Guidelines on Liquidity Risk Management for Finance Companies and Units

1 | P a g e CIRCULAR F. No 172/ IFSCA/Finance Company/Unit Regulations/2021-22/7 June 24, 2021

To, All Finance Companies’ / Finance Units in the International Financial Services Centre (IFSC)

Subject: Guidelines on Liquidity Risk Management for a Finance Company/Finance Unit. The Finance Companies/Finance Units may draw reference to sub-regulation (3) of regulation 4 on Liquidity Coverage Ratio (LCR), of the International Financial Services Centres Authority (Finance Company) Regulations, 2021 (herein referred to as ‘Regulations’) dated March 25, 2021 issued by the Authority. 2. The ability to fund assets and meet obligations as they come due, is critical to the viability of a financial institution. In this context the Liquidity Risk Management framework ensures that the Finance Company/Finance Unit(FC/FU) anticipates liquidity needs and is prepared to meet them. The Authority directs the FC/FU in the International Financial Services Centres (herein referred to as ‘IFSCs’) to adhere to the following guidelines on Liquidity Risk Management. 3. Applicability: 3.1 These guidelines shall be applicable to all FC/FUs registered with the Authority under regulation 3 of the Regulations and intending to undertake activities as mentioned in point 5 and point 6 of the Schedule therein, viz;

• (i) Undertaking one or more core activities with or without non-core activities, and;
• (ii) Undertaking specialized activities with or without core or non-core activities. Further as per sub-regulation (3) of regulation 4 of the Regulations a FU may be allowed to maintain LCR at the parent entity level with specific approval of the Authority.

2 | P a g e Section I Liquidity Risk Management

4. The FC/FU shall have a liquidity risk management framework in order to ensure a sound and robust liquidity risk management system and ensure that it maintains sufficient liquidity. This framework shall be framed by the Board/Governing Body of the FC/FU and shall be in adherence to Basel document titled “Principles for Sound Liquidity Risk Management and Supervision” dated September 2008. Further, the FC/FU shall adhere to the broad principles laid down by the above mentioned Basel document (to the extent applicable and in tune with the nature scale and complexity of their business) with respect to governance of liquidity risk management and measurement and management of liquidity risk. These principles shall be adopted in letter and spirit and whenever subject to supervisory review the FC/FU shall be in a position to demonstrate that the principles are adopted satisfactorily while managing its liquidity risk.
5. Maturity profiling

• (a) For measuring and managing net funding requirements, the use of a maturity ladder and calculation of cumulative surplus or deficit of funds at selected maturity dates shall be adopted as a standard tool. The Maturity Profile should be used for measuring the future cash flows of the FC/FU in different time buckets. The time buckets shall be distributed as under:
  • (i) 1 day to 7 days
  • (ii) 8 days to 14 days
  • (iii) 15 days to 30/31 days (One month)
  • (iv) Over one month and upto 2 months
  • (v) Over two months and upto 3 months
  • (vi) Over 3 months and upto 6 months
  • (vii) Over 6 months and upto 1 year
  • (viii) Over 1 year and upto 3 years
  • (ix) Over 3 years and upto 5 years
  • (x) Over 5 years
• (b) Within each time bucket, there could be mismatches depending on cash inflows and outflows. While the mismatches up to one year would be relevant since these

3 | P a g e provide early warning signals of impending liquidity problems, the main focus shall be on the short-term mismatches, viz., 1-30/31 days. The net cumulative negative mismatches in the Statement of Structural Liquidity in the maturity buckets 1-7 days, 8- 14 days, and 15-30 days shall not exceed 05%, 10% and 20% of the cumulative cash outflows in the respective time buckets. FC/FUs, however, are expected to monitor their cumulative mismatches (running total) across all other time buckets upto 1 year by establishing internal prudential limits with the approval of the Board/Governing body. FC/FUs shall also adopt the above cumulative mismatch limits for their structural liquidity statement for consolidated operations.

• (c) The Statement of Structural Liquidity shall be prepared by placing all cash inflows and outflows in the maturity ladder according to the expected timing of cash flows. A maturing liability shall be a cash outflow while a maturing asset shall be a cash inflow.
• (d) In order to enable the FC/FU to monitor their short-term liquidity on a dynamic basis over a time horizon spanning from 1 day to 6 months, The FC/FU shall estimate their short-term liquidity profiles on the basis of business projections and other commitments for planning purposes.

6. Measurement of Liquidity risk The FC/FU shall monitor certain critical ratios in respect of liquidity risk measurement by putting in place an internally defined limit approved by the Board/Governing Body, for these ratios. The ratios and the internal limits shall be based on an FC/FU’s liquidity risk management capabilities, experience profile and the nature, scale and complexity of their business. The ratios that FC/FU shall monitor shall include but shall not be limited to the following:

• (a) short term$^1$ liability to total assets
• (b) short term liability to long term assets
• (c) Non-convertible debentures to total assets
• (d) short term liabilities to total liabilities
• (e) long term assets to total assets

$^1$ Less than one year

4 | P a g e Section II

A. Liquidity Coverage Ratio

A.1 Definitions

7 For the purpose of this circular, unless the context otherwise requires, the terms herein shall bear the meanings assigned to them below:

• (a) “High Quality Liquid Assets (HQLA)” shall mean liquid assets that can be readily sold or immediately converted into cash at little or no loss of value or used as collateral to obtain funds in a range of stress scenarios.
• (b) Liquidity Coverage Ratio (LCR) shall represented by the following ratio:

$$\frac{\text{Stock of High Quality Liquid Assets (HQLAs)}}{\text{Total Net Cash Outflows over the next 30 calendar days}}$$

• (c) “Unencumbered” shall mean free of legal, regulatory, contractual or other restrictions on the ability of the FC/FU to liquidate, sell, transfer, or assign the asset.

A.2 LCR framework

8. • (a) A FC/FU shall maintain an adequate level of unencumbered HQLA that can be converted into cash to meet its liquidity needs for a 30 calendar-day time horizon under a significantly severe liquidity stress scenario, as specified in these guidelines.

• (b) While the LCR is expected to be met in a single currency, FC/FU are expected to be able to meet their liquidity needs in each currency and maintain HQLA consistent dengan [unclear in source] the distribution of their liquidity needs by currency.
• (c) For the purpose of reporting, LCR shall be reported in USD.

9. The LCR shall be minimum 100% (i.e., the stock of HQLA shall at least equal total net cash outflows) on an ongoing basis. However, during a period of financial stress, the FC/FU shall have the option to use their stock of HQLA and thereby allow LCR to fall below 100%. The Authority shall be immediately reported with respect to use of such stock of HQLA along with reasons for such usage and corrective steps initiated to rectify the situation.
10. The stress scenario for LCR intends to cover a combined idiosyncratic and market-wide shock that would result in:

• (a) a partial loss of unsecured wholesale funding capacity;
• (b) a partial loss of secured, short-term financing with certain collateral and counterparties;

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• (c) additional contractual outflows that would arise from a downgrade in the FC/FU’s credit rating;
• (d) increases in market volatilities that impact the quality of collateral or potential future exposure of derivative positions and thus require larger collateral haircuts or additional collateral, or lead to other liquidity needs;
• (e) scheduled draws on committed but unused credit and liquidity facilities that the FC/FU has provided to its clients; and,
• (f) the potential need for the FC/FU to buy back debt or honor non-contractual obligations in the interest of mitigating reputational risk.

11. High Quality Liquid Assets

11.1 Liquid assets comprise of high quality assets that can be readily sold or used as collateral to obtain funds in a range of stress scenarios. They shall be unencumbered. Assets are considered to be high quality liquid assets if they can be easily and immediately converted into cash at little or no loss of value. The liquidity of an asset depends on the underlying stress scenario, the volume to be monetized and the timeframe considered. Nevertheless, there are certain assets that are more likely to generate funds without incurring large discounts due to fire-sales even in times of stress. 11.2 The fundamental characteristics of HQLAs include low risk (i.e. credit risk, market risk, legal risk or other associated risks); ease and certainty of valuation; low correlation with risky assets and listing on a developed and recognized exchange market. 11.3 The market related characteristics of HQLAs include active and sizeable market; presence of committed market makers; low market concentration and flight to quality (tendencies to move into these types of assets in a systemic crisis). 11.4 All assets in the stock of liquid assets must be managed as part of that pool by the FC/FU and shall be subject to the following operational requirements:

• (a) must be available at all times to be converted into cash;
• (b) shall be unencumbered;
• (c) shall not be co-mingled/ used as hedges on trading position; designated as collateral or credit enhancement in structured transactions or designated to cover operational costs;
• (d) shall be managed with sole intent for use as a source of contingent funds; and,

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• (e) shall be under the control of specific function/s charged with managing liquidity risk of the FC/FU.