Illiquid Assets An Open-ended Fund

Author:Mr Tim Cornick and Lora Froud

Liquidity management is a topical issue in the funds world and it was thrown sharply into focus for managers of open-ended funds following the unexpected Brexit referendum result. This was particularly so for those managers of funds investing in property who were forced to suspend dealing because they could not meet redemption requests.

The FCA was proactive in engaging with such managers in the week leading up to the referendum and has since undertaken supervisory visits to gain a deeper understanding of the liquidity challenges faced in extraordinary market circumstances.

On 8 February the FCA published Discussion Paper 17/1 "Illiquid assets and open-ended investment funds" which revealed what it had learnt from the "test" provided by the referendum and its subsequent supervisory work. Whilst it was generally happy with the way in which mangers dealt with the liquidity crunch, the FCA now seeks to promote discussion on whether any additional rules or guidance would be helpful in assisting managers to comply with their liquidity management obligations.

The issue

Regulated, open-ended funds are permitted to invest, within limits, in certain illiquid asset classes, such as private or unlisted shares, real estate and units in unregulated collective investment schemes which may themselves hold illiquid assets.

Investors are entitled to redeem their interests in such funds at net asset value. Whilst these funds are not obliged to offer daily subscription and redemption opportunities, many of them do in order to meet the requirements of platforms or other intermediaries that are distributing the fund.

In extraordinary market circumstances, such as those immediately following the referendum vote, managers may experience an atypical run of redemption requests. This creates three key issues for the manager:

Does it have enough liquidity in the portfolio to meet the redemption requests? In the prevailing market conditions can it accurately value the underlying assets which need to be sold in order to facilitate the redemption request? If the manager is able to sell some of the portfolio, does it risk giving the redeeming investors a "first mover advantage" in that if the first investors to redeem are paid from cash or the sale of highly liquid assets, later redeemers will need to be paid through the sale of less liquid assets which might be harder to sell and might incur greater transaction costs? Aim of The FCA

The FCA is absolutely clear that it is not intending...

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