With the investment fund industry experiencing significant growth in the past few years, it has become increasingly important to ensure that this industry is resilient and is able to absorb economic shocks. The liquidity transformation activity undertaken by investment fund managers is a main concern. As a result, liquidity risk in investment funds have been central to regulators’ agendas, with liquidity stress testing being a key tool to analyse the resilience of investment funds to extreme but plausible redemption shocks. This issue was recently accentuated due to the economic shock brought about by the pandemic which, amongst others, necessitated central bank intervention and support in most countries. For this reason, the Financial Stability function within the Malta Financial Services Authority revisited the stress testing exercise which it undertook in 2020.
The main findings of this exercise show that, in line with the 2020 evaluation, Maltese retail investment funds would generally cope well under stressed market conditions. Although more retail funds would need to liquidate part of their investment portfolio in the case of an extreme scenario compared to the results obtained in the stress testing exercise carried out in 2020, an improvement in the liquidity risk can be generally detected. This means that retail investment funds domiciled in Malta should be in a position to continue to weather liquidity strains brought about by external factors such as the COVID-19 pandemic.
The stimulus packages implemented by governments and central banks in response to the COVID-19 pandemic had an impact on reducing the cash buffers held by investment funds, which may have been triggered by a number of investment opportunities which materialised in the financial markets during the second half of the year. In fact, after having accumulated cash to weather the peak of the crisis, investment funds started re-investing their liquidity holdings to take advantage of new investment opportunities. The positive level of resilience within the Maltese investment fund industry was also demonstrated by the fact that no material regulatory intervention was required in Malta to resolve liquidity issues.
Going forward, it is the intention of the MFSA to continue monitoring liquidity risk in Maltese retail investment funds by further improving its methodology and by including additional funds within the scope of stress testing.
The full report can be viewed on the MFSA website.
