Fund Management
UK Tightens Rules On Open-Ended Funds

The UK regulator is acting at a time when the dangers of holding illiquid assets inside open-ended funds has been highlighted by problems a few years ago in the property market.
Britain’s main financial regulator has confirmed new rules
covering certain types of open-ended funds that hold illiquid
assets such as property, a topic that has gained added urgency as
shown when brick-and-mortar markets have fallen
sharply.
The Financial
Conduct Authority yesterday confirmed the rules, which apply
from 30 September. The new regime applies to funds such as
non-UCITS retail schemes. They do not cover other types of fund,
such as UCITS, which are already subject to restrictions relating
to such assets.
Open-ended funds holding property can be hit by a sudden rush of
investors exiting if markets turn sour, however briefly, as
happened in June 2016 after the UK referendum vote to leave the
European Union. The root of the issue is making investors aware
that holding illiquid assets can constrain their ability to
redeem in large quantities and at the same time.
The continuing saga of the LF Woodford Equity Income Fund, a
UCITS fund that has been suspended following major client
redemptions by manager Neil Woodford, has rattled investors
and prompted calls for regulatory action.
The FCA said it has considered whether this saga also has lessons
for how non-UCITS funds should be regulated.
The FCA’s new rules require that investors are provided with
clear and prominent information on liquidity risks, and the
circumstances in which access to their funds may be restricted.
They place additional obligations on the managers of funds
investing in inherently illiquid assets to maintain plans to
manage liquidity risk. The rules also aim to reduce the potential
for some investors to gain at the expense of others, and reduce
the likelihood of runs on funds leading to a ‘fire sale’ of
assets which disadvantage fund investors.
'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," Christopher Woolard, executive
director of strategy and competition at the FCA, said.
The FCA said that the rules also bring in a new category of
‘funds investing in inherently illiquid assets’ (FIIA). Funds
that fall into this category carry new requirements such as
having to disclose more information about how liquidity is
managed, and give standard risk warnings in financial promotions,
and take other steps.
The Association
of Investment Companies, which acts for a part of the UK
asset management sector – the closed-ended funds segment - said
that the FCA’s moves were insufficient and will affect some funds
unfairly.
“Retail investors should be able to invest in funds where they
know from the outset how they will be managed and what their
redemption rights are. These should be reliable and should not
change in response to foreseeable market conditions.
“Unfortunately, these proposals fail to achieve this. Disclosure
of the many possible complex measures that might be applied is
both inadequate and unfair,” Ian Sayers, chief executive of the
AIC said.
“Given the recent warnings from the Bank of England regarding the
systemic risks such funds create, we would also have expected a
more urgent approach which addressed these broader risks and not
simply tinkered with existing regulation and only apply these
measures to some funds,” Sayers said. “We hope that the further
work being undertaken with the Bank of England will propose a
more comprehensive and robust solution.
“In contrast to the problems endured by open-ended property funds
following the Brexit vote, closed-ended property funds continued
to trade. Their share prices suffered but bounced back swiftly
when confidence recovered. The closed-ended structure and stock
exchange listing of investment companies mean they are
particularly well-suited to investing in illiquid assets,” Sayers
continued.