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What you need to know
The European Securities and Markets Authority (ESMA) has introduced new guidelines that require UCITS and AIFMs to take a much more practical and fund-specific approach to choosing Liquidity Management Tools (LMTs). The aim is simple: improve how funds manage liquidity risks and reduce the chances of market disruption, especially during periods of stress.
If you’re a fund manager or risk professional, here’s the key message: picking your LMTs means carefully assessing your fund’s characteristics, liquidity stress testing results and other metrics before deciding which tools to apply.
Step 1. Know the required types of LMTs
- One quantitative-based LMT, such as:
- Redemption gates – Limit how much investors can redeem during a certain period.
- Extension of notice periods – Require investors to tell you earlier (“give more notice”) if they want to take their money out.
- Suspension – Temporarily stop new investments (subscriptions), paying out investors who want to leave (redemptions) or buying back fund units (repurchases).
- Redemption in Kind (RiK) – Investors are paid in underlying assets instead of cash. Often used in real estate or private equity funds.
- One Anti-Dilution Tool (ADT), designed to protect existing investors from the negative effects of others entering or exiting the fund, such as:
- Redemption fees – A charge for exiting the fund, often used to discourage short-term trades.
- Swing pricing – Adjusts the NAV depending on cash flows, so costs the costs are paid by the investors who are buying or selling.
- Dual pricing – Uses two different prices: a higher price (offer price) for investors entering the fund, and a lower price (bid price) for those exiting, based on dealing costs.
- Anti-Dilution Levy (ADL) – A one-time charge added when investors enter or exit the fund. It’s different from a redemption fee because the amount stays in the fund to cover trading costs and protect existing investors from dilution.
- Side pockets – Illiquid assets are set aside in a separate portion of the fund, so they don’t affect daily liquidity. Useful when certain assets become untradeable or are impacted by sanctions, defaults, etc.
The idea is that LMTs are not just emergency brakes, but everyday steering mechanisms. They help funds operate smoothly during redemptions, investor inflows or changes in market conditions. Choosing the right combination of LMTs can reduce forced selling and protect remaining investors.
Step 2. Analyse your fund in detail
ESMA wants fund managers to choose LMTs based on a good understanding of their fund. The tools should work well in both normal and stressed market conditions. To make strong and reliable choices, managers need to think about many different situations. According to ESMA, at least the following factors must be considered:
- Legal Structure – For example, ETFs and master-feeder structures may have limits on which LMTs can work in practice.
- Investment Strategy – A fund investing in liquid equities has different needs than one focused on private markets. Liquidity management should reflect the nature and volatility of the assets.
- Dealing Terms – This includes redemption frequency, notice periods, lock-ups and settlement timelines. A fund with daily dealing might need a different toolkit than a fund that only allows redemptions monthly.
- Liquidity of Assets – How easily can your fund sell its assets if many investors want to exit at the same time? This is a key part of understanding your fund’s liquidity profile. Large or sudden redemptions can create serious pressure, especially if the assets are hard to sell quickly. You should also consider how other cash demands, like margin calls, could add to this pressure. And importantly, think about how activating LMTs might affect your fund’s ability to meet these outflows during both normal and stressed market conditions.
- Liquidity Stress Testing Results – These should already be part of your existing regulatory setup under AIFMD or UCITS. Refer to the ESMA Guidelines on Liquidity Stress Testing (LST) for further direction. The new LMT guidelines build on that foundation, asking you to link LST outcomes directly to your LMT setup.
- Investor Base – Are your investors mainly retail or institutional? These groups behave differently under stress — institutional investors may redeem large amounts in one go, while retail flows can be more erratic. Also consider concentration risk: if a small number of investors hold a large share of the fund, even a few redemptions could create significant liquidity pressure.
- Distribution Policy – Does your fund regularly pay out dividends? That can create added liquidity strain, especially in tight markets.
- Operational Barriers – Some LMTs may be technically hard to implement depending on your systems or service providers. A good idea on paper might not be feasible in practice.
💡 Did you know? Liquidity Stress Testing (LST) has already been a regulatory requirement under the ESMA Guidelines on Liquidity Stress Testing (LST)
These new LMT guidelines shine an even brighter light on LST, making it a mandatory input for selecting and calibrating liquidity management tools. It reinforces the importance of having a robust and fund-specific stress testing framework in place.
At Amsshare, we support fund managers in designing and implementing LST processes that meet ESMA’s expectations, and we help build on that foundation to select and calibrate LMTs under the latests guidance.
Step 3. Match LMTs to your fund's needs
Here’s how different elements of your analysis should inform your decisions:
- Dealing terms: If your fund offers daily redemptions, you may need tools that can activate quickly and frequently, like swing pricing or anti-dilution levies. For monthly or quarterly dealing, tools like notice periods or gates might be more appropriate.
- Liquidity of assets: If your portfolio includes hard-to-sell positions — for example, private credit, real estate or small caps — you’ll likely need more robust tools, such as redemption in kind or the option to suspend redemptions under stress.
- Liquidity stress testing results: These tests should reveal where your fund is vulnerable. For example, if stress scenarios show high outflow sensitivity, that might justify calibrating redemption gates or extending notice periods. The logic behind this connection should be clearly documented.
Each tool you choose, and how you set its parameters, should connect back to your analysis. Even when a decision seems obvious or aligns with market practice, it still needs to be backed up with evidence. That’s the essence of good risk management: not just highlighting where things could go wrong, but also showing why the risks are well understood and controlled.
Step 4. Define when to activate the tools
- Setting thresholds from your stress tests
- Monitoring daily or weekly flow data
- Having escalation procedures in place
Defining activation thresholds in advance helps reduce confusion and protects fund governance during stressful situations. It’s also helpful to run internal simulations to test readiness. Should swing pricing kick in at 1% of AUM outflow? Should a gate apply at 10%? These decisions must be justified and periodically reviewed. Sometimes, combining tools makes more sense, like using both swing pricing and redemption gates during periods of heavy outflows.
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