The FCA also says it will be looking into the inherent problem of having large institutional investors in the same fund as retail investors.
Four months after the suspension of the Woodford Equity Income, the Financial Conduct Authority has released its new policy paper on illiquid assets and open-ended funds, detailing several proposals.
According to the paper, the suspension of Woodford Equity Income on the back of its inability to sell its illiquid assets fast enough to match investor withdrawals highlighted the fact that many investors are unaware of the liquidity risk posed by open-ended funds invested in illiquid assets.
Investors, the regulator argues, need to receive clearer information about the potential risks. The FCA also says the Woodford suspension raised questions about the way open-ended funds investing in illiquid assets manage this “liquidity mismatch”, and about whether they should be offering daily redemptions at all.
There are, however, no plans to restrict open-ended funds’ ability to invest in illiquid assets. The FCA notes: “We do not want to prohibit open-ended funds from investing in illiquid or less liquid assets where investors understand and are willing to accept the liquidity risk this can involve.”
The FCA also says it will be looking into the inherent problem of having large institutional investors in the same fund as retail investors. As was the case in the Woodford debacle, institutional investors may withdraw a large sum of money in a single day, creating liquidity issues.
According to Ryan Hughes, head of active portfolios at AJ Bell: “We saw this play out in the Woodford situation, with Kent County Council’s withdrawal of its mandate being the final straw. As such, the FCA will look at whether different redemption conditions should apply to those institutional investors, in order to help protect retail investors.”
The paper also addresses new rules around property funds, many of which were forced to close following a spike in investor withdrawals after the 2016 Brexit vote. The FCA said that it will continue with plans to force funds to suspend trading if there is uncertainty about 20% or more of assets in their portfolio.
Chris Cummings, chief executive of the Investment Association, welcomes the new proposals, which he describes as “recognising the importance of enabling investment in illiquid assets through open-ended funds”.
The Association of Investment Companies, the trade body for closed-ended investment trusts, however, argues that the new proposals still fall short of what is needed.
Ian Sayers, chief executive of the AIC, notes: “Retail investors should be able to invest in funds where they know from the outset how they will be managed and what their redemption rights are. These should be reliable and should not change in response to foreseeable market conditions.
“Given the recent warnings from the Bank of England regarding the systemic risks such funds create, we would also have expected a more urgent approach which addressed these broader risks and did not simply tinker with existing regulation and only apply these measures to some funds.
“We hope that the further work being undertaken with the Bank of England will propose a more comprehensive and robust solution.”