Property funds face stricter checks from September 2020

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Property Funds:

Britain’s
Financial Conduct Authority (FCA), the financial markets regulator,
published tougher rules this week for funds that invest in
hard-to-sell assets, typically property.

Following a string
of instances where open ended funds* have been unable to pay out
money when investors have requested it because illiquid assets such
as property cannot be sold at short notice. In a market downturn this
often presents a major problem for funds with a high proportion of
illiquid assets when investors rush for the exit.

Some so called
“Built on a lie” funds, those sold to investors who are no
aware of the illiquid nature of the investment will now face tougher
rules starting in September 2020.

Some funds investing
in property had to be “gated”, in other words they had to suspend
redemptions during market stress in June 2016 immediately after the
“leave” result of Britain’s referendum to leave the European
Union.

When these funds
were unable to meet promises of daily redemptions, it prompted Bank
of England Governor Mark Carney to describe them as “built on a
lie”.

The FCA came under
more pressure to make a change following the high-profile fund run by
Neil Woodford when he suspended redemptions from his flagship Equity
Income Fund in June this year, a fund which had promised easy daily
redemptions.

It turned out that
Woodford was unable to make payouts after investors lost confidence,
panic set-in and a flood of redemption requests came in. This
situation came about because Woodford had breached a rule limiting
how much it could invest in illiquid assets. But with property funds,
unlike Woodford’s, often all the fund it invested in
illiquid assets.

A new category of
funds therefore, those investing in inherently illiquid assets, or
FIIA funds, from September 2020, will be subject to additional
requirements, including standard risk warnings in financial
promotions, enhanced depositary oversight, and a requirement to
produce liquidity risk contingency plans, says the FCA.

Christopher Woolard,
the FCA’s executive director for strategy and competition, had
said:

“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.”

Ryan Hughes, head of
active portfolios at investment platform AJ Bell has said:

“This means we’re
likely to see funds suspend dealing more frequently and sooner than
they would have done in the past”

Ironically, the new
rules will not apply to EU-regulated funds like the Woodford fund,
even though FCA Chief Executive Andrew Bailey has described the EU’s
rules as “flawed” – the Woodford fund breached the rule that no
more than 10% should be in illiquid assets.

Britain’s
Investment Association has said that the FCA’s approach with its
new rules is “pragmatic and measured” recognising the need to
enable investment in illiquid assets through open-ended funds, albeit
under stricter new rules.

The pool of
open-ended property funds subject to daily monitoring has been
widened by the FCA meaning that smaller property funds, as well as
larger funds that suffered following the 2016 Brexit referendum, will
need to publish daily cash-flow updates.

*Open-end funds
are collective investment schemes that issue and redeem shares direct
to investors, rather than they purchase shares from existing
shareholders on the stock market.

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