The FCA published a Discussion Paper yesterday, which seeks stakeholder views on the practice of investing in illiquid assets through open-ended funds and the challenges that this can pose to managers and investors. Examples of illiquid assets include real assets such as property and infrastructure, as well as financial assets that are inherently illiquid such as unlisted securities, and shares in special purpose vehicles. The FCA invites comments by 8 May 2017, which may lead to a consultation and eventual changes to the FCA’s Handbook and guidance.
This exploration by the FCA has been anticipated as a consequence of the Brexit vote, when several open-ended retail funds were forced to suspend redemptions to deal with the high volume of requests, as investors worried about the outlook for UK real estate. The FCA’s broader intention is to strike a fair balance between protecting investors at a level which reflects their understanding of the nature and risks of the investment, while ensuring that the vehicles that they use do not create or exacerbate risks to markets’ integrity and stability.
Under UK regulation, there is a distinction between ‘authorised’ and ‘unregulated’ funds. An authorised fund is one where the fund vehicle has itself been approved by the FCA. For other types of funds, even though the fund manager and the depositary are likely to be regulated by the FCA (or an equivalent EEA regulator), for instance under the Alternative Investment Fund Managers Directive (AIFMD), the fund itself is not subject to authorisation. Although the focus of the FCA’s paper is on the regulatory framework applicable to authorised funds (in particular Non-UCITS Retail Schemes (NURS) and Qualified Investor Schemes (QIS) that can both invest in real estate), it covers ‘unregulated’ funds too, in the context of possible approaches to improving liquidity management.
The final section of the paper sets out ways in which the FCA could potentially develop its rules and guidance, and it is these possible approaches that are likely to stimulate debate across the industry. The FCA does not intend to ban open-ended funds holding illiquid assets or prevent retail investors from acquiring units in open-ended property funds; the focus is on the regulatory approach in general to open-ended funds that invest in illiquid assets.
We have selected a few of the key points raised for discussion below:
- Considering differential treatment of retail and professional investors - for instance separate unit classes, with different dealing frequencies and notice periods for redemption; or a universal specific diversification requirement for all illiquid asset funds
- Introducing rules on portfolio diversification (for example through caps on holdings of illiquid assets, or guidance on use of liquidity ‘buckets’) and holding uncommitted cash
- Providing more guidance for fund managers about the use of anti-dilution measures which can be imposed to reflect the need to dispose of the fund’s real estate assets quickly in order to provide liquidity
- Introducing direct intervention by the regulator (which is part of a wider project with the Financial Stability Board and the International Organisation of Securities Commissions (IOSCO))
- Encouraging alternative redemption mechanisms, for example secondary market provision and making it easier for open-ended funds to convert to being closed-ended fund whose interests are traded on a secondary market
This paper provides us all with an opportunity to take part in a key regulatory debate that potentially has a broad impact on the development of the regulation of fund liquidity.
Please feel free to call any of the BLP Investment Management team or your usual BLP contact if you would like to discuss any of the issues raised in this briefing in more detail.