First Test of Liquidity Risk Management

February 6, 2020 by Erik Olsen

On January 27, 2020, China announced it was extending its already planned seven calendar day Lunar New Year holiday market closure for three additional calendar days (through February 2); a decision apparently driven by the recent coronavirus outbreak. Mutual funds and exchange-traded funds (collectively, the “Funds”) are expected to prepare for known “extended holiday closures,”1 as part of their liquidity risk management programs. For example, in preparation for the Lunar New Year holiday closure, Funds would have notified their boards of trustees of portfolio holdings whose liquidity classification may be impacted by the closure, the extent to which the Funds’ holding of illiquid investments2 would be anticipated to exceed 15% of net assets, and how the Funds would expect to manage any increased liquidity risk over the closure.

While it is impossible for Funds to predict a last-minute extension event like in the current China scenario, Funds’ should be prepared to amend their current liquidity classification of portfolio securities, monitor the 15% illiquid threshold appropriately, and refactor the potential impact on liquidity risk of the Funds during the course of any market event, including an extension to an already planned extended holiday closure. While it is expected that many Funds may be able to handle a potential liquidity risk in terms of meeting shareholder redemptions based on the overall build and implementation of their liquidity risk management programs, Funds should take use the current China scenario as an opportunity to test their programs.

Funds should generally provide a postmortem to their boards regarding the effects an extended holiday closure had on the Funds’ liquidity risk and holding of illiquid investments. With the current extension instance, Funds may consider a further discussion of how the extension may have impacted the liquidity classification and the Funds’ overall liquidity risk above and beyond what was originally anticipated. Going forward, Funds may consider implementing increased monitoring of market news stories around any previously announced extended market closure, and work with financial counterparties located in-country to inform the Funds of any changes to the closure schedule.

How ACA Can Help

ACA offers compliance consulting services to Funds on the liquidity risk management program rule, along with annual liquidity program assessments and other readiness reviews. To learn more about how ACA can help enhance or strengthen your compliance program, please contact your ACA consultant or Erik Olsen at 240-997-9434.

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Additional Resources

Please visit our Liquidity Risk Management Program Resources page for additional information about the Liquidity Risk Management Program and its requirements for your firm.

About the Author

Erik Olsen is a Managing Director at ACA Compliance Group. He provides ongoing and customized regulatory compliance consulting and compliance program review services to registered investment companies, their investment advisers and sub-advisers, and other service providers. Erik joined ACA in 2012 as a Senior Principal Consultant.

Prior to joining ACA, Erik served as a Securities Compliance Examiner in the U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (Investment Adviser/Investment Company) where he conducted regulatory examinations of registered investment advisers and registered investment companies. He also held positions as a Compliance Director at an investment management company and worked in the Mutual Funds Legal and Accounting Departments at an asset management company.

Erik is a Certified Fraud Examiner. He earned his Bachelor of Business Administration degree in Finance from Loyola College (now Loyola University Maryland).


1 In April 2019, the U.S. Securities and Exchange staff issued a frequently asked question number 34 regarding “extended holiday closures,” or foreign markets having closures of their securities markets that may last seven or more calendar days. In part, the staff stated, “To the extent that investments become illiquid due solely to an extended holiday closure, they are illiquid for a known, temporary duration, and the fund can generally plan its liquidity risk management relating to the market closure in advance. Similarly, such a fund can notify relevant parties in advance, including its board of directors, of investments that will be affected by extended holiday closures and how it expects to manage its liquidity risk during such closures.”

2 Rule 22e-4 under the Investment Company Act of 1940 defines an illiquid investment as an investment that cannot be sold or disposed of in current market conditions in seven calendar days or less without the sale or disposition significantly changing the market value of the investment. Funds may not hold more than 15% of their net assets in illiquid investments.