The Financial Conduct Authority has delayed publishing its conclusion on the liquidity mismatch in open-ended property funds until Q3 at the earliest due to uncertainty over the operational hurdles to overcome to support notice periods.
The regulator said it also wants to factor into its decision industry feedback to a proposed new type of investment vehicle, known as the long-term asset fund (LTAF), which it published a consultation on on Friday.
On the same day the regulator revealed industry responses to its consultation on whether property funds should have notice periods between 90 and 180 days before an investment can be cashed, as well as any alternative proposals.
It came after a raft of open-ended property funds were forced to suspend trading in March last year as the Covid pandemic hit markets. Two funds, Aegon UK Property and Aviva Investors UK Property, remain closed.
See also: M&G Property Portfolio re-opening leaves two still frozen property funds in the spotlight
The FCA said: “We will not take a final decision on our policy position until Q3 2021 at the earliest. This is because we have taken the feedback into consideration, specifically around the operational work necessary for fund managers and most other firms to support notice periods.”
‘Only a small number’ back proposals
The consultation received 70 industry responses but the FCA said “only a small number” agreed with the proposal of at least 90-day notice periods.
Just over half, 56, supported the proposals ‘in principle’ but subject to two conditions.
First, that the wider infrastructure that supports and distributes funds, including platforms’ and advisers’ systems, were able to operationally support notice periods.
Second, that investments in funds with notice periods continued to be eligible assets for Isa purposes. In October last year, HMRC published a consultation on Isas and open-ended property funds which the FCA has said it will take this into account when making its decision.
Those opposed to notice periods argued it would substantially reduce demand for open-ended property funds, eliminating an important element of consumer choice and reducing diversification in retail investors’ portfolios.
They did not think that real estate investment trusts (Reits) offered an appropriate substitute due to their price volatility.
Other concerns were raised around the potential to trigger substantial outflows from property funds, leading to yet more liquidity crises, and the fact that a blunt “one size fits all” solution would not account for different investor needs and liquidity profile in each of the funds.
Some respondents said the measure would not lead to a substantial reduction in cash levels, and others thought it would not eliminate first mover advantage because investors early with their redemption notice would still benefit from being the first in the queue during liquidity crunches.
Alternative proposals
Respondents to the consultation offered a range of alternative proposals for addressing the liquidity mismatch, including:
- – not making notice periods mandatory, but instead optional for fund managers;
- – only applying mandatory notice periods to institutional investors who typically carry out large deals which can lead to liquidity issues within the fund;
- – changing the diversification rules to require funds to hold either a minimum percentage cash balance or a maximum percentage of physical property assets;
- – allowing subscriptions to continue when funds suspend for liquidity purposes (but not when suspensions are driven by material valuation uncertainty);
- – allowing fund managers to defer some or all redemptions for a longer period than the currently permitted one day, when needed.
The FCA said: “If we do proceed with applying mandatory notice periods for property funds, we will allow a suitable implementation period before the rules come into force, to allow firms to make operational changes.
“We note feedback that 18 months to two years would be an appropriate period.”
The long-term asset fund
The FCA said the LTAF would be open-ended and be able to invest in assets such as venture capital, private equity, private debt, real estate and infrastructure.
It is proposing that LTAF rules embed longer redemption periods, high levels of disclosure, and specific liquidity management and governance features. However, the FCA accepted the structure will therefore likely face some of the same operational barriers that property funds would face, if notice periods were introduced.
Will material uncertainty rules apply to LTAF?
Association of Investment Companies chief executive Ian Sayers said the trade body was concerned the rules that require a fund to be suspended when there is material uncertainty over the valuation of its assets will not apply to the LTAF.
“Is this because material uncertainty over valuations could be a permanent feature of an LTAF, given the very illiquid and complex assets that it could invest in?” he added.
“This does not just raise the anomaly that existing funds investing in property would be subject to the material uncertainty protections, but an LTAF investing in property would not. There is a much more fundamental issue. If the assets of an LTAF are always subject to material uncertainty over valuations, then how can investors know that the price set by the manager is a fair one?”
IA supports LTAF
But Investment Association chief executive Chris Cummings said the trade body welcomed the consultation on the LTAF.
He said: “We believe the LTAF can offer a significant additional way for long-term investors to access illiquid investments with appropriate protections, building on the established investment fund model.
“We look forward to continuing to work with regulators and stakeholders to make the LTAF a success as part of the wider initiative to boost the supply of productive finance for the UK economy.”
