The UK’s financial regulator has published new rules designed to prevent a repeat of the shutdown of open-ended real estate funds in 2016.
The Financial Conduct Authority (FCA) has confirmed a number of measures, including requirements that open-ended funds that invest in illiquid assets must suspend dealing when “there is material uncertainty regarding the value” of more than 20% of assets.
According to sources, some of the original proposals have been watered down following consultation with the real estate fund management industry, but many of the key requirements have been retained.
A new detail in the rules means that fund managers may be allowed to continue to trade units under distressed market conditions “where they have agreed with the fund’s depositary” that it is in the best interests of investors.
“This amendment will ensure that the fund manager has the opportunity to make a case for continuing to trade during a period of material uncertainty,” said a leading consultant, John Forbes. “However, the FCA expect the circumstances in which it would be appropriate to do so would be limited.”
The FCA also confirmed the creation of a new category of “funds investing in inherently illiquid assets” (FIIA), which will be subject to greater disclosure around liquidity management and the inclusion of standard risk warnings in financial promotions to retail investors.
The FCA has been responding to liquidity crises that have hit UK open-ended property funds following the Brexit vote in 2016 and the global financial crisis in 2008. More recently, the high profile suspension of the LF Woodford Equity Income Fund has also raised concerns about the practice of providing exposure to illiquid assets through vehicles that offer daily dealing.
The matter is particularly relevant to retail investors – the rules apply to so-called non-UCITS retail schemes (NURS) – but, as IPE Real Assets reported in 2016, institutional investors can also be affected.
Christopher Woolard, executive director of strategy and competition at the FCA, said: “We want people to continue to be able to invest in illiquid assets, such as real estate, through open-ended funds but it is important that they are appropriately protected.
“The new rules and guidance are designed to protect the interests of investors particularly during stressed market conditions. This includes those wishing to redeem their holdings, as well as those wishing to remain invested in the fund.”
Chris Cummings, CEO of the Investment Association, said: “We welcome the FCA’s pragmatic and measured approach, which recognises the importance of enabling investment in illiquid assets through open-ended funds.
“The new rules, which combine enhanced liquidity management with additional disclosure requirements, will benefit investors, helping them make informed choices about their investments and strengthening fund management processes.
“We will continue to work with the industry and regulators to ensure that appropriate liquidity management processes are in place.”
Forbes said he was disappointed that the regulator had not sought to consider alternatives to open-ended funds with daily dealing.
Forbes said: ”I have been arguing for some time that the key development required was to allow the development of less liquid real estate funds, in particular by allowing deferral of redemptions.
The FCA’s policy statement does set out areas for further work. Forbes said: “I hope that this will also include the proposals on deferrals and other possible routes to allow the development of funds for retail investors in which the ability to redeem their investment better reflects the liquidity of the underlying investment assets.”
The Investment Association, which issued a response in coordination with the Association of Real Estate Funds, said it would continue to push its proposals for a “long-term asset fund”, a structure designed for illiquid assets where investors would be able to redeem at “appropriate intervals”.
In the policy statement, the FCA said it intended to explore “the importance of alternative product structures”, including closed-ended funds, and the Investment Management’s proposals.
Melville Rodrigues, partner at law firm Charles Russell Speechlys, said the new rules would reduce the “risk to investors in funds that hold illiquid assets, particularly under stressed market conditions”.
He said: “I also welcome the FCA’s intention to explore alternative UK closed-ended structures – which I suggest could appropriately manage the risks associated with holding real estate and other illiquid underlying investments and be attractive to institutional and other professional investors.”
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