The FCA (Financial Conduct Authority) is consulting on new rules that aim to better protect investors in funds that hold illiquid assets.
The proposed new measures come more than two years after the run on commercial property funds that took place following the vote to leave the EU. Following the vote in July 2016, access to half of the £25 billion Investment Association property sector was frozen, with various firms including M&G and Henderson taking measures to prevent investors from withdrawing their money.
At the time, fund suspensions were put in place to halt large-scale investor redemptions and thereby to avoid firesales of assets, which would have negatively impacted investors who remained.
While, on the whole, the FCA said the suspensions worked in this respect, it believes some lessons need to be learnt. In light of this, it has proposed additional new measures to better safeguard investors in funds that hold illiquid assets.
If introduced, the measures will force fund managers to draw up contingency plans for ‘exceptional circumstances’ and provide investors with more information about the liquidity risks that come with investing in a fund that predominantly holds illiquid assets.
In addition, the FCA has also called for fund managers to suspend dealing before running down liquidity (the fund’s cash weighting), if it is in investors’ best interests. It adds that fund managers should suspend a fund when a valuer has uncertainty about the price of 20 percent of the fund’s assets.
The FCA adds that greater clarity around fund suspensions should also produce a fairer balance between the interests of investors wishing to remain invested and those wishing to sell their units. As a result, it is hoped there will be less incentive for some investors to try to gain a ‘first mover advantage’ by redeeming their units quickly under stressed market conditions.
Christopher Woolard, executive director of strategy and competition at the FCA, says: ‘As well as better protecting consumers, these changes should help to protect and enhance the integrity of the UK financial system. They will increase investors’ understanding of, and confidence in, how funds holding illiquid assets are managed.’
He adds: ‘We expect these changes to result in fewer runs on funds holding illiquid assets, and to reduce complaints from retail investors about perceived unfair treatment when they exit such funds.’
The FCA’s proposals were welcomed by Ryan Hughes, head of active portfolios at AJ Bell. According to Hughes, the measures, if introduced, will mean that property funds (and other funds investing in illiquid assets) are likely to suspend trading sooner and potentially more frequently than they have in the past.
He adds: ‘This isn’t necessarily a bad thing: the rule would make it fairer for investors in those funds and would stop the “first mover advantage”, where the first tranche of investors can cash out while those who redeem after them are stuck in the fund.
‘It will also make the “fair value adjustment” or “market value adjustments” we saw from property funds after the referendum vote become a thing of the past, as the funds would just suspend trading in these circumstances.’
Following the Brexit vote investors rushed to sell, amid fears of a negative impact on both commercial and residential property prices.
In such times it is difficult for directly invested open-ended commercial property funds to meet withdrawals. This is because these commercial property funds own a portfolio of individual properties, and sales are not quickly or easily arranged, particularly in times of market uncertainty. It is therefore hard to raise money quickly. There is also the risk of sales being agreed at much-reduced prices in order to raise funds.
Fears of a collapse in property values proved unfounded after the EU vote, however, as a couple of months later the vast majority of property funds re-opened their doors. Since the suspensions, commercial property funds have responded by increasing their cash weightings.
The consultation remains open to responses until 31 January 2019.