The Financial Conduct Authority (FCA) has unveiled an industry-wide discussion paper on whether further regulatory intervention may be needed to protect consumers in open-ended funds investing in illiquid assets, and ensure market stability.
It said it will draw on responses received by 8 May, together with further supervisory work, to decide whether changes need to be made to Handbook rules and guidance.
The regulator said it does not intend to ban open-ended funds holding illiquid assets - including land and buildings, infrastructure and unlisted securities - or prevent retail investors from acquiring units in open-ended property funds.
However, it wants to start a broader discussion on how regulation could help narrow a potential mismatch between investors' expectations of fund liquidity and the manager's ability to meet those expectations.
"Regulation should ideally allow a wide range of investors to share in the potential returns of illiquid assets and give them an appropriate level of protection that reflects their understanding of the nature and risks of the investment, while ensuring that the vehicles they use do not create or exacerbate risks to markets' integrity and stability," the FCA said.
"We would like to hear views on whether our regulatory regime strikes a fair balance between these aims."
According to the regulator, although investing in illiquid assets provides investors with the opportunity to earn strong investment returns and diversification of portfolio risks, some funds investing in illiquid assets can encounter difficulties if investors expect to be able to withdraw their money at short notice.
It said these difficulties are likely to be exacerbated if an event in the market triggers an upsurge in redemption demand, or conditions change for underlying assets.
An example of this was in the wake of last June's Brexit vote, when a raft of open-ended property funds from the likes of M&G, Aviva Investors, and Columbia Threadneedle were suspended as they struggled to cope with high levels of Brexit-driven outflows.
In the paper, the FCA said it is currently carrying out supervisory work to assess how the liquidity of open-ended property funds was affected before and after the EU referendum.
Talking about the period following the Brexit vote, the regulator said it organised a roundtable meeting with a group of fund managers and depositaries in early July and considered the idea of a general suspension of property funds, although this idea was eventually dropped due to concerns about a loss in confidence in the sector and further market declines.
Commenting on the discussion paper, Megan Butler, executive director of supervision - investment, wholesale and specialist at the FCA, said: "This discussion paper is a great opportunity for all stakeholders to think carefully about the management of risk, particularly around redemptions, if investors are looking for a quick exit.
"We want to engage with fund managers and the investors whose money they manage to understand what problems they think exist.
"Specifically, in the context of open-ended funds we want people to consider how well the current rules address those problems, and what further regulatory intervention might be needed. We look forward to industry and consumers giving us their views and opinions."