Following completion of a consultation commenced in late 2018 the Financial Conduct Authority (FCA) has announced new rules applying to to certain types of open-ended fund investing in inherently illiquid assets such as property. These new rules come into force on 30 September 2020.
Following the result of the UK referendum on EU membership in June 2016, dealing in a number of property funds was temporarily suspended, preventing investors from accessing their money. Dealing in all funds had resumed by the end of the year, but the event raised questions relating to how fund managers use different liquidity risk management tools and how to strike a fair balance between the interests of investors wishing to redeem their holdings and those wishing to remain invested in a fund under difficult market conditions. The FCA consultation in October 2018 sought to identify lessons from this experience
In June 2019, after the consultation closed, a high profile UCITS fund, the LF Woodford Equity Income Fund (the WEIF), suspended dealing. The FCA also considered potential lessons for the NURS regime arising from the WEIF suspension before finalising the new rules.
Scope and applicability of the new rules
The new rules apply to non-UCITS retail schemes (NURS), but will not apply to other types of fund, such as UCITS, which are already subject to restrictions relating to such assets. For in-scope NURS a new category of ‘funds investing in inherently illiquid assets’ (FIIA) is established. FIIA’s will be NURS investing at least 50% of their assets in illiquid assets, which for this purpose will encompass real estate assets, infrastructure projects, certain unlisted shares and interests in other funds which are invested in such assets.
In scope funds which are FIIAs will be subject to additional requirements, including:
- increased disclosure of how liquidity is managed,
- standard risk warnings in financial promotions, and
- enhanced depositary oversight,
From September next year, fund managers of FIIAs will also be responsible for putting in place contingency plans to manage liquidity and, importantly, will also be required to suspend dealing where an independent valuer considersthat there is “material uncertainty regarding the value” of more than 20% by value of illiquid assets. These rules aim to reduce the potential for some investors to gain at the expense of others, and reduce the likelihood of runs on funds leading to ‘fire sale’ of assets which disadvantage fund investors
Funds may only avoid halting dealing where their depositary has agreed the continuation of dealing is in the investors’ best interests. This exception does add some flexibility to the rules, and may help to avoid wider market disruption.
Executive director of strategy and competition at the FCA Christopher Woolard commented that
“We want people to be able to continue to invest in illiquid assets, such as real estate, through open-ended funds but it is important that they are appropriately protected. The new rules and guidance are designed to protect the interests of investors particularly during stressed market conditions. This includes those wishing to redeem their holdings, as well as those wishing to remain invested in the fund.
‘We also want to make it clear that authorised fund managers are responsible for managing the liquidity risk in their funds and acting in the best interests of investors.’
Regulators are clearly taking fund liquidity very seriously, as the new FCA rules follow around a month after the European Securities and Markets Authority (ESMA), the EU’s securities and markets’ regulator, published its own final guidance regarding liquidity stress tests of investment funds. The guidelines require fund managers to “stress test” the liquidity the assets and liabilities of the funds they manage. As with the FCA guidelines, ESMA’s guidelines will came into force on 30 September 2020. It may be the case that the FCA will apply further rules on managing liquidity more widely to other types of open-ended funds in the future.
On October 8, 2019