On 8 October 2018, the Financial Conduct Authority (FCA) published Consultation Paper CP18/27 (Consultation Paper) on open-ended funds and illiquid assets. The Consultation Paper provides feedback to Discussion Paper DP17/1 and builds on the updated Recommendations on Liquidity Risk Management for Collective Investment Schemes (CISs) of the International Organisation of Securities Commissions (IOSCO), published in February 2018.

Background and Objectives

The Consultation Paper is concerned with liquidity risks associated with open-ended funds, specifically Non‑UCITS Retail Schemes (NURSs), that invest in illiquid assets, such as property or infrastructure investments. It is difficult for these funds to raise the necessary cash if a significant number of investors seek to sell units simultaneously and at short notice, especially under uncertain market conditions, such as the UK referendum on EU membership in June 2016. Even though, in this case, market disruption was successfully avoided by suspending temporarily the dealing in several property funds, there is room for improvement of liquidity management tools, according to the FCA.

In light of the above, the Consultation Paper seeks to enhance investor protection by increasing the understanding of the inherent liquidity risks, clarifying liquidity management tools and improving oversight. It also aims to protect the integrity of the UK financial system and balance more fairly the interests and incentives of different investors within the fund. Christopher Woolard, Executive Director of Strategy & Competition at the FCA said that the FCA expects “these changes to result in fewer runs on funds holding illiquid assets, and to reduce complaints from retail investors about perceived unfair treatment when they exit such funds“.

The Consultation Paper

The Consultation Paper proposes the following changes:

  • NURSs holding illiquid assets shall suspend dealing in units if there is ‘material uncertainty’ about the valuation of immovable accounting for at least 20% of the scheme property, according to the Standing Independent Valuer.
  • With a view to improving the quality of liquidity risk management:
    • fund managers investing mostly in illiquid assets shall produce contingency plans to address liquidity risks;
    • depositaries shall oversee funds’ liquidity management processes;
    • guidance will be provided on the circumstances under which dealing should be suspended and on how a fund manager should reach a fair and reasonable value estimate for an immovable that needs to be sold quickly; and
    • fund managers should not build up or hold large cash buffers over a long period, merely to address a potential but unanticipated future investor demand.
  • In order to improve disclosure:
    • fund managers investing mostly in illiquid assets shall include an ‘identifier’ to the name of the relevant fund in order to draw the investors’ attention to the nature of the fund;
    • the fund prospectus shall include details about liquidity risks, liquidity management tools, the circumstances under which they will be used and their potential impact on investors; and
    • fund managers as well as all firms communicating a financial promotion shall include a standard risk warning to financial promotions of these funds.

The FCA proposals are open for consultation until 31 January 2019.