FCA announces 'illiquid' fund category, among other new rules

New disclosure, risk warning and oversight requirements will apply to non-UCITS retail schemes (NURSs) which fall into a new category of 'funds investing in inherently illiquid assets' (FIIA) from 30 September 2020. From the same date, NURSs which invest in inherently illiquid assets will be required to suspend most dealing where there is "material uncertainty" about the value of more than 20% of the fund's assets.

Funds which hold assets which cannot easily be converted into cash can encounter liquidity difficulties if significant numbers of investors try to withdraw their money simultaneously at short notice, as happened shortly after the 2016 referendum on the UK's membership of the EU. More recently, dealing in the LF Woodford Equity Income Fund (WEIF) was suspended after the fund ran into liquidity difficulties. The WEIF is a UCITS, and so regulated at EU level, but the FCA said that the suspension "underlines the importance of effective liquidity management in open-ended funds more generally".

"The FCA has been signalling its intention to increase investor protection in relation to illiquid assets in retail funds for some time, so these new rules, whilst they closely follow news stories about the Woodford fund suspensions, have been expected," said financial regulation expert Anita Ives of Pinsent Masons, the law firm behind Out-Law.

"The FCA's main concern has always been the potential risk to investors who can lose a lot of the value of their investment or simply be unable to realise that value in difficult market conditions. Property funds in particular have come under scrutiny, although these new rules apply to a wider range of assets. The FCA recognises that investors do have some responsibility to make their own decisions about investments, but they can only do that if they have all the necessary information about the assets they are invested in. These rules are intended to help fill that gap," she said.

Funds categorised as FIIAs will be required to produce liquidity risk contingency plans, and to provide their investors with "clear and prominent" information on liquidity risks and the circumstances in which they may be prevented from redeeming their investments at short notice. The FCA said that the new rules would reduce the potential for some investors to gain at the expense of others, and of funds facing the need to carry out 'fire sales' of assets in order to meet redemption requests.

The FCA has encouraged fund managers and depositaries to introduce the new disclosure and liquidity management requirements ahead of the September 2020 deadline, where this is "in customers' interests".

The regulator has taken on board feedback from funds about the additional new requirement that NURSs investing in inherently illiquid assets be required to suspend dealing where their independent valuer determines that there is a material uncertainty regarding the value of over 20% of the fund's assets. Fund managers will be permitted to continue to deal where the fund's depositary agrees that this is in the best interests of the investors.

Christopher Woolard, the FCA's executive director of strategy and competition, said that retail investors should be able to invest in real estate and other illiquid assets "but it is important that they are appropriately protected".

"The new rules and guidance are designed to protect the interests of investors particularly during stressed market conditions," he said. "This includes those wishing to redeem their holdings, as well as those wishing to remain invested in the fund. We also want to make it clear that authorised fund managers are responsible for managing the liquidity risk in their funds and acting in the best interests of investors."

In its policy statement setting out the new rules, the FCA said it was working with the Bank of England on whether fund redemption terms should be better aligned with the liquidity of their assets in order to minimise financial stability risks. It is also considering whether institutional investors should be subject to different redemption conditions from retail investors in the same fund.