The Financial Conduct Authority (FCA) is consulting on new rules designed to improve the structure of open-ended property funds.
The consultation follows several high-profile trading suspensions for these funds, with a liquidity crunch prompting some fund managers to place restrictions on redemptions.
According to the FCA, there is a “liquidity mismatch” with this structure of investment fund, and the new rules would reduce the potential for harm to investors.
The liquidity mismatch occurs because open-ended funds allow investors to buy or sell units each day, but the underlying assets in the fund (commercial property) can take weeks or even months to sell.
Even where the open-ended property fund holds some cash too, which is common for these funds, a sudden flurry of investors wanting to sell their units can be problematic.
Within its consultation, the FCA says: “The terms for dealing in units of some property funds are not aligned with the time that it takes to buy or sell the buildings that the funds invest in.”
So, the FCA is proposing new rules would mean investors need to give notice before selling.
This notice period for investors in open-ended commercial property funds could be as long as 180 days, but the FCA is also consulting on a shorter notice period, at 90 days.
However, before introducing new rules and imposing a notice period on investors wanting to sell, the FCA is asking interested parties to suggest different approaches that would also improve the situation.
The regulator is trying to determine the most appropriate length of the notice period. It is suggesting between 90 and 180 days for these funds.
The FCA says: “Funds should be resilient during periods of stress and operate in a way in which all investors are treated fairly. If we implement this proposal, we will seek to measure success through evidence of fewer incidents of liquidity-related stress in authorised open-ended property funds in the long term.”
As an investor, it’s never nice to think your money is tied up. A redemption notice period of between 90 and 180 days would likely make open-ended commercial property funds a less attractive proposition for retail investors.
However, a new rule along these lines should guard against most unexpected trading suspensions, as fund managers would be able to better plan ahead for redemption requests.
Christopher Woolard, FCA interim chief executive, said:
We think that our proposals will help further our consumer protection objective by reducing the number of fund suspensions, preventing unsuitable purchases of funds, and by increasing product efficiency for fund managers.
We want open-ended funds to provide a structure through which investors can safely invest in less liquid assets which offer attractive expected returns and at the same time supports investment that benefits the wider economy.
We hope the proposed new rules will directly address the liquidity mismatch of these funds making them more resilient during periods of stress and allowing them to operate in a way that all investors are treated equally.
One consequence of introducing a redemption notice period on commercial property funds is that they would no longer be qualifying investments for the purposes of Individual Savings Accounts (ISAs).
The FCA is liaising with the Treasury and HMRC to confirm whether open-ended commercial property funds could still be held within ISAs should their new rules be introduced, and plan to take the response into consideration when formulating the new rules.
The consultation is open for comments until 3rd November 2020, with the final rules expected at the start of 2021.
We will be discussing the proposals within the consultation at our next Informed Choice investment committee, before deciding what such changes could mean for the ongoing viability of open-ended property funds within our client portfolios.
When carefully selected, an appropriate open-ended commercial property fund has a role to play within portfolios, assuming the investment is aligned with the longer-term financial goals of the investor.
By potentially killing off the ISA eligibility of these funds, the FCA might well be overstepping its remit and damaging, rather than improving, competition in the retail financial services sector.