Open-ended commercial property and infrastructure funds will be required to suspend trading when an independent valuer expresses “material uncertainty” about the valuation of 20% of their assets, under planned Financial Conduct Authority (FCA) rules.
A range of new regulations will affect open-ended funds that have more than 50% of their assets in what the regulator deems to be illiquid assets. Experts suggested that this would mean more frequent suspensions but that market value adjusters should become a thing of the past.
The rules will also catch multi-asset funds, which will be required to suspend trading themselves if they have more than 20% of their total assets invested in suspended funds.
The FCA has moved to tighten the regulations due to concerns about the suspension of trading in several open-ended property funds following the UK’s vote to leave the European Union in 2016.
We expect these changes to result in fewer runs on funds holding illiquid assets
Many funds also suspended trading in 2008 in the midst of the financial crisis. It led to concerns that the best-informed investors could steal a march on other unitholders by withdrawing money more swiftly.
Warning labels
Affected funds will be required to add an identifier or label to the name of any relevant fund, “drawing attention to the nature of the fund”. In addition, any financial promotions by the fund manager or distributor will have to include a new standard risk warning.
Managers will have to produce contingency plans for when liquidity risk crystallises, while the regulator is also planning a new duty for depositaries to oversee funds’ liquidity management processes.
The fund prospectus will have to include information about liquidity risks, liquidity management tools, the circumstances in which they may be used and the potential impact on investors.
The regulator said the measures should reduce the risk of a run on a fund and make it less likely that some investors will gain at the expense of others.
It also suggested that a fund manager may suspend dealing before running down the liquidity in the fund, if this is in unitholders’ best interests. It will produce guidance for fund managers about how they should arrive at a fair and reasonable value for an ‘immovable’ (ie illiquid) asset where it needs to be sold quickly.
However, the paper also suggested that fund managers should not build up or hold large cash buffers for a long period, merely to deal with the possibility of unanticipated high levels of redemptions.
Improvement, not overhaul
The regulator said it was pleased that, post-referendum, suspensions and other liquidity management tools generally worked and prevented wider market disruption, while dealing in the affected funds resumed before the end of the year.
It argued that these measures do not represent a major overhaul of the regulatory framework but improvements to the current system.
Christopher Woolard, FCA executive director of strategy and competition, said: “These measures will increase investors’ understanding of, and confidence in, how funds holding illiquid assets are managed. 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.”
Fairer for investors
Ryan Hughes, head of active portfolios at investment platform AJ Bell, said: “The proposals from the FCA will mean that property funds are likely to suspend trading sooner and potentially more frequently than they have in the past. The proposed 20% rule means that when there is even a small amount of uncertainty in the market affecting the value of property and infrastructure, funds will be forced to suspend.
“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.
“The fact that multi-asset funds will have to suspend trading if 20% of their assets are in suspended funds could lead a number of multi-asset funds to restrict the amount they hold in illiquid assets, such as property and infrastructure, so they avoid hitting this 20% rule. This will boost the liquidity of these funds but means that investors may end up with a less-diversified portfolio.
“Another consequence is that multi-asset funds could move more into closed-ended funds, such as investment trusts, to get their property and infrastructure exposure.”
