Liquidity management has been a key part of regulatory reform since the financial crisis in 2008. It has also been the subject of papers from the Financial Stability Board, the European Fund and Asset Management Association, the International Organization of Securities Commissions (Iosco) and, in the UK, the Financial Conduct Authority (FCA), concerned about wider systemic and stability risks should financial institutions fail.
The FCA recently brought liquidity management back into focus for the funds industry with its Illiquid Assets and Open-ended Investment Funds discussion paper. The trigger for this was the suspension of a number of UK authorised real estate funds following the Brexit referendum result.
An impending Brexit brings sharply into focus some competing demands for the UK funds industry. On the one hand, the FCA must continue to consider its market integrity and consumer protection objectives. On the other, the UK must remain a competitive and attractive jurisdiction for fund managers post-Brexit.
The tone of the paper is encouraging – it is clear the FCA does not intend to prohibit open-ended funds from investing in real estate (or other illiquid assets). Instead, the FCA is seeking to positively engage with the industry to determine how current regulation can be enhanced to support fund managers in meeting their obligations and in ensuring good investor outcomes.
The FCA review liquidity management tools such as anti-dilution measures, redemption frequency and notice periods. They also propose a non-exhaustive list of possible improvements, including:
1) Treating professional and retail holders differently by separating them by share class. This is the case in practice in any event, but now we might have different notice periods or dealing frequencies. This would have the consequence that retail investors, who would retain daily dealing, would have an advantage over institutions in being able to redeem more quickly.
2) Having a liquidity buffer by setting a cap on the proportion of illiquid assets held in a fund or by increasing diversification requirements. This could work perhaps as formal guidance to avoid unintentional breaches as property prices move.
3) Requiring managers to follow similar rules to those being introduced in the US in respect of liquidity ‘buckets’ where fund portfolios are subject to limits on the proportion of assets that can be realised for cash within a specific timeframe. In responding, managers could consider how this measure could be framed to be operationally practical for real estate funds.
4) Direct intervention by the regulator, requiring managers to suspend in certain circumstances. This wasn’t required after the referendum and arguably it should not be necessary in a well-functioning market.
Both Iosco and the FCA have acknowledged that the liquidity management tools already available for investment funds are not widely used – perhaps being viewed negatively in the market or not considered operationally practical for property funds (e.g. deferred redemptions on a daily dealt fund).
As such, fund managers should take this opportunity to engage with the FCA, to suggest improvements to existing measures and practical feedback on the new proposals. The aim should be to achieve a stronger framework of liquidity management tools which will support real estate funds, increase investor confidence and understanding, and allow the sector to continue to grow in a post-Brexit UK. The deadline for responses is May 8.
Julian Brown, partner and Laura Houët, principal associate, Eversheds Sutherland
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