8.3 Assessing liquidity risk management

Competent authorities should assess the investment firm’s liquidity risk management framework. For smaller and less complex investment firms this assessment should be streamlined to avoid excessive burden on the authority as well as on the investment firm.

Organisational framework, policies and procedures

Competent authorities should assess whether the investment firm has an effective liquidity risk management framework which enables the firm to identify how it is exposed to liquidity risk. Competent authorities should assess whether the investment firm has established a sound liquidity risk management and controls systems, which enable the investment firm to monitor the effectiveness of its liquidity, level of liquidity risk and compliance with established policies and procedures.

The framework should be proportional to the size, structure and internal organisation of the investment firm and the nature, scope and complexity of its activities, as well as its risk to clients, risk to market and risk to the investment firm. For investment firms that do not deal on own account, the liquidity risk management framework may not need to be separated from other risk-related policies and procedures.

Competent authorities should assess whether the investment firm’s risk management framework considers how the investment firm is able to identify liquid assets shortfalls before stressed conditions occur.

Competent authorities should assess whether the investment firm’s strategies focus on ensuring the ability of the investment firm to continue to operate and pursue new business opportunities through all market environments for an extended period without immediacy liquidating assets or raising additional funding.

When assessing the framework, policies and procedures for liquidity risk management, competent authorities should take into account all of the following criteria:

• a. whether the management body approves policies for managing liquidity risk and discusses and reviews them regularly;
• b. whether senior management is responsible for developing and implementing the policies and procedures for managing liquidity risk;
• c. whether senior management ensures that the decisions of the management body are implemented and actively monitored;
• d. whether the liquidity risk management framework is internally coherent and ensures ILAAP, where available, is comprehensive, and is well integrated into the investment firm’s wider risk management framework; and
• e. whether the policies and procedures are properly defined, formalised and effectively communicated throughout the investment firm.

Competent authorities should assess whether the investment firm has an appropriate organisational framework for liquidity risk management, measurement and control functions. Competent authorities should take into account all of the following criteria:

• a. whether the liquidity risk control and monitoring systems and processes are controlled by independent control functions; and
• b. whether the risk management, measurement and control functions cover liquidity risk in the investment firm, and in particular all areas where liquidity risk can be taken, mitigated or monitored.

Liquidity risk internal control framework

Competent authorities should assess whether the investment firm has a strong and comprehensive control framework and sound safeguards to mitigate or limit its liquidity risk. The liquidity control framework and the safeguard mechanisms may be separated from other risks’ control frameworks or mechanisms. When assessing such frameworks and mechanisms, the competent authorities should take into account all of the following criteria:

• a. whether the limit and control framework is adequate for the investment firm’s complexity, size and business model and reflects the different material drivers of liquidity risk, such as maturity mismatches, currency mismatches, derivatives transactions, off-balance sheet items and intraday liquidity risk;
• b. whether the investment firm has implemented adequate limits and monitoring systems that are consistent with its liquidity risk appetite;
• c. whether the risk limits are regularly reviewed by the competent bodies or control function of the investment firm and clearly communicated inside the firm;
• d. whether there are clear and transparent procedures regarding how compliance with individual liquidity risk limits is monitored and how limit breaches are handled (including clear escalation and reporting procedures); and
• e. whether the limit and control framework helps the investment firm to ensure the availability of sufficient liquid assets.