On 4 September 2023, the European Systemic Risk Board (ESRB) published an issues note on policy options to address risks in corporate debt and real estate investment funds from a financial stability perspective.

The issues note sets out a high-level approach to addressing risks in investment funds that invest in assets which are either inherently illiquid or might become illiquid in times of stress. In particular, the issues note provides an overview of the EU corporate debt and real estate investment fund sector. It also explores fund structural vulnerabilities that could increase systemic risk and assesses the degree to which those vulnerabilities and related systemic risks are currently targeted by the regulatory framework. The issues note also identifies areas of the investment fund framework that should be strengthened and considers how existing or new prudential tools could be used to further address residual systemic risks.

In terms of improving investment fund resilience by adapting certain policy tools, the issues note provides that:

• Structural liquidity mismatch in real estate funds and other funds which invest in inherently illiquid assets could be reduced by ensuring closer alignment between the fund’s redemption terms and its investment strategy. This could be achieved by introducing longer notice periods as well as lower redemption frequency. Also, the risks associated with high demand for redemptions could be mitigated by setting up such funds as closed-end funds.
• Financial stability could benefit if investment funds used anti-dilution liquidity management tools, such as swing pricing, dual pricing, anti-dilution levies or redemption fees, as part of their day-to-day management. This would mitigate first-mover advantage as well as the negative connotations of using such tools only in a crisis.
• Leveraged funds could increase their preparedness for cash needs stemming from margin and/or collateral calls in derivative and repo transactions by holding appropriate liquidity buffers, which could be calibrated through stress testing.

The ESRB welcomes the provisional agreement reached by the European Parliament and the Council of the European Union in the context of the review of the Alternative Investment Fund Managers Directive and the Undertakings for Collective Investment in Transferable Securities Directive. Once adopted, several new provisions will serve to enhance the regulatory and supervisory framework for investment funds from a financial stability perspective.