The Financial Conduct Authority (FCA) has proposed steps to address the liquidity mismatch in open-ended investment funds that has led to numerous fund suspensions in recent years, including the implementation of a 180-day notice period for consumers redeeming investments.

Open-ended property funds across the IA Direct Property sector are currently suspended owing to material uncertainty in valuing their assets amid the fallout from the coronavirus pandemic.

However, previous waves of suspensions, notably including the one seen in the wake of the 2016 Brexit referendum, were linked to mass redemptions that managers were unable to facilitate as a result of the inherently illiquid nature of the funds’ underlying assets.

Open-ended funds have been under the scrutiny of the FCA and the Bank of England for some time, with the regulators previously suggesting notice periods and swing pricing as possible remedies for their “structural mismatch”.

Previous changes to open-ended funds mean that from 30 September, authorised property funds will be forced to suspend when there is material uncertainty over the valuation of more than 20% of their assets.

The FCA now argues that investors in UK authorised property funds, registered as non-UCITS retail schemes (NURS), should be subject to a notice period of 90 to 180 days when withdrawing their capital.

In a consultation paper published today (3 August), the FCA argued that the imposition of a notice period would mean fund managers “could plan sales of property assets so that it could meet redemptions as they fall due”, meaning that managers “better able to plan when to invest or to make asset sales without needing immediately to meet any unexpected requests”.

The FCA also said the change would mean property funds “could tolerate holding less cash than they do currently”, with the relatively high average cash weightings having been a contentious aspect of the sector in recent years, “enabling this money to be invested into property or other permitted assets”.

“It would also send a clear signal to investors in these property funds that they are intended for medium-term to long-term investment,” the FCA said.

“Future investors would better understand that these funds do not truly offer daily, monthly or even quarterly liquidity.

The FCA conceded that the change would not “necessarily solve all the liquidity issues in property funds, or mean that such funds would never suspend dealings”, warning that in periods of “severe market stress” the notice period “may still not be sufficient to give fund managers time to sell the necessary property”.

‘Requests irrevocable’
Practically, the notice period process would see relevant funds’ redemption requests “received and recorded, then processed at the end of a notice period”, the FCA proposed.

It explained: “The investor would receive the value of their investment, based on the unit price of the fund at the first valuation point following the end of their notice period.

“Redemption requests would be irrevocable, so that investors cannot place orders and withdraw them before the end of the notice period if market conditions change.”

Notably, the FCA proposes that the price at which the redemption takes place would be based on the first valuation of the fund at the end of the notice period, meaning that redeeming investors “would be subject to greater ‘market risk’ than they are now”.

The FCA said this is a “fair way to balance the interests of all investors in such funds”.

It added: “We estimate that the introduction of notice periods could potentially deliver a material increase in returns to property fund investors.

“This is due to the funds operating in a more stable and sustainable way, with more assets invested in property and less in cash.”

The FCA said it would continue to work with the Bank of England on the issue of illiquid assets in open-ended funds, and will consult “on any further remedies, if appropriate”, after the conclusion of the current work being undertaken by the Financial Policy Committee.

Feedback on the proposals is expected by 3 November 2020 at the latest, and the FCA will publish a policy statement with final rules as soon as possible in 2021.

Interim chief executive of the FCA Christopher Woolard said: “We think that our proposals will help further our consumer protection objective by reducing the number of fund suspensions, preventing unsuitable purchases of funds, and by increasing product efficiency for fund managers.

“We want open-ended funds to provide a structure through which investors can safely invest in less liquid assets which offer attractive expected returns and at the same time supports investment that benefits the wider economy.

“We hope the proposed new rules will directly address the liquidity mismatch of these funds making them more resilient during periods of stress, and allowing them to operate in a way that all investors are treated equally.”

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