Liquidity management and redemption terms in open-ended credit vehicles
the AIFMD liquidity-management and stress-testing requirements (onshored in the FCA's FUND sourcebook); the FCA's liquidity reforms, including CP25/38 on enhancing fund liquidity risk management; the FSB's 2023 recommendations and IOSCO's 2025 recommendations on liquidity risk management; the ESMA guidelines on liquidity stress testing; and the Financial Policy Committee's work on open-ended-fund liquidity mismatch.
An open-ended or evergreen credit vehicle offers a redemption cycle its multi-year loans can’t match. It lets investors redeem on a set cycle, monthly, quarterly, sometimes more often, while the portfolio is loans that take years to mature and can’t be sold quickly at par. As long as subscriptions and repayments run ahead of redemptions, the promise is easy to meet: outflows come out of cash. Under stress it stops being easy. A fund that hasn’t designed for that moment finds the only way to meet a wave of redemptions is to sell its most liquid loans first, which leaves the investors who stayed holding a more concentrated, lower-quality book. That is liquidity mismatch, and it’s the vulnerability the Bank of England’s Financial Policy Committee comes back to most often when it talks about open-ended funds.
The regulators have answered with two linked demands. Choose and run the right liquidity management tools, calibrated to the fund’s actual assets rather than lifted from a template, so redemptions can be managed fairly under pressure. And hold a liquidity stress-testing file that shows the redemption promise matches the loan book under severe but plausible conditions. The framework has to be operated and tested, not just described in the prospectus.
There’s no single rule headed “open-ended credit fund liquidity”. The obligation is assembled from several layers that push the same way.
The foundation for an alternative investment fund is the AIFMD liquidity-management requirement, onshored in the FCA’s FUND sourcebook at FUND 3.6. A manager of an open-ended fund has to run an appropriate liquidity management system and adopt procedures to monitor the fund’s liquidity risk; it has to keep the liquidity profile of the investments consistent with the redemption policy; and it has to conduct stress tests, under both normal and exceptional conditions, that let it assess and monitor that risk. That last obligation is the legal root of the stress-testing file. It’s given detail by the ESMA guidelines on liquidity stress testing, onshored into the UK framework, which require managers to stress both the assets and the liabilities of their funds.
On top of that foundation sits an active reform programme, and a credit manager should be precise about which part of it reaches its funds. The Financial Stability Board issued revised recommendations in 2023 on structural liquidity mismatch in open-ended funds; IOSCO followed with recommendations on liquidity risk management in 2025; and the FCA is now tailoring both to the UK market through CP25/38 on enhancing fund liquidity risk management, which, following the Financial Policy Committee’s recommendation, pushes managers to have effective anti-dilution tools and to take account of liquidity costs when they use them.
Scope is where it gets specific. CP25/38 is aimed at UCITS schemes and non-UCITS retail schemes; LTAFs, qualified investor schemes and money market funds sit largely outside it, and the liquidity-management requirements for alternative funds are deferred to the 2026 AIFMD review. So for the typical private credit AIF the live obligations are the AIFMD ones at FUND 3.6, backed by the ESMA liquidity stress-testing standards, with the AIFMD-side reform still to come.
CP25/38 still signals the direction of travel, and its detail is worth reading even for funds outside its formal scope. It would require an anti-dilution tool to be available, calibrated for both explicit and implicit liquidity costs on a vertical-slicing basis, including the expected market impact of large sales, and back-tested at least annually for fairness between unitholders, with the conflict between remaining and redeeming investors expressly addressed — a provision the FCA describes as mirroring Article 32 of the AIFMD Level 2 regulation.
In the EU, AIFMD II already requires managers of open-ended funds to select at least two liquidity management tools from a harmonised list. And where a credit vehicle reaches a broader investor base through the Long-Term Asset Fund structure, the LTAF rules in COLL 15.8 impose their own discipline: valuation at least monthly, redemption no more often than monthly, a notice period of at least 90 days, and irrevocable redemption requests, because the asset class is illiquid.
All of it asks for the same thing: match the redemption promise to the real liquidity of the assets, and equip the fund so redeeming investors carry the cost of their own exit rather than passing it to the investors who stay.
Liquidity management tools come in three families, and the manager should make a reasoned selection rather than list the full menu unused.
Anti-dilution tools adjust the price at which investors deal, so the cost of meeting a transaction falls on the investor making it rather than on the fund. Swing pricing moves the dealing NAV to reflect the cost of buying or selling assets to meet net flows. An anti-dilution levy charges the transacting investor directly. Dual pricing sets different prices for subscriptions and redemptions. These are the tools the Financial Policy Committee and IOSCO have pushed hardest, because they go straight at the first-mover problem: the redeeming investor pays the liquidity cost, so the investors who stay aren’t diluted by someone else’s exit. For a credit fund, where raising cash quickly from a loan book is expensive and disruptive, a calibrated anti-dilution mechanism is close to essential. Calibration means estimating the real cost of liquidating loans under stress.
Quantity-based tools control how much can leave, and how fast. Notice periods make investors give warning before they redeem, buying the manager time to raise cash in an orderly way. Redemption gates cap the share of the fund that can be redeemed at any dealing point, spreading large outflows over time. Deferred redemption pushes part of a redemption to a later date. In a redemption wave, quantity-based tools buy time. A credit fund’s redemption frequency, notice period and gate should be set together, as one system tuned to how quickly the book can generate cash.
Extraordinary tools are the last resort. Suspension halts dealing altogether. Side pockets segregate illiquid or impaired assets, so redeeming investors can’t take the good assets and leave the bad ones behind, and so the valuation uncertainty of a stressed loan doesn’t distort the dealing NAV. Redemption in kind hands over assets instead of cash. Last-resort tools need pre-defined triggers set before a crisis, not improvised in one.
| Tool family | What it does, and where it fits a credit fund |
|---|---|
| Anti-dilution: swing pricing, anti-dilution levy, dual pricing | Makes the redeeming investor bear the liquidity cost. The regulators’ preferred first line; the work is calibrating it to the real cost of liquidating loans. |
| Quantity-based: notice periods, gates, deferred redemption | Buys time and spreads outflows. Set as one system with redemption frequency, matched to how fast the book generates cash. |
| Extraordinary: suspension, side pockets, redemption in kind | Last-resort protection for remaining investors. Defined in advance, used in real stress, side pockets especially for impaired loans. |
Selecting from the toolkit is a reasoned exercise. The manager picks the tools that suit the fund’s assets and investor base, records why each was chosen and how it’s calibrated, and makes sure they’re not just named in the fund documents but operable in practice, with the data, the governance and the decision rights defined so a tool can be deployed quickly and fairly when it’s needed.
Disclosure is the other half of selection, and the international standards have moved it to the centre. IOSCO and the FCA expect a fund to tell investors, clearly, which liquidity management tools it may use and the circumstances in which it would use them, so an investor knows before subscribing that redemptions might be swung, gated, deferred or suspended. Disclose the toolkit and its triggers up front, then apply the tools in line with what was disclosed. A disclosed tool applied as disclosed is not a surprise to investors.
The stress-testing file is where a credit manager shows that the redemption promise and the loan book are compatible. The stress-testing file is frequently requested and often incomplete. The requirement is to stress both sides of the balance sheet.
On the asset side, the file tests how quickly, and at what cost, the loan book could be turned into cash. That’s harder for credit than for traded assets, because there’s no screen price. The manager has to model how much of the book could be sold, repaid or refinanced over various horizons, and at what discount to carrying value in a stressed market, remembering that in a crisis the most liquid loans go first and what’s left gets progressively harder to move. The output is a realistic liquidation profile.
On the liability side, the file tests redemption behaviour. That means modelling plausible and severe redemption scenarios: investor concentration, the risk that large investors redeem together, the correlation of redemptions with market stress, and the effect of any preferential liquidity terms granted in side letters. A fund with a handful of large investors who could all leave at once has a very different liability profile from a granular one, and the file has to reflect that.
The two sides then come together, and the updated standards give the manager a vocabulary for it. The central measure is a redemption coverage ratio that combines both sides to show whether the liquidity available matches the liquidity demanded under stress. Around it sit the disciplines the updated liquidity-stress-testing standards expect: systematic liquidity bucketing of the assets; internal triggers for both large single redemptions and the cumulative effect of smaller ones, rather than reliance on a third-party administrator; the inclusion of non-redemption pressures such as margin and collateral calls; and a contingency funding plan for extreme but plausible stress. The question underneath all of it is whether, under a severe but plausible scenario of the kind the Bank of England’s system-wide exploratory scenario describes, a global shock tipping into a deep recession, the fund could meet its redemptions without disadvantaging the investors who remain, and if not, which tools would be deployed, when, and to what effect. Good practice adds reverse stress testing, working backwards to the redemption level at which the structure fails, so the manager knows its breaking point. The file should be dated, governed, and signed off by the board or the relevant committee, then refreshed on a cycle and after any material change, so it stays a live assessment rather than a one-off.
The stress test should inform redemption terms and tool design. Redemption terms, notice periods, gates and anti-dilution calibration should all be set in light of what the stress testing shows, so the fund’s promise rests on tested tools and assets rather than optimism.
Don’t promise more liquidity than the assets can support. A book of multi-year private credit can’t offer daily or even monthly liquidity without leaning heavily on gates and anti-dilution, and the further a fund’s redemption terms run ahead of its asset liquidity, the more it depends on those tools working perfectly under stress, which is exactly the moment they’re hardest to use. Aligning dealing frequency and notice periods to the book’s real liquidity — the LTAF principle — is the strongest protection, and the one a stress-testing file tends to point toward.
This runs straight into fairness between investors. The whole point of anti-dilution tools and fair application of the LMTs is that the investor who redeems in stress bears the cost of their own liquidity, so the investors who stay aren’t quietly subsidising the exit. It’s also why preferential liquidity terms in side letters are so damaging to an open-ended credit fund. An investor with shorter notice or a gate exemption can get out ahead of everyone else, taking the liquid assets and the better price — the first-mover advantage the whole liquidity framework exists to neutralise. Preferential liquidity side letters must not undercut the tools that protect other investors.
This insight is provided for general informational purposes only and doesn’t constitute legal, investment, or regulatory advice.