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New Rules: Inherently Illiquid Assets & Open-ended Funds

PS 19/24: Illiquid Assets & Open-ended Funds

2nd October 2019

On Monday (30 September 2019) the FCA confirmed new rules in Policy Statement PS19/24 that will apply to certain types of open-ended fund investing in inherently illiquid assets, such as property.

Effective in one year’s time on 30 September 2020, the new rules will apply to these funds, (known as NURs – non-UCITS retail schemes), but will not be applicable to other types of funds, such as UCITS, since they are already subject to restrictions relating to such assets.

The new rules will require that investors are given clear and prominent information relating to liquidity risks in addition to the circumstances whereby access to their funds might be restricted.

This will place additional obligations upon the managers of funds that invest in inherently illiquid assets to maintain plans to manage liquidity risk.

The aim of these rules is to reduce the potential for some investors to gain at the expense of others, as well as to reduce the likelihood of runs on funds that might lead to a ‘fire sale’ of assets that then disadvantages fund investors.

Why New Rules?

After the UK referendum on Brexit in June 2016, many open-ended property funds, (an inherently illiquid investment), encountered difficulties when lots of investors tried to withdraw their money at the same time. The short notice and the simultaneous withdrawals meant that a number of property funds had to suspend dealing temporarily.

In addition following the suspension of the LF Woodford Equity Income Fund, a UCITS fund, the FCA has assessed whether there were any lessons to be learned.  

The result? Some new regulatory measures that aim to:

• Help investors understand better any restrictions on access to their investments and the circumstances in which these restrictions will be placed on the funds.
• In the case of funds investing in immovables, reduce the potential for some investors to gain at the expense of others because units have been incorrectly priced, due to uncertainty about the value of assets held in the fund.
• Reduce the likelihood of a run, which could substantially reduce the value of investments for those left in the fund and possibly destabilise the market more widely.

In addition, the new rules will:

• Introduce a new category of ‘funds investing in inherently illiquid assets’ (FIIA). Funds that fall into this category will be subject to additional requirements, including increased disclosure of how liquidity is managed, standard risk warnings in financial promotions, enhanced depositary oversight, and a requirement to produce liquidity risk contingency plans. These requirements will not apply where a fund matches the dealing frequency of its shares to the liquidity of its assets.
• Impose a requirement that NURSs investing in inherently illiquid assets must suspend dealing where the independent valuer determines there is material uncertainty regarding the value of more than 20% of the fund’s assets. However, the FCA will allow fund managers to continue to deal where they have agreed with the fund’s depositary that this is in the investors’ best interests.

In essence, the changes to the Handbook will affect three broad areas, namely Suspension of dealing in units; Improving the quality of liquidity risk management; and Increased disclosure.

While the FCA’s new rules focus upon NURSs rather than UCITS, the suspension of the Woodford Investment Fund highlights the importance of effective liquidity management in open-ended funds more generally.

The regulator has suggested that Fund managers and depositaries may wish to consider whether it would be in customers’ interests to adopt some of the measures in the Policy Statement implementation date (30 September 2020), where these do not conflict with the rules applicable until that date.

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