Non-UCITS retail schemes (NURSs) investing in inherently illiquid assets such as property are to be forced to abide by new liquidity rules from next year, with the Financial Conduct Authority (FCA) moving to ensure investors are “appropriately protected”.
The new rules, which will come into force on 30 September 2020, aim to ensure NURSs managers provide investors with clearer and "prominent" information on liquidity risks, and the circumstances in which access to their funds may be restricted.
It will also place additional obligations on the managers of funds investing in inherently illiquid assets to maintain plans to manage liquidity risk.
The FCA is also aiming to reduce the potential for some investors to "gain at the expense of others", and reduce the likelihood of runs on funds leading to a ‘fire sale' of assets which disadvantage fund investors.
A new category of "funds investing in inherently illiquid assets" is also set to be formed, with funds within this category subject to additional requirements. This includes increased disclosure of how liquidity is managed, standard risk warnings in financial promotions, enhanced depositary oversight, and a requirement to produce liquidity risk contingency plans.
There will also be a requirement that NURSs investing in inherently illiquid assets must suspend dealing where the independent valuer determines there is material uncertainty regarding the value of more than 20% of the fund's assets.
Executive director of strategy and competition at the FCA Christopher Woolard said the regulator wants investors "to continue to be able to invest in illiquid assets, such as real estate, through open-ended funds but it is important that they are appropriately protected".
He added: "The new rules and guidance are designed to protect the interests of investors particularly during stressed market conditions. This includes those wishing to redeem their holdings, as well as those wishing to remain invested in the fund."
The FCA will, however, allow fund managers to continue to deal where they have agreed with the fund's depositary that this is in the investors' best interests.
Every fund in the IA UK Direct Property sector, where the 2016 property gatings took place, is a UK OEIC and will therefore be covered by the new rules.
In an additional announcement, the FCA said that the suspension of UCITS fund Woodford Equity Income, which is heading into its fourth month, "underlines the importance of effective liquidity management in open-ended funds more generally".
The FCA, in partnership with the Bank of England, is now "assessing how funds' redemption terms might be better aligned with the liquidity of their assets in order to minimise financial stability risks".
It said it wants to provide "appropriate protection to investors, without compromising the supply of productive finance".
Commenting on the FCA's new rules, CEO of the Investment Association Chris Cummings welcomed the "pragmatic and measured approach, which recognises the importance of enabling investment in illiquid assets through open-ended funds".
He added: "Fund suspension is not undertaken lightly and acts as an important and sometimes necessary tool to protect investors' interests. The new rules, which combine enhanced liquidity management with additional disclosure requirements, will benefit investors, helping them make informed choices about their investments and strengthening fund management processes.
"We will continue to work with the industry and regulators to ensure that appropriate liquidity management processes are in place. We also look forward to further developing the IA's proposed Long-Term Asset Fund to help widen access to more illiquid assets, opening up investment opportunities."
Ryan Hughes, head of active portfolios at investment platform AJ Bell noted that the FCA is "pushing ahead with its plans to force funds to suspend dealing if there is uncertainty about the valuation of 20% or more of its assets", adding that this means we are "likely to see funds suspend dealing more frequently and sooner than they would have done in the past".
He added: "The knock-on effect of this is that multi-asset funds or funds of funds that invest in open-ended property funds may also have to suspend dealing if the property funds temporarily shut. As such, we could see multi-asset funds move towards closed-ended funds, such as investment trusts, for property exposure. In a worst case scenario we could see them restricting their allocations to these illiquid assets to below 20%, in turn reducing the diversification of the funds for investors.
"The regulator has backed down on its plans to stop property funds continually having a large cash buffer. This means we'll see a continuation of the status quo, where property funds often have around 20% of their assets in cash, on which they charge the full management fee and which serves as a considerable drag on returns for investors."