Yesterday, the Financial Conduct Authority (FCA) published a consultation paper on the liquidity mismatch in authorised open-ended property funds (CP20/15). The FCA proposes to introduce redemption notice periods for non-UCITS retail schemes (NURS) that invest 50% or more of their assets in immovables (with these funds being known as “funds predominantly investing in property” or FPIPs).
What are the proposed new rules?
The FCA proposes the following dealing structure for FPIPs.
- Each investor’s redemption request would be received and recorded, then processed at the end of a notice period. The FCA is consulting on a notice period of between 90 and 180 days.
- A redeeming investor would receive the value of their investment, based on the unit price of the FPIP at the first valuation point following the end of their notice period.
- Redemption requests would be irrevocable. Investors cannot place a redemption request and withdraw them before the end of the notice period if market conditions change.
FPIP managers would be required to ensure that warnings are given to retail investors covering: (i) the market risk they would be exposed to during the notice period; (ii) the length of the notice period associated with their investment; and (iii) the irrevocable nature of the redemption requests (FPIP Risk Warnings).
The FCA is welcoming feedback on the proposals by 3 November 2020, with a view to publishing a final policy statement and final handbook rules as soon as possible in 2021.
How does this consultation sit with the new rules for funds investing in inherently illiquid assets (FIIAs) coming into effect on 30 September 2020?
This consultation builds on the new rules for FIIAs set out in the FCA's September 2019 policy statement (PS19/24). The FCA’s proposal envisages that a property fund meeting both the FIIA and FPIP conditions would be an FPIP. An FPIP would be subject to all of the FIIA rules, except for the prescribed risk warning for retail investors under COBS 4.5.16R and 4.5A.17R (which the FCA does not believe would be appropriate for FPIPs). Instead, an FPIP manager would be required to provide the FPIP Risk Warnings.
Redemption notice periods are not a panacea
The FCA’s proposal is intended to better protect consumers by (i) reducing the likelihood of a property fund suspension due to a lack of liquidity (which would in turn reduce the likelihood of a "run" on the fund); (ii) improving disclosure of the illiquidity risk associated with property funds; and (iii) increasing the potential for higher investment returns by enabling property funds to hold less cash and have greater exposure to property assets.
However, the FCA does not consider that notice periods would necessarily solve all liquidity issues in property funds, and is supportive of considering other initiatives (such as the Investment Association’s proposed long-term asset fund (LTAF)) to facilitate investment in long-term assets. Interestingly, the LTAF proposal envisages the use of notice periods as part of the liquidity management toolkit; it also goes further by proposing that an LTAF manager should be allowed to structure redemptions to match the liquidity profile of the LTAF’s underlying assets, for example by offering a dealing frequency of up to every two years. We will be keeping an eye out for any further developments later this year on the LTAF proposal.
In this paper, we set out a possible way of addressing this structural mismatch through a proposal to require investors to give notice before their investment is redeemed.