Regulators have proposed sweeping rule changes in the fund sector, after a series of high-profile scandals this year.
The Bank of England and Financial Conduct Authority (FCA) on Monday published the interim findings of a review into open-ended funds, calling for changes to the way these funds are priced. The recommendations follow issues with open-ended funds managed by Neil Woodford and asset manager M&G this year.
The review, published on Monday alongside the Bank of England’s Financial Stability Report, said open-ended funds that invest in illiquid assets and offer daily redemptions should give investors who withdraw at a day’s notice a “price discount.”
The idea is to reflect the lower price fund managers could get for illiquid assets when they are forced to sell them in a hurry.
“There should be greater consistency between the liquidity of a funds assets and its redemption terms,” Bank of England governor Mark Carney told journalists at a press conference on Monday.
In practice, this would mean people who put money into property funds or similar would face a haircut on their returns if they try to withdraw funds at a day’s notice.
The alternative for fund managers who don’t want investors to suffer losses would be to change their redemption periods to weekly or monthly to better reflect the time needed to sell illiquid assets like buildings, private company stock, infrastructure investments, or similar.
Open-ended funds have been in regulatory cross-hairs this year after a series of high-profile issues around liquidity in these funds.
Well-known investment manager Neil Woodford was forced to suspend withdrawals from his £3.7bn flagship fund in July after a high-level of withdrawals left him unable to sell assets fast enough to meet the redemptions. The incident triggered a series of events that ultimately led to the collapse of Woodford’s entire business.
More recently, asset manager M&G was forced to gate its UK Property Portfolio fund after a series of “unusually high and sustained outflows” left it unable to sell its buildings fast enough to meet withdrawals.
Open-ended funds create ‘units’ that are sold to investors. When investors sell, the fund pays out based on its net asset value. In contrast, closed-ended funds can trade at a discount or premium to their net asset value depending on demand in the secondary market.
The current system favours investors who pull their cash out of funds first, as any discounts suffered on the sale of underlying assets are not translated into redemptions. The proposed rule changes would make the system fairer and aim to prevent ‘runs’ on funds that suffer higher than usual withdrawals.
“The mismatch between the redemption terms and the liquidity of some funds’ assets means there’s an advantage to investors who redeem ahead of others, particularly in stress,” Carney said.
“This has the potential to become a systemic risk as first-mover advantage could prompt a destabilizing rush to the exit.”
The FCA is working on how to convert these proposed changes into binding rules and will publish final proposals next year.