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September 18, 2017 Mr. Shane Worner Senior Economist International Organization of Securities Commissions Calle Oquendo 12 28006 Madrid Spain Submitted via email to: consultation-04-2017@iosco.org; consultation-05-2017@iosco.org Re: Comment on International Organization of Securities Commissions (“IOSCO”)

Collective Investment Scheme (“CIS”) Liquidity Risk Management Recommendations and Open-Ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration

Dear Mr. Worner,

BlackRock, Inc. (together with its affiliates, “BlackRock”)1 is pleased to have the opportunity to respond to the Consultation on CIS Liquidity Risk Management Recommendations (“IOSCO 2017 Recommendations”) to update the March 2013 Principles of Liquidity Risk Management for Collective Investment Schemes (“2013 Liquidity Report”) and the request for public comment on Open-Ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration (“Good Practices Document”).2 As a fiduciary for our clients, BlackRock supports a regulatory regime that increases transparency, protects investors, and facilitates responsible growth of capital markets while preserving consumer choice and assessing benefits versus implementation costs. Liquidity and redemption risk management is an integral part of portfolio management and fund managers have been performing liquidity and redemption risk management for a very long time.3 That said, BlackRock has long been a proponent of “raising the bar” on liquidity risk management (“LRM”) industrywide,4 and we commend the Financial Stability Board (“FSB”) and IOSCO for focusing on fund liquidity risk management (“LRM”).

Effective risk management must be grounded in the practical with an awareness that

things that have never happened before can and do happen. As such, judgment and prudence,

1 BlackRock is one of the world’s leading asset management firms. We manage assets on behalf of institutional and individual

clients worldwide, across equity, fixed income, liquidity, real estate, alternatives, and multi-asset strategies. Our client base includes pension plans, endowments, foundations, charities, official institutions, insurers and other financial institutions, as well as individuals around the world.

2 IOSCO, Consultation on CIS Liquidity Risk Management Recommendations (Jul. 2017), available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD573.pdf (IOSCO 2017 Recommendations); IOSCO, Consultation Report on Open-ended Fund Liquidity and Risk Management – Good Practices and Issues for Consideration (Jul. 2017), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD574.pdf.

3 Since BlackRock’s inception in 1988, we have been measuring and managing liquidity risk, though our practices have evolved over the years, in line with changing market dynamics in various asset classes. See BlackRock, ViewPoint, Addressing Market Liquidity (July 2015), available at http://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-addressing-market-liquidity-july-2015.pdf (“Liquidity ViewPoint”).

4 See Appendix A for a list of publications.

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as well as operational and regulatory flexibility, are required when setting risk management policies and parameters. BlackRock agrees with IOSCO’s principles-based approach to LRM for collective investment schemes (“CIS”, “funds”, “investment funds”). We largely agree with the framework outlined as a baseline for robust LRM. In particular, we are supportive of:

(i) Beginning LRM in the design phase of products to ensure alignment of redemption terms and investment strategy;

(ii) Availability and feasibility of a broad range of liquidity tools; (iii) Disclosure related to a fund’s liquidity risk and potential use of liquidity tools; (iv) Contingency planning to ensure the ability to use backup liquidity measures; and (v) Individual fund stress testing. As we noted in our letter to the FSB regarding the Recommendations on Asset

Management Vulnerabilities, a “one-size-fits-all” approach is not appropriate for the regulation of LRM, given the necessity of tailoring LRM practices to the unique characteristics of each fund.5 We believe the principles-based approach taken by IOSCO finds an effective balance in providing necessary guidance while (in most cases) preserving fund manager flexibility to act in the best interests of all shareholders under a variety of circumstances. We have made some suggestions for IOSCO’s consideration throughout this letter. We begin with several thematic comments followed by an overview of our suggested amendments to the proposed recommendations, and ending with detailed responses to the individual questions. At a very high level, our comments coalesce around the following broad themes:

(i) A robust risk governance framework, including an independent risk management

function, is fundamental to good risk management, including effective LRM;

(ii) Flexibility in the use of liquidity tools must be preserved in the course of promulgating LRM standards, as it is impossible to accurately predict the nature or circumstances of future liquidity stress events or financial crises;

(iii) Disclosures about fund liquidity risks and liquidity tools should be straightforward

and based on factual information; they should not include projections or forecasts.

(iv) Individual fund liquidity stress tests are useful analytical tools; however they are

only one component of the LRM process and should never be prescribed by regulators as a substitute for the informed judgement of the fund manager;

(v) The FSB has acknowledged that ETFs are materially different than traditional

open-end funds. Therefore, ETF portfolio liquidity would be better addressed in IOSCO’s “Principles for the Regulation of ETFs”, rather than within the scope of this consultation.

(vi) Regional and national authorities (“regulatory authorities”) should take proactive

steps to monitor the use of liquidity tools and to help minimize operational impediments to the use of liquidity tools and data gaps that hinder fund manager LRM efforts.

5 BlackRock Letter to FSB, Comments on Consultative Document for Proposed Policy Recommendations to Address Structural

Vulnerabilities for Asset Management Activities (Sep. 21, 2016), available at https://www.blackrock.com/corporate/en-se/literature/publication/fsb-structural-vulnerabilities-asset-management-activities-092116.pdf.

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BlackRock has written extensively on fund LRM over the last several years. We have included a list of relevant publications in Appendix A. We highlight that the objective should always be to balance operationalizing measures designed to mitigate potential risks with the need to preserve end-investors’ abilities to save for their long-term financial needs, thereby facilitating investment in the real economy. It is from this perspective that we arrive at our comments in this letter. We appreciate the opportunity to engage with IOSCO on this important project and we look forward to continuing the dialogue.

Sincerely, Barbara Novick Vice Chairman Alexis Rosenblum Director, Global Public Policy Group

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I. Importance of a Robust Risk Governance Framework

A robust risk governance framework is fundamental to a fund manager’s effective implementation of all aspects of risk management, including LRM. We believe that all fund managers should have a formal and well-defined firm-wide risk governance framework that starts at the top of the organization. Having a robust risk governance framework in place underpins all of the proposed recommendations. To this end, we believe it would be worthwhile for IOSCO to consider adding more specific comments on governance to the final Good Practices Document and/or IOSCO 2017 Recommendations. In particular, the risk governance framework should include a risk management function that is independent of portfolio management (for independent oversight of risk management) with direct access to the fund management company board of directors (or other governing bodies of the fund manager).6 This is essential to ensuring that all risks including liquidity risks in a fund, are properly managed. In addition, the risk governance framework should include other control groups, such as portfolio compliance and valuation oversight, that are responsible for elements of an independent risk management process. A legal & compliance function should also be involved and play a role in overseeing related compliance matters.

BlackRock follows the approach described above and employs a “three lines of defense”

model as part of its risk governance framework. As a first line of defense, the firm expects individual portfolio management teams to take primary responsibility for managing the investment risks, including liquidity risk, associated with the portfolios that they manage, and to ensure that they are following key controls, fund mandates, and regulations. The second line of defense is our dedicated risk management group, Risk & Quantitative Analysis (“RQA”), which monitors the risk profiles of portfolios managed on behalf of clients and regularly engages with the portfolio management teams to ensure risk positioning is deliberate, diversified, and scaled. .Risk management provides a layer of oversight or “checks and balances” on the portfolio management process through the provision of independent subject matter expertise and the use of “constructive challenge” to ensure that best practices are being applied, that risk is evaluated independently, and that portfolio managers are constructing client portfolios consistent with clients’ reasonable expectations. The third line of defense is our internal audit function that independently validates investment businesses’ adherence to key controls and policies and provides independent substantiation of control issues either self-identified by investment teams or flagged by independent risk management and evidences compliance with key controls.

II. Beginning LRM in the Design Phase of a Fund

With agree with IOSCO that fund LRM begins in the design phase of a fund. Fund managers should carefully review fund redemption terms to ensure appropriate alignment with the fund’s investment strategy and investor base. This includes careful consideration of which backup tools should be embedded into a fund’s structure, as well as the appropriate redemption frequency and notice period. It should be emphasized, however, that ensuring a fund’s structure and redemption terms are consistent with the investment strategy pursued by the fund is not the same as requiring the redemption frequency (e.g., daily, monthly, etc.) to equal the liquidity of all of the fund’s holdings. The overall fund structure including available LRM tools should be considered together. In this context, it is important to remember that (i) investment funds are often the only access to professional asset management available to individual

6 Certain regulatory regimes already require this independence of the risk management function e.g., the requirements of Article

15 of the EU’s Alternative Investment Fund Managers Directive.

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investors; (ii) investment funds are an investment vehicle commonly used in retirement plans as a retirement savings tool;7 and (iii) investors with a long investment time horizon, such as those saving for retirement, are well-placed to benefit from capturing an [il]liquidity premium and often achieve this through investments in investment funds held in retirement accounts. Of course, the risk-return tradeoff in investing means that the additional returns associated with less liquid asset classes may also entail the additional risk that in a stressed environment, an investor’s ability to realize all of an asset’s “intrinsic value” may be challenged for some period of time. However, carefully balancing this tradeoff ensures that interpretations of the recommendations do not inadvertently reduce the availability of investment products that help a variety of investors meet their retirement and savings goals.

III. Preserving Flexibility in the Use of Liquidity Tools

We commend IOSCO for recognizing the importance of “tail risk tools” to address “tail risk scenarios” and encouraging the adoption of a broad toolkit in this regard. We believe that the list of tools described in the IOSCO 2017 Recommendations and Good Practices Document is comprehensive. However, even when a broad toolkit is available to funds, we cannot forget that attempting to predict the nature or circumstances of the next financial crisis is a very difficult task. In order to be effective, temporary disruptions in redemption privileges that result from the use of liquidity tools need to be seen and understood as rare but anticipated events. Likewise, any regulatory authority comments with respect to liquidity tools must find an appropriate balance between encouraging robust fund LRM processes to avoid liquidity challenges in the normal course, while being supportive of the use of liquidity tools when the circumstances necessitate. Indeed, the liquidity tools including redemption gates and suspensions have been employed effectively, such as in the case of UK property funds in the wake of the UK referendum, to address liquidity challenges without a negative impact on financial stability. In this regard, we further highlight the importance of maintaining flexibility in permitting the use of the various extraordinary measures to ensure that fund managers can respond to a variety of situations. To this end, we believe that IOSCO should avoid encouraging prescriptive measures that might inadvertently reduce a fund’s flexibility in responding to a crisis situation. Instead, we recommend a more flexible approach that would allow fund managers, fund boards, and regulators to draw from a broad toolkit so they can react in the best interests of shareholders, should they be faced with a spike in redemptions or other extraordinary circumstances. Our comments on several of the recommendations are suggestions meant to help ensure a sufficient level of flexibility is preserved in all cases.

IV. Straightforward and Factual Disclosures

We generally agree with the principles IOSCO has set out with regard to fund

disclosures about liquidity risk. Investors should understand the liquidity risks of the fund in which they are investing and the liquidity tools that a fund may employ to address liquidity challenges. Disclosures should be straightforward and should not include forecasts about future scenarios. We are not supportive of public disclosure that requires forecasts, projections about the future, or subjective assessments on the part of the fund manager. These types of disclosures can be misleading and can create perverse incentives, as disclosures to investors can have marketing implications for a fund. We suggest the removal of any language

7 According to the Investment Company Institute (“ICI”), 45% of US mutual funds are retirement account assets as of October

31, 2015. Retirement accounts include employer-sponsored defined contribution plans and individual retirement accounts. Mutual fund assets include long-term funds and money market funds. See Investment Company Institute, “The U.S. Retirement Market, Third Quarter 2015” (Dec. 2015), available at www.ici.org/info/ret_15_q3_data.xls.

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suggesting that fund managers disclose information to investors based on projections of future portfolio holdings or other subjective assessments. This language should be replaced with an affirmative statement indicating that disclosures to investors should be straightforward and based on factual information.

V. Stress Testing as an Analytical Tool

We are supportive of developing principles for the stress testing of individual open-end

funds and we are in agreement with the majority of comments included in the IOSCO 2017 Recommendations. However, we believe that regulators’ expectations as to the intellectual validity and predictive power of liquidity stress tests and their uses by fund managers must be appropriately calibrated to the practical reality, given the large number of assumptions they embed. In particular, while liquidity stress tests can be helpful tools to inform risk managers about potential liquidity risks to which a fund might be subject under a variety of scenarios, they cannot be expected to:

Accurately predict the future. Our ability to understand what future adjustment processes for market prices (which vary by the time needed to liquidate and trade size) would be in stressed market conditions is necessarily limited based on: (i) what has actually happened historically; and (ii) available data to analyze price behavior, as this data is either incomplete or limited to small quantities of traded amounts during normal markets versus large quantities in disrupted markets, which makes it difficult to infer all outcomes that are possible. As such, like other ex-ante forecasts, there is limited confidence that results predicted by stress tests will actually come to fruition. Further, the predictive power of liquidity stress tests is significantly limited by data availability constraints, as well as the need to employ simplifying assumptions.

Predict the behavior of other market participants. Liquidity stress tests are designed to test whether a fund could meet the redemption demands of its shareholders under hypothetical stressed conditions using parameters that assume a market-wide liquidity event. Any attempt to not only predict a fund’s ability to sell assets at a certain price in a given timeframe, but to also forecast the potential behavior of other market participants who may or may not act in a similar manner to the fund in question, would necessarily require a variety of simplifying assumptions to the analysis, reducing its utility as an analytical tool since the results will be almost totally assumption driven. Stresses on asset values implicitly suggest that broader market-wide selling is taking place by virtue of price declines, including potentially selling by other funds managed by the manager. However, as we have observed during several market events, simply because redemptions are taking place in one fund, does not necessarily mean that other funds are experiencing redemptions or that other investors are not purchasing these securities.8

8 For example, in December 2015, the Third Avenue Focused Credit Fund, a daily open-end fund investing in distressed credit

suddenly announced it would cease meeting customer redemptions. While mutual fund investors redeemed $9.6 billion from high yield bond funds that month, we observed that several institutional clients added to their high yield allocations, viewing the sell-off as an attractive buying opportunity. In September 2014, we saw another example of this behavior. Following Bill Gross’s announcement to leave PIMCO, some asset managers left the PIMCO Total Return Fund, while others decided to stay put. Many of the asset stayed invested in bonds. Some went to other bond mutual funds and some went into bond ETFs. This idiosyncratic event at a single asset manager did not change the demand for the asset class – just the demand for that asset manager. See BlackRock, ViewPoint, Breaking Down the Data: A Closer Look at Bond Fund AUM (Jun. 2016), available at https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-breaking-down-the-data-bond-fund-aum-june-2016.pdf; Speech by Barbara Novick, Liquidity in Financial Markets (Nov. 15, 2016), available at

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Prescribe a mechanical course of action in response to stress testing results. Liquidity stress tests are analytical tools that can be used to analyze how a fund might perform under extreme stress scenarios. While such tools are helpful as part of a risk management process, the results of hypothetical liquidity stress tests should not result in a mechanical response, rather they should act as a flag for additional review or scrutiny from the responsible person(s). To this end, we believe IOSCO should include statements indicating that under no circumstance should liquidity stress tests be prescribed by regulators as a substitute for the informed judgement of portfolio managers and/or risk managers.

Another important area for consideration when developing guidance related to stress

testing of individual funds is that such guidance must carefully balance what might be theoretically ideal versus practical reality. In some cases, what is theoretically ideal from a regulator’s perspective (e.g., that fund managers actually have the ability to accurately forecast the number of days it will take to liquidate fund holdings at a given price), may simply not be realistic (e.g., the over-the-counter nature of fixed income markets with limited transparency and relatively modest number of transactions makes it difficult to accurately measure and forecast liquidation costs and timing).

From a redemption risk perspective, the ability to reliably forecast redemptions is at the

frontier of actual industry practice and is as of yet, unproven. Access to detailed transactional activity of individual fund investors is restricted for many retail funds due to contractual limitations and/or operational constraints. For many of these retail funds, investor transactions are incorporated into omnibus trades provided to fund managers by fund distributors who sell products issued by a number of asset managers. Thus, asset managers with retail funds distributed by third parties do not necessarily have access to the detailed transactional history needed to fully study investor redemption behaviors across investor segments within individual funds. This means that the analysis of redemption behavior is still in nascent stages of development. Even with existing data, the length of available time series to deeply study investor behavior varies significantly, since some funds may be quite old, whereas other funds may be brand new.

With these limitations as context, we believe it is important to highlight that any guidance related to liquidity stress testing explicitly acknowledge that such guidance is not a substitute for the judgement of portfolio and risk managers who are responsible for making decisions that are in the best interest of all fund shareholders. In particular, fund managers should be allowed to exercise their judgment with respect to how to respond to the results of their liquidity stress tests. While the desire to somehow pre-empt a hypothetical future liquidity problem may be great, the lack of complete and consistent data or experience with this type of analysis requires a staged and measured approach. Since the “science” of liquidity stress testing for mutual funds is still in its early stages, regulatory authorities should first aim to set the development on these processes in motion for funds where they are not already in place and then carefully observe how they progress across the industry. In addition, regulatory authorities can be helpful in fostering the development of the “science” by working with the industry to identify data gaps and taking actions to improve data availability, particularly by mandating the flow of key data fields on client types through the intermediary chain back to managers. As we have explained previously, even the largest asset managers have rather limited ability to access the underlying data regarding the activities of their third-party distributed funds.

https://www.blackrock.com/corporate/en-us/literature/publication/barbara-novick-remarks-brookings-liquidity-financial-markets-111616.pdf.

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VI. Unique Structure and Risks of ETFs

Care must be taken to ensure that any regulations for ETFs are appropriately tailored to the unique structure of ETFs. The FSB recognized the distinction in Annex 3 of its final policy recommendations on Asset Management Vulnerabilities, when it stated: “ETFs generally do not pose the issues…with respect to open-ended funds (i.e., issues related to on demand liquidity and first-mover advantage)”.9 The FSB further noted that the liquidity recommendations might need to be tailored to ETFs. We agree with these statements.

This is because ETFs differ from traditional open-end funds (“OEFs”) in many respects,

most importantly regarding how liquidity is provided to investors. For starters, in most cases, ETFs use different mechanisms than OEFs for providing liquidity to investors and establishing prices at which share transactions occur. Investors in an OEF buy new shares and redeem existing shares directly with the OEF at a specified time each day, at a price determined by the OEF that is the OEF’s best estimation of net asset value (“NAV”) per share. As a result, when there is a significant imbalance between buyers and sellers, an OEF usually must purchase or sell portfolio holdings in response to subscriptions and redemptions. OEF investor liquidity is derived directly from the OEF, its portfolio holdings, or backup sources of liquidity. In contrast, ETF shares can be traded directly with other market participants through “secondary market trading” of ETF shares, typically occurring on listed exchanges where ETF markets are the most developed, for example in the United States. Secondary market trading of ETF shares means that buying and selling occurs at a market-determined price agreed between investors without the ETF’s direct involvement. Secondary market transactions directly between buyers and sellers provide each with liquidity based on market demand. Any imbalance between buyers and sellers affects the ETF share price but does not, by itself, directly lead to purchases or sales of holdings by the ETF. The volume of ETF shares traded through secondary market transactions can be many times greater than the amount of shares issued or redeemed directly by the ETF.10

ETFs incorporate a feature (commonly referred to as the arbitrage mechanism) that

seeks to keep the market price within close range of an ETF’s NAV by providing a mechanism that adjusts the supply of available shares through transactions with a defined small group of institutional investors, known as Authorized Participants (“APs”),11 who are permitted to trade large blocks of shares directly with an ETF. These types of transactions, called creations and redemptions, are categorized as “primary market” trading of ETF shares. Unlike OEF shares, redemptions of ETF shares by APs can be generally intended to be, and often are, effected in-kind. The notion of liquidating securities for cash to meet redemptions is, then, substantially irrelevant when in-kind transactions are used to meet redemptions. We note that the FSB’s Annex 3 did raise potential concerns about one or more APs pulling away from the ETF market in turbulent conditions. We explore the role of APs and why this type of scenario is not a

9 FSB, Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities (Jan. 12, 2017),

available at http://www.fsb.org/wp-content/uploads/FSB-Policy-Recommendations-on-Asset-Management-Structural-Vulnerabilities.pdf (“FSB Recommendations”) at 46.

10 BlackRock, ViewPoint, Bond ETFs: Benefits, Challenges, Opportunities (Jul. 2015), available at http://www.blackrock.com/corporate/en-pt/literature/whitepaper/viewpoint-bond-etfs-benefits-challenges-opportunities-july-2015.pdf; BlackRock, ViewPoint, Exchange Traded Products: Overview, Benefits and Myths (Jun. 2013), available at http://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-etps-overview-benefits-myths-062013.pdf.

11 For additional detail on APs, see BlackRock, ViewPoint, A Primer on ETF Primary Trading and the Role of Authorized

Participants (Mar. 2017), available at https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-etf-primary-trading-role-of-authorized-participants-march-2017.pdf (“AP ViewPoint”).

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systemic risk concern in our ViewPoint entitled, A Primer on ETF Primary Trading and the Role of Authorized Participants.12

Regulatory authorities have, in several cases, recognized the need for LRM regulation

that is tailored for ETFs. For example, in the US, the SEC recently finalized a rule that focused on the ability of funds to meet redemptions by liquidating portfolio holdings for cash. While this concept is relevant for OEFs, it is not relevant for ETFs because creations and redemptions are generally in-kind and the investors in ETFs can obtain liquidity by trading their shares on the secondary market, externalizing transaction costs from the ETF and mitigating liquidity risk. To address this materially important difference between ETFs and OEFs, the SEC included in its final rule an exemption for “In-Kind ETFs” from requirements to classify the relative liquidity of fund holdings and from the requirement to set a “highly liquid asset minimum.”13 In Europe, the European Securities and Markets Authority (“ESMA”) ETF Guidelines and the Markets in Financial Instruments Directive (“MiFID”) are designed to address the specificities of ETFs operated in the European Union (“EU”).14

We recommend IOSCO focus its current efforts on OEFs, while highlighting that some of

the recommendations may apply to a subset of ETFs.15 This could be followed on by targeted enhancements to the 2013 Principles for the Regulation of Exchange-Traded Funds (“IOSCO 2013 ETF Principle”), if IOSCO deems this necessary. However, we generally find the 2013 Principles sufficient to guide the regulation of ETFs. In particular, we are very supportive of principles 1 and 2 in the IOSCO 2013 ETF Principles, which highlight the need for a classification system to clearly differentiate different types of exchange-traded products.16

VII. Responsibilities of Regional and National Authorities to Facilitate Fund LRM

IOSCO’s proposals place the responsibility for LRM squarely on fund managers. We agree that this is appropriate and that it is important for regulatory authorities to set high expectations for the fund managers operating within their jurisdiction. That said, regulatory authorities should also be encouraged to play a role in ensuring that fund managers within their jurisdiction can deliver on all the aspects of the IOSCO 2017 Recommendations to the best of their abilities.17 In this regard, regulatory authorities can be helpful in developing regulatory regimes that set a baseline standard for LRM and permit the broadest possible liquidity “toolkit”. However, simply permitting tools to be used is insufficient. This is because, in some cases,

12 AP ViewPoint.

13 SEC Final Rule, Investment Company Liquidity Risk Management Programs (Oct. 13, 2016), available at https://www.sec.gov/rules/final/2016/33-10233.pdf.

14 ESMA Guidelines on ETFs and other UCITS issues, ESMA /2014/937EN, Sections VII to IX (Aug. 1, 2014), available at https://www.esma.europa.eu/sites/default/files/library/2015/11/esma-2014-0011-01-00_en_0.pdf; BlackRock, Letter to ESMA, Developing Europe’s Market Structure for Exchange Traded Funds: Key Principles for MiFID ‘Level 2’ and the Central Securities Depositary Regulation (Apr. 9, 2014), available at http://www.blackrock.com/corporate/en-gb/literature/publication/etf-market-structure-letter-to-esma.pdf.

15 We note that there are a subset of ETFs that typically redeem for cash, like an OEF, for structural reasons related to the underlying portfolio holdings. While these types of ETFs certainly resemble OEFs more so than other types of ETFs that redeem in-kind, they still have the additional layer of secondary market liquidity for the ETF shares. As such, we recommend that these types of ETF also be addressed through specific and tailored regulations that are specific to their structure and unique characteristics.

16 IOSCO, Final Report, Principles for the Regulation of Exchange-Traded Funds (Jun. 2013), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD414.pdf (“IOSCO 2013 ETF Principles”).

17 For examples of the differences in tools available to managers from jurisdiction to jurisdiction, see the IOSCO Final Report: Liquidity Management Tools in Collective Investment Schemes: Results from an IOSCO Committee 5 survey to members of December 2015; available at: https://www.iosco.org/library/pubdocs/pdf/IOSCOPD517.pdf.

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limitations to the operational infrastructure or other fundamental impediments challenge fund managers’ abilities to employ the tools. For example, the SEC recently finalized a rule that will permit 1940 Act funds to employ swing pricing after the rule’s effective date.18 However, while many fund managers indicated their support for swing pricing in principle, there are numerous operational impediments to the implementation of swing pricing due to the current structure of the mutual fund ecosystem in the US. These impediments were outlined in the July 12, 2016 Global Association of Risk Professionals (“GARP”) letter to the SEC.19 Similarly, the success of any liquidity risk stress testing efforts will be based on the ability of fund managers to create a meaningful and relevant stress scenario for each individual fund, which requires sufficient transparency into a fund’s redemption activity that could be achieved through greater transparency into the underlying activity into omnibus accounts. In some cases, the ability to access detailed information about the transactional activity of individual fund investors who access funds through omnibus trades is limited for many retail funds due to contractual limitations and/or operational constraints. Thus, asset managers with retail funds distributed by third parties do not necessarily have access to all the transactional history needed to fully study investor redemption behaviors.

To the extent regulatory authorities believe that the use of a tool or access to a dataset

is important to fund LRM, regulatory authorities should be proactive in addressing infrastructure challenges. If regulatory authorities are not willing to provide support to fund managers in encouraging operational feasibility and access, it is not practical for regulatory authorities to expect a given tool to be utilized by fund managers. In this regard, we suggest that IOSCO include affirmative statements in the final documents indicating that regulatory authorities have a responsibility to investigate impediments to accessing sufficient data and/or other operational impediments to the use of liquidity tools. If impediments are identified, regulatory authorities should take action, where possible, to minimize or eliminate those impediments. We believe that the inclusion of such a statement would help to underscore the fact that both fund managers and their regulators have responsibilities to “raise the bar” on LRM industrywide. We believe the best outcomes will be achieved through a collaborative approach that encourages cooperation between fund managers and regulators. In addition, regulatory authorities should seek to develop harmonized and consistent standards across jurisdictions, wherever possible.

Lastly, IOSCO should clearly acknowledge that even the best managers with well-

designed funds cannot guarantee liquidity in all situations given that there may be instances where the market simply does not support providing liquidity at a given time (e.g., market closure). While investment funds have proven their ability to meet redemptions under a variety of market stress scenarios including the 2008 crisis (with very limited exceptions), this is theoretically an intrinsic risk of all OEFs and while it needs to be properly disclosed and managed prudently, it should be acknowledged by regulatory authorities. Regulatory authorities can be helpful in ensuring regulation that sets a minimum standard for LRM practices to limit these occurrences, and also in providing oversight and supervision to ensure liquidity tools are available and operationally feasible to be used during times of stress.

18 SEC Final Rule, Investment Company Swing Pricing (Oct. 13, 2016), available at https://www.sec.gov/rules/final/2016/33-

10234.pdf. 19 GARP, Letter to the SEC, Response to Proposal to SEC on Swing Pricing and Transparency for Omnibus Accounts (Jan. 12,

2016), available at https://www.sec.gov/comments/s7-16-15/s71615-33.pdf.

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VIII. Summary of Recommendations

As we noted previously, we are generally supportive of the overall LRM framework that IOSCO has proposed. We view our suggestions as areas where the proposed recommendations could be improved to ensure the IOSCO 2017 Recommendations meet their objective of fostering a high standard for LRM practices globally, while avoiding unintended consequences for investors. Below is a very high level summary of our suggestions for improving the IOSCO 2017 Recommendations. In the detailed responses to individual questions, we provide a more detailed discussion.

Suggested Amendments

Scope of Recommendations

The scope of the recommendations should be OEFs.

ETFs, MMFs, and CEFs should be excluded.

IOSCO’s 2013 ETF Principles address the regulation of ETFs.

Recommendation 3 Dealing frequency

We recommend IOSCO add references to additional considerations (e.g., liquidity tools, borrowing capacity) that may factor into a decision about a fund’s dealing frequency.

Recommendation 4 Dealing arrangements

Individuals permitted to approve products should be expanded beyond “senior management and/or board level within the responsible entity” to account for different organizational structures.

The word “liabilities” should be replaced with the word “redemptions” given that fund shareholder redemption requests are not liabilities.

We recommend adding borrowing capacity to the examples of additional liquidity management tools.

Recommendation 7 Disclosure

Disclosures to investors should be straightforward and factual.

The language regarding disclosures based on projected or likely portfolio holdings should be removed to avoid potential issues that arise when publicly disclosing forecasts or other projections.

The language specifying that funds should disclose how and when they will use liquidity tools is overly prescriptive and could reduce flexibility to use liquidity tools under stress circumstances that may not have been conceived of in advance. We recommend this language be removed.

Disclosing the groups or committees that will decide to invoke liquidity tools is an unnecessary level of detail and should be omitted.

Recommendation 8 Effective governance

While not specifically addressed in the Consultation, we recommend IOSCO consider the addition of more detail on appropriate risk governance frameworks.

IOSCO should consider whether recommendations relating to the risk governance framework would be better placed at the beginning of the recommendations in its own section, given that good risk governance, including having an independent risk management function, underpins all of the other LRM recommendations.

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Recommendation 12 Identifying emerging liquidity pressures

We believe the proposed text is sufficient.

Recommendation 13 Relevant data and factors

We recommend IOSCO add a comment to this recommendation highlighting that regulatory authorities can be helpful in ensuring sufficient data is available to fund managers.

Recommendation 14 Fund level stress testing

Individual fund liquidity stress tests are useful analytical tools and we are supportive of the development of principles for individual fund liquidity stress testing.

It should be recognized, however, that individual fund liquidity stress tests are only one component of the LRM process and should never be prescribed by regulators as a substitute for the informed judgement of the fund manager.

Recommendation 14 should acknowledge that individual fund stress testing is not expected to accurately predict the future or predict the behavior of other market participants, as these expectations would be beyond the scope of the current state of the practice for fund liquidity stress testing.

Recommendation 16 Contingency planning

We believe the proposed text is sufficient.

Recommendation 17 Implementation of additional liquidity management tools

We suggest IOSCO highlight that regulatory authorities should be proactive in investigating and addressing impediments to the implementation of the broader possible liquidity “toolkit”.

IX. Responses to Individual Questions Q1. The 2013 Liquidity Report related to open-ended CIS and where determined by the responsible entity, to some closed-ended CIS. Should the proposed text laid out below apply also to the same range of CIS? Should certain CIS or types of CISs be excluded from any particular requirements, or be subject to a different requirement, because of their investment strategies, ownership concentrations, redemption policies, or some other factor that makes them more or less prone to liquidity risk?

We recommend the scope of the IOSCO 2017 Recommendations be limited to

traditional open-end funds, and that money market funds (“MMFs”), ETFs, and closed-ended funds (“CEFs”) be excluded. While each of these product types share some commonalities with OEFs, they also have fundamentally different structural characteristics and risks that are better addressed by a separate set of principles tailored to their unique characteristics. This will limit confusion about the nature of these products and will permit regulators to develop robust regulatory regimes that can fully accommodate a range of fund structures.

Exchange Traded Funds. In Annex 3 of its policy recommendations on Asset

Management Vulnerabilities, the FSB highlighted the fact that ETFs are different than other types of OEFs, stating: “ETFs generally should not pose the issues described in Section 2.1

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with respect to open-ended funds (i.e. issues related to on-demand liquidity and first-mover advantage).”20 Further, the FSB noted that its recommendations regarding liquidity mismatches “may require tailoring to address the peculiarities of ETFs.”21 While the need to tailor regulation should not suggest that ETFs are not subject to any liquidity risks, the reality is that the liquidity risks to which ETFs are subject and the efficacy of tools, which could be used differ from those of OEFs. To this end, we believe that LRM issues specific to ETFs would be better addressed through IOSCO’s June 2013 Principles for the Regulation of Exchange Traded Funds, given that these principles are specifically tailored to ETFs.22 If IOSCO is not amenable to this approach, we recommend that IOSCO include a comment similar to the comment included in the FSB Final Report, indicating that ETFs are different than OEFs, and responsible entities should tailor LRM practices to account for the unique structure of the ETF.

Money Market Funds. The FSB excluded MMFs from its policy recommendations on

Asset Management Vulnerabilities because “regulatory reforms with respect to MMFs have been implemented (or are currently in process of being implemented) in many jurisdictions.”23 Given the different nature and risks associated with MMFs, MMFs need to be subject to regulation that is tailored to this unique product set. Indeed, IOSCO has already produced recommendations to specifically address MMFs in its October 2012 Policy Recommendations for Money Market Funds. In this document, IOSCO noted the importance of addressing regulations specifically to MMFs, stating: “MMFs present several features which make them unique among the CIS universe. Accordingly money market funds should be explicitly defined in the regulation.” Further, regulators have enacted reforms specific to MMFs in both the US and the EU.24 These reforms have treated MMFs separately from other types of funds, recognizing their unique structure and risks.

As such, it logically follows that MMFs (and similar cash investment vehicles) should be

treated separately with respect to LRM recommendations. Further, the October 2012 Policy Recommendations address the need for MMFs to hold sufficient liquid assets, to perform stress testing, to disclose risks to investors, and to have features in place to address “exceptional market conditions and substantial redemptions pressures”. 25 To this end, we recommend that IOSCO exclude MMFs from the scope of the CIS Liquidity Risk Management Recommendations.

Closed-End Funds. The IOSCO 2013 Liquidity Report notes that the reason for the

inclusion of closed-end CIS is that “some of the material in the principles is relevant (for example, such CIS may need to meet margin calls or other cash commitments to counterparties on a timely basis).”26 The risks described in this aspect of the 2013 Liquidity Report refer to “funding risk”, rather than “fund liquidity risk”. Funding risk refers to the risk that a fund might not be able to meet its liabilities (for example liabilities associated with borrowings or leverage),

20 FSB Recommendations at 46.

21 FSB Recommendations at 16.

22 IOSCO 2013 ETF Principles.

23 FSB Recommendations at 1.

24 For US MMF reforms, see 79 Fed. Reg. 157 at 47736-47983. For EU MMF reforms, see Official Journal of the European Union, Regulation 2017/1131 of the European Parliament and of the Council on Money Market Funds (Jun. 14, 2017), available at http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017R1131&from=EN.

25 IOSCO, Policy Recommendations for Money Market Funds: Final Report (Oct. 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf.

26 IOSCO 2013 ETF Principles at 2.

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whereas fund liquidity risk refers to the risk that a fund could not provide cash to investors in a timely manner without materially diluting fund shareholders. Closed-end funds do not offer redemptions of fund shares, meaning that they do not experience fund liquidity risk. Therefore, we recommend that closed-end funds be excluded from the IOSCO 2017 Recommendations. Good Practices Document Q2. Do respondents agree with the general considerations around liquidity risk management? Are there other issues that should be included?

Yes. We agree with the general considerations around LRM. Namely we support: (i) Beginning LRM in the design phase to ensure alignment of redemption terms and

investment strategy; (ii) Availability and feasibility of a broad range of liquidity tools; (iii) Disclosure related to a fund’s liquidity risk and potential use of liquidity tools; (iv) Contingency planning to ensure the ability to use backup liquidity measures; and (v) Individual fund stress testing.

Q3. Does the Good Practices Document cover the key considerations regarding liquidity risk management tools, including their use in normal and stressed scenarios? Are there other issues that should be considered? Are there other key tools that should be included? Do you agree with the pros and cons in regards to the use of each tool? Are there other pros and cons that should be considered?

We agree with the list of liquidity management tools discussed in the Good Practices Document. However, we suggest the deletion of the paragraphs at the beginning of Chapters 1 and 3 that state that “liquidity transformation” is a structural feature of investment funds, for which LRM is designed to address. LRM is designed to ensure that all investors in a fund (both redeeming and remaining shareholders) are treated equitably, even during periods of heightened liquidity risk. By protecting all investors in the funds, any theoretical concerns about “first-mover advantages” in funds are mitigated. Any document describing “good practices” for LRM should begin by highlighting that this is the objective of LRM practices. We recommend the introduction to the Good Practices Document be revised to reflect this important aspect of fund manager’s and securities regulators’ responsibilities to fund shareholders. Q4. Do you agree with the general considerations regarding stress testing? Are there other issues that should be included?

Please see our response to Questions 11-13.

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Exchange-Traded Funds (“ETFs”) Q5. Should ETF’s be subject to different liquidity requirements than other CIS?

a. If not, should ETFs be included within the scope of the 2017 Liquidity Recommendations? (i) If yes, are changes needed to be brought to the 2017 Liquidity

Recommendations to reflect ETFs specificities? Which ones? (ii) If not, please explain why ETFs should not be included within the scope

of the 2017 Liquidity Recommendations if they have partly similar liquidity issues as other CIS.

b. If ETFs should be subject to different liquidity requirements than other CIS, what should they be?

Q6. Are there key liquidity related issues specifically regarding ETFs?

The FSB recognized that ETFs are different than OEFs in Annex 3 of its final policy recommendations on Asset Management Vulnerabilities, when it stated: “ETFs generally do not pose the issues…with respect to open-ended funds (i.e., issues related to on demand liquidity and first-mover advantage)”.27 We agree with Annex 3 of the FSB’s recommendations.

While ETFs do not present the same “first-mover advantage” or liquidity risk concerns as OEFs, ETFs do rely on the health of the exchange, market-maker, and AP ecosystem to ensure the arbitrage mechanism is functioning efficiently. These elements of the ETF structure are different than the liquidity risks to which OEFs are subject. To this end, we recommend that IOSCO focus its current efforts on traditional open-end funds, while highlighting that some of the recommendations may apply to at least a subset of exchange-traded products (“ETPs”). This could be followed on by targeted enhancements to the 2013 IOSCO Principles for the Regulation of Exchange-Traded Funds if IOSCO deems this necessary. However, we generally find the 2013 Principles sufficient to guide the regulation of ETFs. Proposed Additional Guidance and Recommendations Q7. Does this guidance on the design phase process capture the best of current good practices in the design of CIS?

We agree with the importance of appropriately aligning a fund’s redemption terms to the fund’s investment strategy and investor-base. We are supportive of the additional guidance in Recommendations 3 and 4 on how to accomplish such alignment. That said, we have made several suggestions for ways to improve upon this section:

Recommendation 3 – Dealing Frequency The proposed additional text under Recommendation 3 focuses on the decision around

whether or not a fund should be “open-ended”, and if it should be open-ended, what dealing frequency is appropriate. The proposed text in Recommendation 3 does not, however, address other aspects of a fund’s redemption terms aside from dealing frequency. There are many other considerations that responsible entities should take into account when structuring a fund. These include, but are not limited to, notice periods and backup liquidity tools (i.e., permitted by regulation and operationally feasible). Without taking a holistic view of all aspects of a fund’s redemption terms, it is impossible to determine whether a fund’s dealing frequency is 27 FSB Recommendations at 46.

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appropriate. As such, we recommend that these additional considerations be added to the proposed text.

Recommendation 4 – Dealing Arrangements We agree with the assertion in Recommendation 4 that: “The initial design of a CIS

presents an opportunity to put arrangements in place to underpin effective liquidity risk management.” In this regard, fund managers should assess the potential liquidity risks a fund may face and subject new funds to an approval process that considers relevant liquidity risk factors in the decision-making process. We have listed several suggestions to improve the proposed text below:

Approval Process.

With respect to the approval process, we suggest amending the language stating the approval must be given by the “senior management and/or board level within the responsible entity.” We believe that flexibility in who is involved in the approval process should be permitted to accommodate a variety of different approval processes that may be required for various fund structures (even for different funds managed by the same fund manager). For example, in many cases, fund boards (rather than that fund management company board of directors) are responsible for the approval of new funds under their purview. Likewise, responsible entities may form committees or teams of people with expertise on the relevant asset classes, fund structures, investor-base, etc. to review new products. So long as these types of practices entail some level of independence from portfolio management, we believe they should not be precluded from participating in and/or overseeing the approval process simply because they are not a member of senior management or of the responsible entity’s board of directors. Additionally, in general, only public companies have a board of directors. Greater flexibility in the language used in this recommendation would help ensure the recommendation is applicable to the diverse range of corporate structures that exist within the asset management industry.

Liquidity Risk Management Practices – Liabilities. We recommend changing the title of this section from “Liabilities” to “Redemptions”. As

the IOSCO 2013 Liquidity Report states, “An investor in a CIS is a shareholder, as opposed to a depositor in a bank, who is a creditor”.28 The use of the term “liabilities” can, therefore, be misleading because shareholder redemption requests are not liabilities; rather they are more appropriately described as redeemable equity. The risks associated with redeemable equity are very different from those associated with short-term funding liabilities.

With respect to the suggestion that responsible entities should ex ante assess the “likely

risk appetite of target investors,” we note that the decision of whether or not to invest in a given fund is one made by the end-investors themselves (often in consultation with a financial advisor or investment consultant), rather than by the asset manager. As such, asset managers are limited at most as to giving a generic statement as to the target market for a specific fund (as under MiFID II), as it is presumed that if there is appropriate disclosure around the risks to which a fund is subject, investors and/or their advisors will determine whether or not to invest in that fund based on its alignment with their risk appetite and target asset allocation, other than on an

28 IOSCO 2013 ETF Principles at 1.

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individual basis or more commonly as part of a wider diversified portfolio.29 To this end, we believe these concerns would be better addressed by ensuring appropriate disclosure around liquidity risk using industry templates such as the European MiFID template, and we therefore suggest this reference be removed from Recommendation 4.

Liquidity Risk Redemption-Constraining ‘Additional Liquidity Management Tools’.

We recommend adding borrowing capacity to the list of backup measures, including lines of credit, inter-fund lending,30 and repo. Funds should consider whether establishing

borrowing facilities is necessary or appropriate, including considering potential costs to the fund. Additionally, we suggest IOSCO consider whether this section might be better placed under Recommendation 3, as the tools available to the fund should be part of considerations around fund redemption terms.

Recommendation 8 – Governance At present, risk management governance is included as Recommendation 8 under “Day-

to-Day Management.” While we agree that risk governance is part of day-to-day oversight, we note that a robust risk governance framework is fundamental to all of the recommendations, including product design, contingency planning, stress testing, use of liquidity tools, etc. Further, we consider governance one of the most important aspects of risk management. To this end, we recommend IOSCO consider whether Recommendation 8 should be included earlier as a section of its own in the IOSCO 2017 Recommendations.

Further, we recommend that IOSCO consider expanding the guidance on what an

appropriate risk governance framework looks like and the level of “independent oversight” that is appropriate. In our view, fund managers should have a formal and well-defined firm-wide risk governance framework that starts at the top of the organization with the management company board of directors (or other governing body). The risk governance process should include a risk management function that is independent of portfolio management (for independent oversight of investment, liquidity, counterparty credit, operational, and technology risks) with direct access to the fund management company board of directors (or other governing bodies of the fund manager). This is essential to ensuring that all risks including liquidity risks in a fund, are properly managed. In addition, the risk governance framework should include other control groups, such as portfolio compliance and valuation oversight, that are responsible for elements of the independent risk management process. Legal & compliance teams should also be involved in this framework and play an important role in overseeing related compliance matters.

We believe that a focus on strong risk governance will serve as an important foundation

for IOSCO’s and the FSB’s efforts to “raise the bar” on LRM industrywide. In particular, we believe that as a baseline, IOSCO should encourage the designation of a person or group of people to be responsible for overseeing the LRM program, at least some of whom have independent reporting lines from portfolio management. The SEC recently adopted this construct for 1940 Act open-end funds in its LRM Rule.31 In the EU, the Alternative Investment

29 ESMA, Final Report: Guidelines on MiFID II product governance requirements (Jun. 2, 2017), available at

https://www.esma.europa.eu/file/22318/download?token=fR1heny3.

30 Where applicable. We recognize, for example, that inter fund lending is not applicable to UCITS given the relevant legislative constraints.

31 SEC Final Rule, Investment Company Liquidity Risk Management Programs (Oct. 13, 2016), available at https://www.sec.gov/rules/final/2016/33-10233.pdf.

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Fund Managers Directive provides specifically for a robust liquidity management framework requiring AIFMs of OEFs to employ an appropriate liquidity management system, including procedures to monitor the liquidity risk of the AIF and to ensure that the liquidity profile of the investments of the AIF complies with its underlying obligations.32

Q8. Does Recommendation 7 capture appropriate additional liquidity disclosures?

Yes, we agree with the general sentiments in Recommendation 7. Investors should understand the risks of the fund they are investing in and how the fund can meet redemptions in both normal and stressed market conditions. Funds should have clear and concise disclosures to investors regarding risks related to any liquidity tools available to the fund. Clear disclosure of LRM tools to investors can help to align redemption behaviors of investors with the liquidity profile of the fund. That said, we believe that fund managers must be able to reserve flexibility in the manner in which the tools are used to address a given liquidity situation. This is because there is simply no way to accurately predict the nature or circumstances of any future liquidity challenge or financial crisis. As such, fund managers and investors are best served by a regime that supports the use of a wide range of liquidity tools (by limiting regulatory and operational impediments) and affords flexibility to fund managers to make decisions that are in the best interests of shareholders based on the circumstances of a given situation. In this regard, we question the prescriptive nature of some of the disclosure elements discussed in Recommendation 7 and suggest they either be reworded or eliminated, for the reasons described below:

Disclosure of general approach fund will take were it to face a liquidity pressure.

This assumes fund managers know in advance what the liquidity pressure will look like, which is not the case. Attempting to predict what situation will arise and then disclosing how that situation will be handled could serve to reduce a fund manager’s flexibility during an actual liquidity event. This could result in less than ideal outcomes, as not all tools are appropriate for all funds in all situations and managers should be encouraged to carefully consider the most appropriate tools to include in a fund structure and the appropriate course of action to take in order to protect all fund shareholders based on the situation at hand. To this end, we suggest this bullet be replaced with a bullet that notes that funds should disclose all liquidity tools available to the fund and the fact that these tools could be used at the fund manager’s (or in some cases, the regulator’s) discretion, should the fund experience liquidity strain.

Disclosing groups or committees that will decide whether to invoke liquidity tools.

This disclosure is an unnecessary level of detail. Instead, funds should have a robust risk management framework with internal policies for reviewing and escalating the invocation of various liquidity tools.

Information about projected portfolio holdings.

Disclosures to investors should be straightforward and should not include forecasts about future scenarios. We are not supportive of public disclosure that requires forecasts, 32 Article 16 AIFMD. For further details of the liquidity rules applicable to AIFs and UCITS see the AMIC/EFAMA report on

managing fund liquidity risk in Europe April 2016 at https://www.efama.org/Publications/EFAMA_AMIC_Report_Managing_Fund_Liquidity_Risk_Europe.pdf.

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projections about the future, or subjective assessments on the part of the fund manager. These types of disclosures can be misleading and can embed perverse incentives, as disclosures to investors can have marketing implications for a fund. We suggest the removal of any language in Recommendation 7 (or elsewhere) suggesting that fund managers should disclose information to investors based on projections of future fund holdings or other subjective assessments. We recommend replacing this language with an affirmative statement indicating that disclosures to investors should be straightforward and based on factual information. In general, we believe it would be sufficient for fund managers to disclose general information about any potential liquidity risks associated with investing in the asset classes and/or markets in which the fund is permitted to invest pursuant to its investment guidelines. Q9. Should additional wording be included in Recommendation 12 concerning how responsible entities should proceed when faced with the need to sell assets to the extent that might lead the CIS to vary from its investment strategy.

No. we believe that the proposed text is sufficient.

Q10. Does the proposed additional guidance under Recommendation 13 constitute the appropriate approach for a CIS to assess its redemption obligations and liabilities? If not, what else would you suggest?

With respect to the availability of information on the underlying investors in a given fund, we recommend IOSCO add a comment in this section encouraging regulatory authorities to be proactive in ensuring the availability of information about the types of investors in omnibus accounts, where it is not currently readily available. Q11. Are there procedures or practices that responsible entities currently use to implement their stress tests which have been found to be particularly informative to responsible entities and which are not consistent with or included in the approach set out here? If so, please provide examples. Q12. Are there procedures or practices that responsible entities have not found to be particularly useful which the proposed approach to liquidity stress testing would encourage and why? Q13. Is the proposed approach to the design and operation of stress testing processes realistic and does it deal with the key issues?

We are supportive of the inclusion of individual fund liquidity stress testing in the IOSCO 2017 Recommendations, and generally agree with the objective of updating Recommendation 14 to accomplish this. However, we believe that regulators’ expectations as to the intellectual validity and predictive power of liquidity stress tests and their uses by fund managers must be appropriately calibrated to the practical reality, given the large number of assumptions they embed. In particular, while liquidity stress tests can be a helpful tool to inform risk managers about potential liquidity risks to which a fund might be subject under a variety of scenarios, they cannot be expected to:

Accurately predict the future. Our ability to understand what future adjustment processes for market prices (which vary by the time needed to liquidate and trade size) would be in stressed market conditions is necessarily limited based on: (i) what has actually happened historically; and (ii) available data to analyze price behavior, as this data is either incomplete or limited to small quantities of traded amounts during normal markets versus large quantities in disrupted markets, which makes it

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difficult to infer all outcomes that are possible. As such, like other ex-ante forecasts, there is limited confidence that results predicted by stress tests will actually come to fruition. Further, the predictive power of liquidity stress tests is significantly limited by data availability constraints, as well as the need to employ simplifying assumptions.

Predict the behavior of other market participants. Liquidity stress tests are designed to test whether a fund could meet the redemption demands of its shareholders under hypothetical stressed conditions using parameters that assume a market-wide liquidity event. Any attempt to not only predict a fund’s ability to sell assets at a certain price in a given timeframe, but to also forecast the potential behavior of other market participants who may or may not act in a similar manner to the fund in question, would necessarily require a variety of simplifying assumptions to the analysis, reducing its utility as an analytical tool since the results will be almost totally assumption driven. Stresses on asset values implicitly suggest that broader market-wide selling is taking place by virtue of price declines, including potentially selling by other funds managed by the manager. However, as we have observed during several market events, simply because redemptions are taking place in one fund, does not necessarily mean that other funds are experiencing redemptions or that other investors are not purchasing these securities.33

Prescribe a mechanical course of action in response to stress testing results. Liquidity stress tests are analytical tools that can be used to analyze how a fund might perform under extreme stress scenarios. While such tools are helpful as part of a risk management process, the results of hypothetical liquidity stress tests should not result in a mechanical response, rather they should act as a flag for additional review or scrutiny from the responsible person(s). To this end, we believe IOSCO should include statements indicating that under no circumstance should liquidity stress tests be used as a substitute for the informed judgement of portfolio managers and/or risk managers.

Based on the aforementioned limitations of liquidity stress testing, we recommend the

following sentence be removed from Recommendation 14, as these uses of stress testing, while perhaps ideal in theory, are not practical expectations based on the realities of how liquidity stress testing works:

“For example, the responsible entity could analyze the number of days that it would take to sell assets and meet liabilities in the stressed scenarios simulated, taking into account where practical and appropriate the expected behavior of other market participants (e.g. the behavior of other CIS managed by the same responsible entity) in the same conditions, any known inter-fund relationship such as inter-fund lending arrangements, and any actions the responsible entity would take (e.g. imposition of contingent liquidity management tools).” With respect to data limitations, as alluded to above, another important issue in

operationalizing Recommendation 14 is the fact that accurate liquidity stress testing with at least some level of predictive capacity is dependent upon access to data that is not available to fund managers in many cases today. As such, any guidance on fund liquidity stress testing must start with guidance to fund distributors and/or transfer agents that permits fund manager access

33 See footnote 8.

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to necessary data on redemption behaviors to facilitate the predictive value of stress tests. As such, we recommend that IOSCO include in Recommendation 14, statements that regulatory authorities should play a proactive role in encouraging regulatory authorities to ensure this data is available to fund managers in a consistent format.

Q14. Does the proposed additional guidance under Recommendations 3, 7 and 12 add effectively to the available guidance?

Yes, subject to our comments in the previous questions. Q15. Does Recommendation 14 capture the best of current good practices in stress testing?

Please see our responses to Questions 11-13. Q16. Does the recommendation add up to an effective testing procedure which will lead to the smooth triggering of applicable liquidity management tools when appropriate? Q17. Other than those examples listed above, are there any additional scope and/or aspect that you consider necessary and appropriate to be included as part of the contingency plan for an effective implementation of liquidity management tools by CIS/responsible entities?

Yes, we are supportive of the addition of Recommendation 16 regarding contingency

planning to the IOSCO Principles and do not have any further comments on the proposed text.

Q18: How do existing CIS envision transitioning to Recommendation 17?

We do not view Recommendation 17 as requiring a great deal of transition beyond what is already market practice. As a general matter, funds will seek to incorporate backup liquidity measures into fund structures to the extent they are permitted by regulation and are operationally feasible. Where the use of tools is not operationally feasible, this situation is often due to circumstances outside of the fund manager’s control. For example, the SEC recently finalized a rule that will permit 1940 Act funds to employ swing pricing after the rule’s effective date. However, while many fund managers indicated their support for swing pricing in principle, there are numerous operational impediments to the implementation of swing pricing due to the current fund infrastructure in the US. To the extent regulatory authorities believe that the use of a tool is important to fund LRM, authorities should play a proactive role in addressing infrastructure challenges, to facilitate broad adoption of various liquidity management tools. If regulatory authorities are not willing to provide support to fund managers in encouraging operational feasibility, it is not practical for regulatory authorities to expect a given tool to be utilized by fund managers. In this regard, we suggest that IOSCO add a statement to Recommendation 17 indicating that regulatory authorities should be proactive in investigating and addressing impediments to the implementation of the broader possible liquidity “toolkit” for funds under their jurisdiction based on IOSCO’s previous research highlighting the different levels of availability of tools between jurisdictions.34

34 IOSCO, Final Report, Liquidity Management Tools in Collective Investment Schemes: Results from an IOSCO Committee 5

survey to members (Dec. 2015), available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD517.pdf.

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Appendix A: List of BlackRock Publications Discussing Liquidity Risk Management

Title Description

ViewPoint – A Primer on ETF Primary Trading and the Role of Authorized Participants March 2017

This ViewPoint explains how shares are created and redeemed in ETFs. This process, known as ETF primary trading, facilitates inflows and outflows from the underlying portfolios of these mutual funds. We discuss APs, market makers, and the distinct roles they play in ETF primary trading. We also consider the possibility of an AP stepping back from its role and explain the expected impact on ETFs and markets.

ViewPoint – Addressing Market Liquidity: A Broader Perspective on Today’s Euro Corporate Bond Market September 2016

This ViewPoint is a continuation of previous BlackRock publications addressing market liquidity and the ownership of the world’s financial assets, focusing specifically on euro denominated debt including corporate bonds.

ViewPoint – Breaking Down the Data: A Closer Look at Bond Fund AUM June 2016

This ViewPoint explores the diversity of US bond funds and the range of investments made by funds within each category. We then review data on investor flows in the largest categories of bond funds to analyze investor behavior in response to historical market stress events.

ViewPoint – Addressing Market Liquidity: A Broader Perspective on Today’s Bond Markets February 2016

This ViewPoint is intended to inform discussions about bond market liquidity by integrating data we have known about for a long time (e.g., bond ownership by pensions and insurers) with newer data that highlights structural changes to bond market liquidity. We make a number of observations to provide a more comprehensive foundation for the dialogue on bond market liquidity. Note that updated Fed Z.1 data has recently become available and this report will be updated shortly.

Open-End Fund Liquidity Risk Management Programs; Swing Pricing – SEC January 2016

This comment letter responds to the SEC’s request for comment on their proposed rule on liquidity risk management programs for funds. We agree with the SEC that every fund should conduct liquidity risk management and we provide some specific suggestions to strengthen the proposal.

ViewPoint – Addressing Market Liquidity July 2015

This ViewPoint defines the different concepts that have been referred to as “liquidity” that are often conflated, highlights some of the ways that asset managers are already adapting, and provides recommendations for actions to improve the market ecosystem. Our recommendations take a three-pronged approach: (i) market structure modernization, (ii) enhance fund “toolkit” and regulation, and (iii) evolution of new and existing products.

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ViewPoint – Bond ETFs: Benefits, Challenges, Opportunities July 2015

This ViewPoint provides an overview of the structural features of ETFs. We discuss the benefits of bond ETFs, including transparency and price discovery, and some of the challenges, including the need for a classification system that better distinguishes among several types of exchange-traded products. We offer some suggestions for concrete regulatory actions that can extend the benefits of ETFs to a broader investor base and improve financial stability.

Notice Seeking Comment on Asset Management Products and Activities – FSOC March 2015

This letter responds to the FSOC’s request for comment on asset management products on activities, which focuses on four key areas: (i) liquidity and redemptions, (ii) leverage, (iii) operational risk, and (iv) resolution.

ETFs Help Improve Market Stability: A Closer Look at Fixed Income ETF Behavior During Recent Bond Market Movement October 2014

This publication examines the behavior of bond markets and fixed income ETFs during the period of significant asset flows following September 26, 2014. This experience is an illustrative case study of how fixed income ETFs provide liquidity, price transparency, and fair allocation of costs amidst periods of market stability, as well as during periods when markets are challenged with uncertainty or significant asset flows.

ViewPoint – Fund Structures As Systemic Risk Mitigants September 2014

This ViewPoint examines and compares the structural features of several fund types across a range of jurisdictions and identifies a number of existing regulations that serve to mitigate “run risk” and protect investors.

ViewPoint – Who Owns the Assets? A Closer Look at Bank Loans, High Yield Bonds and Emerging Markets Debt September 2014

This ViewPoint analyzes the dynamics of bank loans, high yield bonds, and EMD and examines the liquidity risk management practices of mutual funds that hold these asset classes.

ViewPoint – Who Owns the Assets? Developing a Better Understanding of the Flow of Assets and the Implications for Financial Regulation May 2014

This paper explains the differences between asset owners, asset managers, and intermediaries and highlights the impact that post-financial crisis monetary policies and financial regulatory reforms have had on asset owners.

ViewPoint – Exchange Traded Products: Overview, Benefits and Myths June 2013

This ViewPoint provides a detailed overview of ETPs with a focus on ETFs. The paper explains some common misconceptions about how ETFs work.

ViewPoint – ETFs: A Call for Greater Transparency and Consistent Regulation October 2011

In this ViewPoint, we provide background on the history and structure of ETFs, summarize concerns raised by regulators, and recommend reforms that would improve the marketplace for ETFs. We support uniform standards on labeling, transparency, disclosure, and reporting that would reduce systemic risk, improve investor protection, and help ensure that investors understand precisely the risks and attributes of the products that they are purchasing.