Warning over FCA rules aimed at preventing Woodford repeat

Proposals by the Financial Conduct Authority (FCA) aimed at preventing a repeat of the Woodford crisis could lead multi-asset funds or funds of funds to move away from funds holding illiquid assets, according to an investment manager.

The FCA this week published new rules applying to some types of open-ended fund investing in illiquid assets such as property.

It has introduced the new rules in response to the suspension of trading in the Woodford Equity Income Fund fund in June after Kent Pension Fund decided to withdraw its £263m investment.

Announcing the new rules, Christopher Woolard, executive director of strategy & competition at the FCA, said: ‘We want people 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.

“The new rules and guidance are designed to protect the interests of investors particularly during stressed market conditions.”

The new rules apply to funds known as non-UCITS (Undertakings Collective Investment in Transferable Securities) retail schemes (NURSs), but not to other types of fund, such as UCITS, which are already subject to restrictions relating to such assets.

The FCA measures will introduce a new category of ‘funds investing in inherently illiquid assets’ (FIIA).

These will be subject to additional requirements, including 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.

However, they will not apply where a fund matches the dealing frequency of its shares to the liquidity of its assets.

In addition, the FCA is introducing 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.

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.

The FCA said: “Funds which hold less liquid assets can encounter liquidity difficulties if significant numbers of investors simultaneously try to withdraw their money at short notice, as seen shortly after the EU referendum in 2016 when a number of property funds had to suspend dealing. 

“In stressed market conditions, assets that are less liquid can also suffer from a high degree of valuation uncertainty.”

However, Ryan Hughes, head of active portfolios at investment platform AJ Bell, said this rule will mean funds are likely to suspend dealing more frequently and sooner than they would have done in the past.

He said: “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.”

Ian Sayers, chief executive of the Association of Investment Companies (AIC), said: “Given the recent warnings from the Bank of England regarding the systemic risks such funds create, we would have expected a more urgent approach which addressed these broader risks and not simply tinkered with existing regulation and only apply these measures to some funds.

“We hope that the further work being undertaken with the Bank of England will propose a more comprehensive and robust solution.”