applies equally to all investors and interest of non-redeeming investors is preserved).

Therefore, AIFM can activate redemption gates at a higher level than the preset activation threshold but not below it.

Non-executed part of redemption orders should be automatically transferred to the next dealing date (and may have priority over subsequent orders). Investors should have the right to withdraw any unexecuted orders. Fund could still be open for subscriptions. These provisions do not apply to European Long-Term Investment Funds (ELTIFs, which are subject to separate Delegated Regulation; see our client alert for more).

Most applicable for funds with a strongly concentrated investor base and those with illiquid/hard-to-sell assets (or that may become so during stressed market conditions). They may be less suited for valuation issues (when instead an AIFM could consider suspensions of subscriptions, repurchases, and redemptions, together with NAV suspension).

Contrary to suspensions of subscriptions, repurchases, and redemptions, a fund that applies a redemption gate could still be open for subscriptions. A gate’s duration and frequency to be determined by the AIFM on a case-by-case basis.

For funds marketed to retail, activated only in specific circumstances and to be carefully calibrated.

Activation threshold to be disclosed in fund rules/ constitutional docs, and use of gates can be automatic or at the manager’s discretion when the threshold is exceeded.

A time buffer that is added to the normal notice period for redemption orders and should apply equally to all investors/share classes. Can apply to a predefined number of dealing dates.

AIFM cannot accept redemption orders placed after a notice period extension that do not comply with the extension.

Should not affect dealing frequency (if notice period is extended, the dealing frequency should not be modified).

Recommended for funds whose liquidity can deteriorate quickly in times of stress and for AIFs invested in assets that are less liquid.

Should be considered in normal and stressed market conditions and in specific circumstances (e.g., redemption pressures and/or temporary valuation uncertainty).

Timing of announcements of any extensions to be carefully considered to avoid an increase in redemption requests.

Unless solely marketed to professional investors or for AIFs that are EU-regulated exchange-traded funds tracking an index, redemptions in kind can be used only for redemption requests by professional investors and if the redemption corresponds to a pro rata share of the assets held by the AIF.

AIFM to apply the same type of transfer of assets (i.e., pro rata of each asset or not) to all redeeming professional investors in that AIF.

Activated on NAV calculation dates in light of the minimum valuation frequency, at the AIFM’s discretion.

Independent third party to perform an additional valuation of assets in question.

Suspensions of subscriptions to be applied simultaneously/in parallel with suspensions of repurchases and redemptions, on a temporary basis to all investors and accompanied with a plan for the future of the AIF (e.g., reopening the AIF, creating a side pocket, or liquidation of the AIF).

Any unexecuted orders placed before a suspension shall not be executed before the AIF is reopened for subscriptions, repurchases, and redemptions.

Can be applied together with a suspension of the NAV calculation, particularly in the case of uncertain valuation and when it is not possible to compute the fund NAV. In other cases, the AIFM should continue to value the fund assets and publish an NAV.

Manager to formalise a detailed plan as early as possible and ensure activation on a temporary basis (whilst noting that in some cases their use is in anticipation of the AIFM’s decision to liquidate the fund). Guidance includes a nonexhaustive list of elements to include in the plan.

Guidelines also include calibrations criteria (including determining the activation threshold for a suspension, criteria for assessing and monitoring the conditions that prompted it, and determination of when they no longer exist).

Orders treated in strictest confidence, to avoid any investors benefiting from information on the probability that an LMT will be activated.

Side pockets

(other LMT)

AIFM can choose between: (i) physical separation (and any assets with valuation issues or legal uncertainty can be transferred into a new fund or remain in the original AIF); or (ii) accounting segregation (in the case of any valuation issues or legal uncertainty allocated to a dedicated share class of the AIF but otherwise new subscriptions, redemptions, and repurchases executed based on NAV).

In either case, investors to receive interests on a pro rata basis to their AIF holding; side pockets should be closed for subscriptions and redemptions, and managed with the sole purpose of being liquidated.

No reinvestment of cash from asset sales.

AIFM needs operational capacity and governance for efficient use of side pockets; should have a detailed plan (including strategy, relevant costs, expected timeline, contingency planning, and investor communication) that investors are aware of.

Calibration to include determining the activation threshold; criteria for assessing and monitoring conditions that prompted the activation (and for determining when they no longer exist); and for reviewing and potentially revising that decision.