Insight / Blog
Liquidity Management Tools: New ESMA Guidelines
23.04.2025
Jan De Spiegeleer
CEO
Ruben Kerkhofs
Executive summary
What you need to know
On April 15th, 2025, the European Securities and Markets Authority (ESMA) finalized its final report on the guidelines on the selection and calibration of Liquidity Management Tools (LMTs) applicable to UCITS and open-ended AIFs. The guidelines are mandated under the revised UCITS Directive and AIFMD, requiring fund managers to select and calibrate a minimum of two LMTs – One quantitative LMT and one ADT (Anti-Dilution Tool) – to manage redemptions under both normal and stressed market conditions.
The key words in the final report are calibration and monitoring. All LMTs need to have a solid quantitative foundation. Fund managers should review existing liquidity frameworks and disclosures now to ensure full compliance ahead of the RTS effective date.
Who is in scope and what is the timeline?
These guidelines apply to both UCITS, and open-ended AIFs managed within the EU. They come into effect alongside the Regulatory Technical Standards (RTS) on LMT characteristics. For existing funds, the guidelines must be applied within 12 months from the RTS application date. National Competent Authorities (NCAs) are required to notify ESMA of their compliance within two months of official publication.
What are Liquidity Management Tools?
Liquidity Management Tools (LMTs) are used by funds to manage redemption pressure and liquidity risk. These are typically implemented to ensure a fair treatment of investors whilst preserving the fund’s stability and reducing the risk of forced asset sales.
Under the ESMA guidelines, Liquidity Management Tools are grouped into two main categories: (1) Quantitative-based LMTs, and (2) Anti-Dilution Tools (ADTs). Quantitative LMTs manage the liquidity risk of a portfolio through the volume and timing with which investors can exit the fund, whereas ADTs are mainly used to adjust pricing or cost allocation to ensure that redeeming (or subscribing) investors bear the true cost of their transactions. This true cost incorporates both implicit and explicit costs of the fund flows.
Even though the guidelines provide some recommendations on which LMTs/ADTs to use, the Q&A clearly stresses that the selection of LMTs is to the discretion of the fund manager and the technical standards shall not restrict the ability of managers to use any appropriate liquidity management tool. However, LMTs that are not part of the official list do not count towards the requirement to have at least one quantitative-based LMT and one ADT.
Quantitative LMTs
The ESMA guidelines provide a list of LMTs that can be used to manage the volume and timing of redemptions.
Anti-Dilution Tools
Besides the quantitative LMTs, fund managers should also consider the selection of at least one ADT for all types of funds to mitigate material investor dilution and potential first mover advantage. The activation levels of ADTs should be set in advance and properly monitored under normal and stressed market conditions. In cases of limited market liquidity and/or valuation uncertainty, it can be challenging to activate ADTs. In these cases, fund managers may consider the use of other quantitative-based LMTs.
ADTs need to be applied in both normal and stressed market conditions to impose the estimated costs of liquidity on subscribing and/or redeeming investors. The estimated cost of liquidity should include both explicit and implicit transaction costs using, for example, the slippage methodology. It should also be based, as a starting point, on costs associated with transacting a pro-rata slice of all assets in the portfolio, unless this does not fairly reflect actual liquidity costs. The calibration of LMTs should be regularly reviewed and adjusted if needed.
The ESMA guidelines provide a list of both quantitive & anti dilution LMTs
Liquidity Management Tools (LMTs)
Quantitative LMTs
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Only in exceptional cases should the manager activate suspensions. The guidelines provide some non-exhaustive examples of such exceptional circumstances like asset valuation difficulties, severe liquidity issues, a critical cyber incident, and others. Suspensions are considered the most restrictive LMT and should only be used as a last resort.
Specifically in the case of uncertain valuations, the suspensions may include the suspension of the NAV calculation. Fund managers must further ensure that suspensions are only activated on a temporary basis meaning that the goal should be to re-open the fund, liquidate it, or activate side pockets, if necessary, at a certain point in time.
Relevant calibrations for suspensions should include (1) the criteria for assessing and monitoring the conditions that prompt their activation, and (2) the criteria for reviewing and potentially revising the decision to suspend.
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According to the guidelines, a maximum level of redemption in each time period (redemption gate) should be considered for all funds, as assets could potentially suffer from liquidity issues during stressed market conditions. The application of this LMT could avoid the need for suspensions and is particularly relevant for funds with concentrated investor bases or portfolios prone to liquidity deterioration in stress scenarios. The application of redemption gates when there is valuation issues may be less suited. In that case, fund managers may still consider the use of suspensions including a NAV suspension.
The activation threshold should be calibrated based on, among others, the NAV calculation frequency, the investment objective of the fund, the liquidity of the underlying assets, the current market conditions, and the expected cash flows. There is no need to restrict the maximum period for redemption gates as long as they remain temporary in nature. It is at the fund manager’s discretion to determine these matters on a case-by-case basis.
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This LMT provides additional time to the asset manager to prepare for an orderly entry or exit of a client into the portfolio at a given date in the future. This extra time granted to the portfolio manager facilitates the adjustment of the portfolio. Particularly, this should be considered by funds whose liquidity is particularly susceptible to deteriorations in stressed market conditions and AIFs with less liquid assets (like real estate and private equity).
Anti-Dilution Tools
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Funds that invest in assets with a fixed, transparent and/or foreseeable transaction cost, such as real estate agencies or notary fees, and funds that invest in less liquid assets should consider the application of redemption fees. The methodology for calibrating the predetermined range of redemption fees should reflect higher cost of liquidity for stressed market conditions.
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Fund managers should consider the selection of swing pricing for funds whose underlying assets are actively traded and information on trading costs is available and frequently updated. The swing pricing model foresees a correction of the NAV whenever a redemption or subscription triggers a specified threshold. Subscribers into the fund will pay more than the NAV for the dealing date whereas a redemption takes place at a price below the NAV. This threshold for the swing factors is also subject to calibration. Hence it may be applied but the fund manager should be able to justify this on an ex-post basis.
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Dual pricing, in which a fund lists both a ‘bid’ and an ‘ask’ price can be used by funds investing in assets whose liquidity cost are reflected primarily by a bid-ask spread. However, fund managers should still account separately, by additional adjustments to the NAV, any significant market impact or explicit transaction costs.
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Funds with high investor concentrations, significant levels of subscriptions and/or redemptions, investing in less liquid assets (high-yield bonds, small cap), or where information on trading costs is generally available, should consider the use of an ADL which is a variable levy (fee) applied to the fund NAV (mid-price) increasing the price paid by subscribers and reducing the amount received by redeemers. The ADL can be either activated on a continuous basis or dynamically based on pre-defined triggers. The calibration of the ADL should be reviewed in relation to changing market conditions and should include all estimated implicit and explicit transaction costs.
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Only in exceptional circumstances should fund managers consider the activation of side pockets. Again, the ESMA provides a non-exhaustive list of examples including fraud, financial crises, or wars affecting a particular sector or region. In the calibration of side-pockets, fund managers should consider the circumstances for activating them, setting the criteria for assessing and monitoring these conditions, the merit of placing some cash to manage potential liabilities on the side pockets, and the criteria for reviewing and potentially revising the side-pocket decision. Side pockets must be appropriately disclosed in fund documents, and their activation should not permanently impair investor redemption rights for the liquid portion of the fund.
What about disclosures to investors?
One of the most notable changes in the final guidelines relates to disclosures to investors. In earlier drafts, the ESMA had proposed detailed requirements for disclosing LMTs including activation thresholds, LMT policies and even elements of internal governance. This was met with a lot of resistance by the respondents to the ESMA’s earlier consultation paper. This criticism has resulted in the removal of these disclosure-specific guidelines in the final text.
However, the removal from the guidelines does not remove the obligation to disclose as existing Level 1 legislation (i.e., the UCITS directive and AIFMD) already mandates disclosures. Under the amended AIFMD (2024), an AIFM must make available to investors a detailed description of the AIF’s liquidity risk management, including redemption rights in normal and exceptional circumstances and the use of liquidity management tools. The AIFMs managing open-ended funds are also required to periodically disclose any material changes in liquidity arrangements through annual reports or investor updates.
The UCITS regulation likewise mandates a disclosure of the fund’s redemption policy and liquidity tools. The fund’s prospectus or constitutional documents must set out the redemption rights of investors under normal and exceptional circumstances, and any ability to activate LMTs.
Conclusion
The ESMA guidelines on LMTs is a step forward towards a unified framework for liquidity risk management in UCITS and open-ended AIFs. Fund managers are now required to select appropriate tools and to align governance, documentation, and disclosure practices with their selected LMTs and ADTs. The guidelines require specific attention for the implementation of monitoring tools and model validations under both normal and stressed market conditions.
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