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In June 2019, the suspension of the Woodford Equity Income Fund and subsequent wind-up raised important questions about how liquidity is managed in authorised funds, particularly with respect to investment in illiquid assets.
In January 2020, the Financial Conduct Authority (FCA) issued a ‘Dear CEO’ letter to authorised fund managers (AFMs). The letter outlined the FCA’s supervision priorities and reminded firms of the central responsibility to ensure effective liquidity management in funds. The letter also referenced the December 2019 joint Bank of England and FCA work to explore liquidity mismatch in open-ended funds.
From a regulatory perspective liquidity management and the related issue of fund suspensions has remained high on the industry’s agenda for 2020. There is now greater clarity on the new regulatory framework as many of the pieces of the jigsaw are either in place or are under detailed consultation. The exception to this is the joint Bank of England/FCA work where conclusions are now expected to be published in Q1 2021.
New mandatory suspension rules
From 30 September new mandatory suspension and enhanced liquidity monitoring rules and new disclosure rules came into force for funds investing in illiquid assets (FIIAs). The scope of the new rules is restricted to non-UCITS retail funds (NURS) property funds or to NURS funds with indirect exposure to immovables, such as multi-asset funds holding units in property funds, or feeder funds of property alternative investment funds (PAIFs).
Whilst the rules came into force in September, in practice the rules on mandatory fund suspension were adopted by the industry in March as Standing Independent Valuers (SIVs) of property funds met to discuss concerns surrounding the valuation of property, in part caused by the lack of transactional data and consequential material uncertainty about the valuation of those assets. This led to the majority of funds in the property sector suspending on the grounds of material uncertainty. While fund suspensions have created challenges for some investors, the decisions were taken to protect the interests of all investors in the fund and have been reviewed at least every 28 days as part of the formal fund suspension governance process.
More recently conversations have concerned the resumption of dealing as material uncertainty clauses have been lifted by SIVs. Of interest is the requirement to resume dealing “as soon as reasonably practicable” after:
- the SIV’s material uncertainty assessment applies to less than 20% of the value of the scheme property; and
- the scheme’s depositary gives its approval for the temporary suspension to be removed.
The wording “as soon as reasonably practicable” could be interpreted to mean as soon as material uncertainty falls below 20% of the scheme property. However, the FCA has made clear before lifting a suspension that fund managers should ensure there is sufficient liquidity to meet the expected level of redemptions.
Where possible solutions need to be found so as to ensure investors can continue to benefit from the diversification advantages of investment in property
To date, some of the property funds we act for have reopened, some are in the process of reopening and others have changed the basis of fund suspension from material uncertainty to liquidity.
The introduction of notice periods for daily dealing property funds
The publication of the FCA’s consultation paper on liquidity mismatch in authorised open-ended property funds (CP20/15) has proved to be controversial as it could require investors to give notice – potentially of up to 180 days – before their investment is redeemed from an open-ended property fund. Additionally, the proposed rule changes could risk these funds being excluded from ISAs as they may no longer be qualifying investments for a stocks and shares ISA. Self-invested personal pension providers would also be affected as they would face higher capital adequacy requirements if they hold property funds. The proposed notice period may also give rise to some operational challenges for financial advisers wanting to rebalance client portfolios, which may make them more reluctant to recommend property funds to their clients. The issue of notice periods has also made reopening some property funds more challenging as the new rules have created uncertainty among the investor community, and this has made it harder to quantify expected level of redemptions.
These are important questions, and where possible solutions need to be found so as to ensure investors can continue to benefit from the diversification advantages of investment in property. At NWTDS, we strongly think a notice period is an important tool within the liquidity toolkit.
Updated Investment Association liquidity
We are expecting the Investment Association (IA) to publish an updated liquidity management guidance paper in Q1 2021 to reflect recent developments. Publication is expected after the December publication of the Bank of England’s Financial Stability Report to ensure it is aligned to the latest standards.
Despite fears in March that significant outflows due to Covid-19 would lead to a liquidity crisis, this did not happen. The overwhelming majority of funds remained open, suggesting that investment funds do not represent a systemic risk to the financial system. The property funds which suspended were generally due to concerns about material uncertainty rather than fund liquidity issues. Many of these funds have now reopened or are in the process of reopening.
While many of the pieces of the regulatory framework are now in place, there are still missing pieces, such as whether the FCA/Bank of England will introduce asset classification for liquidity (liquidity buckets) similar to US Securities and Exchange Commission rules. This means that liquidity will remain high on the industry’s regulatory agenda for some time to come.