The Financial Conduct Authority (FCA) is consulting on the future of illiquid assets and open-ended investment funds.
This follows the well-publicised suspension of dealings by open-ended property funds in the immediate aftermath of the EU referendum, many of which remained closed or 'gated' for several months to protect existing investors from a mass of redemptions.
However, the issues it raises are relevant to all open-ended funds investing in illiquid assets, including infrastructure and private equity assets.
Industry participants will be pleased to hear that the FCA is not advocating broad structural changes, such as banning open-ended funds from holding illiquid assets or preventing retail investors from investing in open-ended property funds.
The regulator's latest Discussion Paper is rather about gauging whether improvements might be made to existing liquidity management tools in order to enhance investor and market outcomes in a cost-effective and proportionate way.
At the time of last summer’s fund suspensions, the FCA indicated that it would be investigating further the circumstances leading up to the suspensions.
Regulators have also been looking more generally at the risks associated with open-ended funds investing in illiquid assets and the possible impact on financial stability.
Real estate is perhaps the best understood illiquid asset class but it is by no means the only one and it is not the sole focus of the Discussion Paper, which lists a number of other illiquid asset classes, including private equity and infrastructure.
Many open-ended funds investing in illiquid assets are available to retail investors through non-UCITS retail schemes (NURS). Retail investors may not fully understand the risks inherent in open-ended funds which invest in illiquid assets and indeed may not be aware of those risks, despite the disclosures available in fund prospectuses and other documents.
The Discussion Paper represents the FCA seeking to gather more evidence as to whether more, or different, rules and guidance are needed to support market stability and protect consumers, without preventing them from having access to a diversified range of investment opportunities.
What changes is the FCA suggesting?
The areas for potential change identified in the Discussion Paper are:
1) Different investors, different share classes
Helping to balance the different needs of professional and retail investors by requiring funds to have different unit classes for these different categories of investor.
This might enable authorised fund managers to continue to offer retail investors a high degree of liquidity (on the basis that the impact of suspension of dealings requests by retail investors is likely to be relatively low and easily managed) while imposing longer notice periods or less frequent dealings to institutional investors.
The FCA also posits the possibility of an authorised fund manager having to manage the diversity of its investor base more actively. The intention behind this would be to ensure that no single investor, or bloc of investors, represented such a significant proportion of the fund that a decision to redeem would be difficult to manage without selling illiquid assets.