This week, the FCA published its policy statement in response to the feedback to its Consultation Paper CP18/27 on illiquid assets and open-ended funds.
The consultation, prompted by gating of funds after the announcement of the Brexit vote in June 2016, also takes into account the current and ongoing gating of the LF Woodford Equity Income Fund (the WEIF).
In open-ended funds, the crux of the matter is where underlying assets that are hard to sell with any speed are in potential conflict with daily dealing, allowing investors to withdraw their funds with virtually no notice. Since the fund manager is liable to facilitate the withdrawal, large or unexpected liquidity requests, or a run on liquidity can lead to delays in investors encashing investments they thought were immediately accessible.
The FCA is therefore putting the following measures in place for non-UCITS retail schemes (NURSs), with the new rules coming into force on 30 September 2020:
- A new category of ‘funds investing in inherently illiquid assets’ (FIIA) has been created for NURSs which have, or intend to invest at least 50% of their scheme property in inherently illiquid assets.
- FIIA managers must include additional disclosure in their prospectus of the details of their liquidity risk management strategies, including the tools they will use and the potential impact on investors.
- FIIAs must include a risk warning in financial promotions to retail clients: ‘[Name of fund] invests in assets that may at times be hard to sell. This means that there may be occasions when you experience a delay or receive less than you might otherwise expect when selling your investment. For more information on risks see the prospectus and key investor information document.’
- FIIA managers will need to produce contingency plans for dealing with liquidity risks.
- Depositaries of FIIAs must have greater oversight of the processes used to manage the liquidity of the fund, including gating.
While the policy statement focuses specifically on NURSs, which are open-ended, liquidity considerations in other investment structures could come under scrutiny. This is particularly relevant where investor expectations of accessing their funds don’t match the reality.
For the regulator, “an adequate understanding of the liquidity properties of funds investing in illiquid assets is important to protecting investors’ interests”. As a result, the FCA is “considering whether the remedies set out in this policy statement should apply more widely than NURSs, and also whether we should be exploring a wider range of potential remedies, both for NURSs and for other types of funds. We are working with the Bank of England’s Financial Policy Committee to assess how funds’ redemption terms might be better aligned with the liquidity of their assets to minimise financial stability risks without compromising the supply of productive finance (see the Financial Stability Report).”
The FCA glossary has already been updated with a definition of ‘inherently illiquid assets’ which includes immovables, investments in an infrastructure project, transferable securities that are not readily realisable, and any other security or asset that is not listed or traded on an eligible market and has particular features that make the process of buying or selling difficult or time-consuming.
Among other things, this definition could apply to many of the assets in a portfolio of Enterprise Investment Scheme qualifying shares, assets in a Business Relief service, P2P loan portfolios, and debt based securities. And while there is widespread recognition among industry stakeholders of the high occurrence of illiquid assets within these asset classes, ensuring all investors are fully aware of what that means remains an ongoing challenge.