The Financial Conduct Authority (FCA) is consulting on proposals to reduce the potential for harm to investors from the liquidity mismatch in open-ended property funds. The new rules as proposed would require investors to give notice – potentially of up to 180 days - before their investment is redeemed. The FCA welcomes any feedback and is particularly keen to hear suggestions for alternative measures that might achieve the same outcome.
At present investors in these funds can buy and sell units on a frequent – often daily – basis. But the underlying property in which these funds invest cannot be bought and sold at the same frequency. This creates a liquidity mismatch. When too many investors simultaneously redeem their investments, a fund manager may need to suspend dealings in the units of the fund because of the liquidity mismatch between the fund units and the underlying property assets.
The illiquid nature of property also means that a reliable price is not always readily available, and in some market conditions the fund units cannot be priced with confidence. This can also lead to a need to suspend dealings in fund units.
Property fund suspensions have occurred with increasing frequency in recent years, including following Brexit and in the current coronavirus pandemic.
Fund suspensions exist to protect investors in exceptional circumstances. However, the FCA has seen repeated suspensions of these funds over recent years for liquidity reasons, which suggests that there may be wider problems. The FCA is concerned that the current structure could disadvantage some investors because it incentivises investors to be the first to exit at times of stress. This can potentially harm those who remain if the fund suspends or assets are sold rapidly due to liquidity demands.
The proposed notice period would allow the manager to plan sales of property assets so that it could better meet redemptions that are requested. It would also enable greater efficiency within these products as fund managers would be able to allocate more of the fund to property and less to cash for unanticipated redemptions.
Christopher Woolard, Interim Chief Executive of the FCA, 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.’
The FCA will publish a Policy Statement with final rules as soon as possible in 2021. The consultation remains open to responses until 3 November 2020. The FCA also continues to engage with other stakeholders on considering new initiatives within the regulatory framework that would facilitate investments in long-term assets.