Following several high-profile fund suspensions, the Financial Conduct Authority (FCA) has started a process to protect investors in open-ended funds investing in hard-to-sell, illiquid assets; the move could have far-reaching consequences for the future of daily traded investment funds – writes Christian Leeming

 

As well as the recent high-profile suspension of Neil Woodford’s Equity Income Fund, seven UK property funds were gated following the Brexit vote in 2016 as were a range of absolute return bond funds at Swiss asset manager GAM in 2018; the suspensions highlighted the ‘liquidity mismatch’ between the time it takes to sell assets held by a fund whilst offering investors daily redemptions.

In each case, fund managers exposed to difficult to sell, illiquid assets, were unable to meet withdrawal requests from investors.

‘‘liquidity mismatch’ between the time it takes to sell assets held by a fund whilst offering investors daily redemptions’

Initially only applied to property funds, FCA is considering extending its reforms to the wider fund industry; from September 2020, funds in a newly created category of ‘funds investing in inherently illiquid assets’ will be subject to greater disclosure and required to produce liquidity risk contingency plans – FCA will require funds to halt trading if there is uncertainty about the value of 20% or more of their portfolios.

In announcing its plans, FCA said: ‘The [Woodford fund] suspension shows that liquidity considerations are not confined to those open-ended funds with exposure to property or other immovables. Liquidity issues can extend to other open-ended funds, including UCITS, where they have holdings of less liquid assets, even including investments in listed equities if there is not a liquid market in those equities. Similarly, some bonds may be listed without there being a liquid market for those securities.’

FCA said it planned to explore remedies that could help to avert another Woodford crisis, including examining the practice of daily dealing and any potential conflict between institutional and retail investors holding the same fund.

It will also look at fund managers’ disclosures, to ensure that investors have clear information about liquidity mismatches and how they would be handled; FCA said Woodford investors: ‘were not aware of, or did not appear to understand, the liquidity risk to which they were exposed’, and were in the dark about ‘the impact this [liquidity] risk might have on their ability to realise their investments on demand’.

‘a blueprint for a new structure called a ‘long-term asset fund’ for illiquid asset’

FCA said it intends to consider notice periods for investors wishing to release their cash and reduced dealing frequency for funds exposed to illiquid assets; it may also consider different redemption conditions for institutional investors after Kent County Council’s decision to redeem its £263m holding led to the Woodford fund being suspended: ’The events surrounding the suspension of the [Woodford fund] highlighted how the ability of a single large investor to redeem, or attempt to redeem, on a single day, a large investment in an open-ended fund can have significant consequences for both that investor and other investors that remain invested within the fund,’

Critics of open-ended funds have questioned whether there is a fundamental incompatibility between daily traded open-ended funds and illiquid assets, preferring a closed-ended structure.

In response, asset management trade body, The Investment Association, is developing a blueprint for a new structure called a ‘long-term asset fund’ for illiquid assets which would block investors from drawing their money out daily in order to avoid a liquidity mismatch.

Further work is also being undertaken by the Bank of England, where governor Mark Carney said funds that hold illiquid assets but offer daily redemptions are ‘built on a lie’.

 





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