The Financial Conduct Authority (FCA) has launched a discussion paper that questions whether further regulatory intervention is needed to protect consumers in open-ended funds investing in illiquid assets.
The paper suggests that one possible option is to introduce rules that would separate retail and institutional investor money, in order to help reduce the risk that a fund will experience liquidity problems in a ‘stressed situation’.
The FCA makes the point that professional investors such as multi-managers pump in large amounts of money, so therefore have a more significant impact on liquidity compared to retail investors with much smaller sums. Thus, the FCA put forward the idea that in a stressed situation retail investors should have ‘first-mover advantage over professional investors’.
Another potential remedy mentioned by the FCA is to include rules or guidance on the use of liquidity ‘buckets’, so that fund portfolios are subject to hard or soft limits on the proportion of assets that can be realised for cash within a specific timeframe.
The regulator, however, has ruled out an outright ban on open-ended funds holding illiquid assets such as land and buildings, infrastructure or unlisted securities.
The FCA said it ‘would not suggest interventions aiming to restructure the existing regime’. The regulator further added: ‘So, for example, we do not intend to ban open-ended funds holding illiquid assets or prevent retail investors from acquiring units in open-ended property funds.
‘We do not believe such changes would advance our financial stability or consumer protection objectives, because of the predictable costs and negative impact they would be likely to cause.’
Funds that invest in illiquid assets have come under FCA spotlight following a slew of funds moving last summer to prevent investors from cashing in their chips. More than half of the £25 billion invested in the Investment Association’s commercial property sector was 'gated' shortly after last June’s Brexit vote.
Investors rushed to sell amid fears the Brexit vote would have a negative impact on both commercial and residential property prices, particularly in London. In such times it is difficult for open-ended commercial property funds to meet the scale of withdrawals.
This is because the affected commercial property funds own property directly (as opposed to holding property company shares), and real estate sales are not quickly or easily arranged - particularly in times of market uncertainty. It is therefore hard to raise money quickly.
These fears have proved, so far at least, to be overstated. As a result the majority of commercial property funds re-opened their doors in September and October.
However, cash weightings in open-ended UK commercial property funds have risen to over 20 per cent, compared to around 10-15 per cent around six months ago.
The FCA’s discussion paper is open for feedback until 8 May 2017. The regulator will consider feedback and publish a response later on in the year, which may include proposals for new or amended rules.
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