The UK’s Financial Conduct Authority has launched a discussion paper about risks created when consumers use open-ended funds, such as property funds, to gain exposure to assets that may be difficult for the fund manager to buy, sell or value quickly.
The FCA said via a statement earlier today that it has launched a consultation paper into the risks and appropriateness of ‘illiquid assets’ that may include land and buildings, infrastructure, and financial assets such as unlisted securities.
One area that the paper discusses is the possibility of general retail investors money being split from that invested by professional investors such as discretionary fund managers. To “stimulate debate”, in its paper the regulator gives some examples of “possible policy approaches” that it might use to solve the party fund conundrum. It suggests that the idea that professional and institutional investors may hold a “significant or even predominant” portion of a portfolio, is potentially disadvantaging retail investors.
‘Retail and professional investors split’
“Some commentators suggest [the status quo] is unsatisfactory for retail investors, because their interests may be different to those of professional investors, ” the FCA’s consultation paper said. “To protect the interest of retail investors better, one approach would be to have rules that prevent the investment of both retail and professional investors’ monies in the same fund.”
The FCA probe has been triggered follows a collapse in the UK property market last summer in the aftermath of the Brexit vote, with, as reported, many of the largest open-ended property fund providers imposing blocks on investors accessing their funds due to plunging prices and a rush of investors wishing to move finds out of the assets.
After a period of a few months most providers were able to lift the sanctions, but the situation raised the question about appropriateness of open-ended property funds and whether or not retail investments into property should be restricted to closed-ended vehicles.
“With this discussion paper, we aim to gather evidence to decide whether more (or different) rules and guidance are needed to support market stability and protect consumers, without preventing them from having access to a diversified range of investment opportunities,” the FCA said.
The FCA said that it wants stakeholders to tell them what problems they think exist where open-ended funds hold illiquid assets, how well the current rules address those problems and what further regulatory intervention might be needed.
“Open-ended funds investing in illiquid assets may experience difficulties if investors expect to be able to withdraw their money quickly and at short notice,” the FCA statement said. “Many funds offer daily dealing opportunities to investors, but hold assets that are not revalued on a daily basis. This creates a tension, as assets cannot be sold in a day to meet daily redemption requests.
‘Fair price to investors’
“If managers cannot determine an accurate and up-to-date valuation for assets in the fund, they cannot be sure they are offering a fair price to investors wishing to sell. So, if the market for the underlying assets is affected by sudden, severe changes in conditions, leading to price falls that are not fully reflected in fund valuations, some investors might be able to sell their holding for more than it is worth, disadvantaging the remaining investors in the fund,” the FCA statement added.
Ryan Hughes, pictured left, head of fund selection at AJ Bell, said that the discussion paper is “very much welcomed”, however, he urged that the “widest possible thought” is given to the implications of managing liquidity in funds and urged the FCA to take “a strong lead” in potentially removing daily trading in such funds.
“The investment industry has moved to a point where offering daily trading on a fund regardless of the asset class has become the norm,” said Hughes. “While this optically helps customers, it creates other problems where we see high levels of cash held to offset the liquidity risk. The liquidity problem is solved, but the side effect is increased cash drag and poorer performance.
“The ideal scenario may be that the FCA, fund management industry and customers accept that offering daily trading in illiquid assets is not the right approach and ultimately not in investors best interests. The trouble is that there is no advantage for any fund manager moving first on this issue. This will only be solved by the FCA taking a strong lead.”
The FCA has urged interested parties to send comments by 8 May using its online response form. If any changes are to be made to rules then a further consultation paper will be launched outlining the changes, later this year.
The FCA said that is looking for responses from; operators and investment managers of these funds, ancillary service providers, intermediaries, such as platform service providers, pension plan operators (eg those offering SIPPs and SSaS), financial advisers, ife assurance companies with exposure to illiquid assets such as property, either by direct investment or through holdings in investment funds, discretionary wealth managers and other professional or institutional investors.
The regulator also welcomed input from individual consumers and groups representing their interests.