The Malta Financial Services Authority (MFSA) recently published a Dear CEO Letter following a thematic review on liquidity risk management and investment processes among Management Companies responsible for Alternative Investment Funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS) funds.
The review covered approximately 23% of authorised Management Companies in Malta during 2024, using desk-based assessments, supervisory meetings, and on-site inspections. Its aim was to assess the adequacy and effectiveness of liquidity risk management policies and operational practices across a representative sample of licensed Management Companies.
The 20-page letter provides regulatory insights into prevailing market weaknesses, supervisory expectations, and best practices for ongoing compliance. For boards, compliance officers, risk managers, and portfolio managers alike, it stresses the necessity of embedding robust liquidity risk frameworks into day-to-day operations—not merely as a formal requirement but as a fundamental pillar of sound governance and investor protection.
Why This Matters
From a regulatory standpoint, the letter explicitly requires all Management Companies to conduct and document a gap analysis based on the thematic review’s findings and recommendations. This documented analysis must be available to the MFSA upon request and may be examined in future supervisory interactions.
Management Companies are also urged to take necessary measures to align their processes, policies, and procedures with the Authority’s expectations. These measures should be proportionate and appropriate to the firm’s nature, size, and complexity.
Beyond compliance, liquidity risk management is critical for maintaining fund stability, especially during periods of market stress. Weaknesses in this area can damage investor confidence, amplify systemic risk, and expose firms to regulatory action and reputational harm.
Key Findings from the MFSA’s Review
The review found widely varying standards of practice. While some firms demonstrated mature, well-documented frameworks, others lacked sufficient rigor or clarity in key areas. The main themes identified include:
1. Governance and Oversight Require Strengthening
MFSA observed that Boards of Directors were often presented with liquidity risk reports focusing on quantitative metrics only, without qualitative explanations or meaningful recommendations from the Risk Management function. In some instances, Boards did not proactively respond to liquidity risks highlighted in liquidity stress testing reports, and escalation/reporting frameworks were unclear.
The Authority requires clear allocation of roles between Board, Committees, Risk, Compliance and Portfolio Management, documented escalation triggers for material liquidity issues, and regular, actionable reporting that leads to timely governance decisions — with Board‑approved policies reviewed at least annually.
The frequency of liquidity stress testing (LST) should be increased during exceptional market conditions to ensure fund liquidity profiles remain robust and consistent with redemption obligations. Testing methodologies must be clearly defined and based on prudent and conservative criteria.
The review also noted the following shortcomings:
- Lack of specific procedures for managing liquidity under stressed scenarios, such as contingency plans.
- Insufficient elaboration on the roles of the Board, Committees, and risk management functions.
- Lack of clarity on reporting formats and frequency to Boards.
- Absence of a clear framework for escalating liquidity concerns, especially when internal liquidity limits are breached.
Moreover, escalation procedures and active challenges from Investment Committee members were often insufficient.
Management Companies now also bear the responsibility to perform and document due diligence on suitability of Investment Committee members, ensuring decisions are made by qualified, fit individuals.
2. Liquidity Risk Frameworks Were Often Incomplete
Some firms did not maintain comprehensive, documented liquidity risk management policies tailored to their specific investment strategies and investor profiles. A number of UCITS managers were found to assume that listed securities had remained liquid without testing this, even when trading activity had fallen significantly.
Liquidity risk reports to Boards should be submitted frequently and clearly, explicitly including conclusions and recommendations from the Risk Management function. Boards should assess these reports and provide direction on liquidity management as appropriate.
Documented processes for escalating liquidity matters to the Board are vital. Such processes must ensure that material concerns—such as breaches of liquidity risk limits or mismatches between the fund’s liquidity profile and redemption demands—are reported without delay.
Management Companies must ensure implementation of liquidity contingency plans when necessary and monitor liquidity continuously to allow timely corrective actions.
3. Stress Testing Practices Were Weak or Inconsistent
While all firms conducted Liquidity Stress Testing (LST), the MFSA found some to lack sufficient complexity or robustness. Simplified assumptions not tailored to fund characteristics—for example, and redemption shock models not aligned with actual redemption behaviors—were common.
4. Inadequate Ongoing Monitoring of Liquidity
Liquidity assessments were often performed only at trade approval stages, with limited ongoing monitoring during the fund lifecycle, despite the fact that market conditions and investor behaviors can change rapidly.
The MFSA found that while 87% of Management Companies perform pre‑trade liquidity checks, over half rely on broad statements without clear methodologies, and 16% have no formal processes, especially for long‑term or illiquid assets and certain OTC instruments.
Some UCITS managers applied an automatic “liquidity presumption” to listed securities without verifying whether they had in fact become illiquid.
MFSA stresses that listing is only an initial indicator — all instruments, listed or not, must be subject to regular liquidity checks, and if an asset no longer meets UCITS eligible asset criteria, it must be reclassified and brought within the 10% limit on funds which can be invested in units of other UCITS Schemes or other collective investment schemes, with corrective action documented.
Firms are expected to document clear, fund‑appropriate procedures assessing both asset‑level liquidity (e.g., trading volumes, spreads) and portfolio‑level impact against redemption policies, supported by data and integrated into investment decision‑making. Liquidity analysis should be embedded into pre-trade assessments, portfolio monitoring, and redemption planning.
The MFSA advises that systematic ongoing liquidity monitoring using a blend of quantitative metrics (like liquidity and redemption coverage ratios) and qualitative insights is necessary to detect and mitigate emerging risks in a timely manner.
5. Integration Between Risk Management and Investment Teams Was Sometimes Weak
The MFSA noted limited interaction in some companies between portfolio managers and risk management functions, potentially causing misalignment between investment strategies and liquidity realities.
The letter encourages active, transparent collaboration between investment desks and risk officers. Liquidity considerations must be embedded effectively into portfolio construction, asset allocation, and redemption planning.
Other observations:
The review also made the following general observations:
- Suitability: Assessments of investment committee members often omitted checks on time commitment and conflicts; the MFSA requires comprehensive, documented diligence covering qualifications, independence, and potential conflicts.
- Succession: Some companies lacked plans for key person risk; proportionate, documented arrangements are expected to ensure operational resilience.
- Conflicts: Where persons held both economic interests and decision-making roles, firms must separate duties, add independent oversight, and ensure recusals or role changes if conflicts persist.
- ESG: Some Article 6 funds neither integrated sustainability risks nor justified this; firms should provide data‑based explanations for non‑integration or put in place formal, documented ESG risk assessment and mitigation processes.
Call to Action for Management Companies
The Dear CEO Letter clearly signals supervisory expectations requiring all Management Companies to conduct a thorough review and documented gap analysis of their liquidity risk management frameworks, policies, and operational procedures.
Specifically, firms must:
- Address any identified shortcomings either internally or highlighted by the MFSA.
- Strengthen Board engagement with liquidity oversight.
- Ensure senior management actively challenges and supports liquidity risk governance.
- Enhance stress testing procedures to better simulate realistic scenarios.
- Align investment decision-making processes closely with liquidity risk considerations.
Implications for AIF and UCITS Managers in Malta
The MFSA’s message is unequivocal: liquidity risk management is a key regulatory priority, and non-compliance or oversight gaps are unacceptable.
Though no formal enforcement measures are announced in this letter, failure to act may trigger focused supervisory inspections, enhanced scrutiny during licence applications or variations, and greater emphasis on liquidity governance in ongoing supervisory engagements.
Best Practices Moving Forward
The Dear CEO Letter outlines best practice standards, including:
- Board Engagement: Establish a regular agenda item for liquidity risk at Board and Committee meetings, ensuring active challenge and accountability at the highest level.
This keeps liquidity management at the forefront of strategic oversight, enabling directors to make informed decisions, track risk trends, and intervene promptly when metrics deteriorate.
- Clear Documentation: Maintain updated, fund-specific liquidity risk policies and procedures that reflect the specific nature of each fund under management.
Well‑crafted documentation supports day‑to‑day decision‑making, demonstrates compliance to regulators, and ensures there is no ambiguity in roles, responsibilities, or escalation processes.
- Scenario-Based Stress Testing: All firms conducted Liquidity Stress Testing (LST), but some used overly simplified or non‑fund‑specific assumptions, and it was unclear if frequency increased in stressed markets.
MFSA expects LST to be tailored to each fund’s strategy, use prudent and well‑documented assumptions, adjust frequency in volatile conditions, and inform both portfolio actions and contingency planning, with ongoing scenario/methodology reviews. Use a variety of stress scenarios covering market-wide shocks, sector downturns, and idiosyncratic events on key holdings.
Stress testing should incorporate multiple severe but plausible market scenarios, be performed at a frequency aligned with the complexity of the funds, and must meaningfully influence investment and contingency decisions.
The LST must be capable of informing portfolio decisions and contingency actions in both normal and stressed market conditions.
- Integrated Liquidity Consideration
The regulator emphasises that listing on a regulated market is only an initial liquidity indicator — managers must regularly assess all instruments and, if eligibility criteria are no longer met, reclassify them and bring them within UCITS investment limits while taking corrective measures.
- Cross-Functional Collaboration: Encourage dialogue among portfolio managers, risk officers, and compliance teams.
This ensures that liquidity considerations are not treated in isolation, but are embedded into trading decisions, risk assessments, and compliance monitoring, reducing the chance of blind spots and improving the fund’s ability to respond quickly to emerging risks.
- Investor Protection Focus: Recognise that strong liquidity frameworks are essential safeguards for investor confidence and market reputation.
By maintaining structures and processes that protect redemption rights and ensure fair treatment of all unit‑holders, firms uphold their fiduciary duty, preserve trust, and reduce the likelihood of reputational damage during market stress.
- Procedural checklists for LRMP/LSTP: Where pre-trade investment restriction checks are carried out on spreadsheets, the Authority recommends that a checklist reflecting the relevant investment restrictions and, where applicable, assessments of asset eligibility criteria done prior to investing is documented. That checklist should be signed off accordingly by the inputter and reviewer. Management Companies are also strongly advised to implement features to prevent accidental formula changes and data alterations. Additionally, the functionality and underlying workings of the spreadsheet should be periodically reviewed to ensure their continued accuracy and integrity.
Final Thoughts
This thematic review and MFSA letter emphasize that liquidity risk management is a fundamental fiduciary duty. In today’s volatile global markets, failure to manage liquidity effectively can cause more than regulatory penalties—it can undermine market stability and stakeholder trust in Malta’s fund sector.
The message is clear: Malta’s investment management community must integrate liquidity awareness deeply into their operating culture, and support it with robust policies and strong engagement from the boardroom all the way down to the trading desks.
