In brief
Liquidity events do not become problematic simply because investors seek redemptions. They become problematic when a fund lacks an effective framework for managing redemption activity during periods of market stress. While severe market disruptions and liquidity crises cannot always be anticipated or prevented, a well‑designed liquidity management framework can provide fund managers with the tools and flexibility needed to navigate challenging market conditions. Although the deployment of liquidity management tools is sometimes portrayed negatively, the use of those tools may instead demonstrate that the fund’s risk management framework is functioning as intended and that fund managers are engaging in prudent risk management to protect both redeeming and remaining investors.
Periods of market volatility inevitably test those arrangements. While redemption pressure is often viewed as an operational issue, its consequences extend far beyond fund administration. Forced asset sales, valuation pressures, unequal outcomes among investors and erosion of investor confidence can affect both redeeming and remaining investors, potentially impairing the long-term stability of the fund.
A robust liquidity management framework should combine carefully drafted constituting documents, clearly articulated liquidity management policies and effective governance processes. Together, these elements establish the mechanisms through which redemption activity is managed.
Fund managers should therefore periodically review their liquidity management framework to ensure that their constituting documents, policies and governance processes remain aligned with the fund’s investment strategy, liquidity profile and evolving market conditions.
An effective liquidity management framework should not rely on a single mechanism. Rather, it should incorporate a range of complementary tools designed to manage redemption activity in an orderly and transparent manner. While Canadian securities regulators have published guidance touching on liquidity risk management and related governance practices, as described below, Canada does not have a dedicated statutory or regulatory regime prescribing the liquidity management tools that private investment funds must adopt. As a result, many investor-facing liquidity rights and restrictions are established contractually through the fund’s constituting documents rather than by legislation. The key components of a liquidity management framework therefore fall into two categories: constituting document provisions, which establish the contractual rights and obligations applicable to investors, and governance policies and procedures, which are more internal in nature and support the implementation of those provisions.
Download the full alert of International: Building an Effective Fund Liquidity Management Framework