The impact of the liquidity management and leverage regulations enacted in the AIFMD and the CRD IV on the investment services industry in Malta

Abstract

The financial crisis of 2007 and the subsequent liquidity crisis tested the adequacy of risk assessment both on markets and firms. The use of complex financial products combined with excessive leverage resulted in difficulties to unwind positions. The lack of proper governance structures as well as the fundamental failures that resulted in a shortage of market liquidity led regulators to develop new risk management safeguards to ensure that risk is managed coherently. The proposed regulatory initiatives require the implementation of documented policies with clear reporting lines in order to prevent failures within firms and to mitigate the systemic risk that may arise out of contagion. Regulatory initiatives focused on requiring a risk management function that has the responsibility to assess, monitor and manage risk independently from the other operational functions. Through stress testing that analyses the impact of extreme events on a firm’s portfolio, the effectiveness of regulation was increased. More importance has been placed on the risk manager who needs to liaise with the board of directors and other parties such as the portfolio manager to determine appropriate risk limits in line with the Licence Holder’s strategy. Moreover, new requirements were introduced to measure and report the leverage of a portfolio. In addition, new quantitative liquidity reporting requirements were introduced to enhance transparency and allow supervisors to better monitor risk. The new legislative provisions may however result in increased costs to firms, as they have to employ qualified risk managers and implement Information Technology infrastructures that are capable of meeting the complexity of reporting obligations. The study considers the implications on investors and Licence Holders of the changes in liquidity management and leverage regulations brought about by European Directives. An analysis of the application of the proportionality principle is conducted to provide recommendations on the application of the Directives in the local context.