Daily Dealing Meets Illiquid Assets: When Does a Liquidity Mismatch Arise?
An open-ended fund offers daily redemptions – while part of the portfolio becomes difficult or even impossible to trade. What happens when asset liquidity and the liquidity available to investors begin to diverge?
For asset managers, this question is more relevant than ever. Since 1 March 2024, Swiss regulation expressly requires the liquidity of a collective investment scheme to be appropriate in relation to its investments, investment policy, risk diversification, investor base and redemption frequency. A two-year transitional period applied to existing collective investment schemes; this period has now expired.
Daily Dealing versus Asset Liquidity
Daily redemption rights do not automatically mean that every individual portfolio position must be capable of being liquidated on a daily basis.
The key question is whether the fund's overall liquidity profile is compatible with its redemption terms and its potential obligations towards investors.
This is where the classic liquidity mismatch arises: investors may request liquidity while certain portfolio positions can only be sold with a delay, at significant price discounts or, temporarily, not at all.
The regulatory requirements therefore go well beyond a point-in-time assessment. The explanatory provisions relating to the CISO provide, among other things, for liquidity stress testing. Factors such as the investment policy, underlying assets, fund size, redemption terms and investor base should be taken into account when designing such tests. Scenarios involving exceptional market conditions should also be considered.
Side Pockets: When Individual Assets Become Illiquid
Since 1 March 2024, Article 110a CISO provides an explicit legal basis for side pockets.
Individual illiquid assets of a collective investment scheme may be segregated from the remaining portfolio. However, this does not happen automatically. FINMA may approve such segregation upon a reasoned request from the fund management company or SICAV where an exceptional situation exists, the measure is in the interests of the investors as a whole, and the fund contract or investment regulations provide for side pockets. The decision must subsequently be published.
The Federal Council's explanatory materials are even more specific: side pockets may be particularly relevant where a material and clearly identifiable part of the portfolio has become illiquid for an indefinite period. Because of the impact on investors' rights, they should only be used in exceptional circumstances and, in principle, as an ultima ratio.
The benefit is that individual illiquid positions do not necessarily have to block the liquidity of the remaining liquid portfolio. Investors retain the same proportional participation in the segregated portfolio as they held at the time of segregation.
Liquidity Risk Management Starts Earlier
For precisely this reason, side pockets are not a substitute for forward-looking liquidity risk management.
The key questions arise much earlier, during portfolio construction: How liquid are the assets under normal and stressed market conditions? How quickly could larger positions actually be sold? What does the investor base look like? And does this align with the fund's redemption frequency?
FINMA's recent supervisory activities demonstrate that it is focusing closely on these issues. FINMA conducted its own liquidity stress tests for Swiss investment funds for the first time. In the tests conducted in 2025, under the stress scenario applied, 8.2% of the bond funds examined and 3.3% of the equity funds examined had insufficient liquidity. FINMA carried out more detailed investigations in relation to the affected funds.
Conclusion
A liquidity mismatch does not begin only when an asset can no longer be traded.
For asset managers, the key issue is whether the portfolio's liquidity remains compatible with the fund's redemption frequency and investor base even under stressed conditions.
Side pockets may provide an instrument for individual assets that have become illiquid in exceptional circumstances. However, the regulatory threshold for their use is deliberately high.
The central question for portfolio management is therefore:
How resilient is the fund when investors demand liquidity precisely when the market is no longer providing it?
Peak Compliance AG specialises in outsourcing solutions in Compliance and Risk Management for portfolio managers and managers of collective assets in Switzerland and Liechtenstein.
