The FCA’s aim is to improve investor protection by correcting the structural mismatch between the liquidity these funds offer to investors and the time it typically takes to sell the underlying assets.
This consultation builds on the new rules for open-ended funds investing in inherently illiquid assets set out in the FCA’s September 2019 policy statement (PS19/24), and which come into force on 30 September 2020.
It also follows a long period of discussion in the industry on whether property funds are appropriate for retail investors; whether daily dealing is feasible and whether fund managers have the appropriate tools to effectively manage long term investments within the confines of existing rules and structures.
What is a “FPIP”?
A “fund investing predominantly in property” is, thankfully, not intended to be another term presented to investors but to be used within the FCA rules to differentiate the funds to which the proposed new rules would apply.
In short, these would be any non-UCITS retail scheme (“NURS”) which:
- invests 50% or more of its assets in immovables; OR
- invests in other schemes that invest in immovables to the same extent; AND
- where that NURS operates limited redemption arrangements, those arrangements provide for dealing more frequently than 90 or 180 days. The time period here forms part of the consultation (see below).
The FCA intends only to capture funds that do not already operate redemption arrangements reflecting the typical time needed to sell the underlying property assets.
The FCA also proposes to allow a dispensation for certain existing funds. Under the proposals, the new rules would not affect existing funds that deal no more frequently than once a month as the FCA considers that these have, historically, not been subject to the same suspension issues as a result of liquidity mismatch and are not usually marketed to retail investors.
However, once the new rules are in force, any new NURS investing predominantly in property would be classified as a FPIP and would therefore require a redemption notice period.
What are the proposed new rules?
The FCA proposes that investors in FPIPs should be subject to a notice period of 90 to 180 days when redeeming their investment, in order to move towards rectifying the liquidity mismatch. the length of the notice period is one of the key issues in CP20/15 and is discussed further below.
The FCA proposes the following main changes to a FPIPs dealing structure:
- Each investor’s redemption request would be received and recorded, then processed at the end of a notice period of between 90 and 180 days.
Practical consequence: The introduction of the notice period will of course have an impact on the internal administration of a FPIP, but it will also impact suitability assessments and platform processes. Unit-linked insurers and SIPP providers will also be affected. It is crucial that any unintended consequences, or issues which will take time to iron out before the proposed rules are implemented, are fed back to the FCA during this consultation process.
- The investor would receive the value of their investment, based on the unit price of the FPIP at the first valuation point following the end of their notice period
Practical consequence: an investor would not know the exact amount they would receive until the next valuation point, which could take 180 days or more, after their decision to redeem. This leaves investors more exposed to market risk than they are currently. The FCA believes this is a ‘fair way to balance the interests of all investors’ in property funds. It is, however, unlikely to be attractive to many retail investors.
- Redemption requests would be irrevocable – investors could not place a redemption request and withdraw it before the end of the notice period if market condition change.
Practical consequence: As above, investors are more open to market risk. However, not doing this could lead to the fund manager selling property to meet redemption requests that are subsequently cancelled.
What is the proposed redemption notice period?
As noted above, this is a key point on which the FCA is seeking feedback in CP 20/15. The draft rules in the CP propose two options: (i) at least 90 days and no more than 180 days or (ii) 180 days.
The FCA is keen to understand the industry’s views on the notice period, recognising the balance between, on the one hand, setting an acceptable timeframe for retail investors and, on the other hand, giving enough time for funds to sell properties at the best price that can be obtained.
The FCA seeks to set a time period that takes into account:
- How long it takes to sell commercial property;
- How far ahead a retail investor might plan their financial affairs; and
- The level of market risk an investor would be exposed to.
In responding to the consultation, the industry should also consider any operational or practical issues that might influence the FCA’s approach. For example, how would platforms support a 180 day redemption period? Will managers need time to change their systems? The FCA is already aware of the potential issues for ISA investors and are in discussions with HMRC. It is clear that a notice period will be set, and this is likely to be at least 90 days. Proposing solutions to any practical issues will help the FCA’s process and, hopefully, result in workable rules for the industry.
Who would be affected by the proposed new rules?
Mainly, CP20/15 affects operators and depositaries of funds that would be classified as FPIPs.
However, as a result of the operational and client facing nature of this change, there is a much wider impact across the industry - affecting all who invest in, administer or offer FPIPs. It is important that the FCA receives feedback to the consultation from all affected parts of the industry.
What other impacts are there on the FPIPs?
- Changes to FPIP documents
The proposed rules will mean changes to a FPIP’s dealing structure – this will require FCA approval in the normal way. However, although this would normally be considered a fundamental change (requiring shareholder approval), the FCA has confirmed that implementation by FPIPs of the proposed rules would be classified as significant, as they are a result of regulatory change.
- Definition of “significant” changes
Currently, under COLL 4.3.6R(3), where a fund manager makes a “significant” change, shareholders must be given at least 60 days’ notice so they can consider the change and sell their shares if they disagree with it.
The FCA considers that the notice period for redemptions should also be allowed for in this procedure. As such if fund is operating a dealing notice period of 90 days, the FCA proposes that significant changes would need to be communicated to shareholders at least 150 days in advance.
This will have an unwelcome business impact on all future change projects involving the FPIP as managers will need to schedule changes a very long time in advance – even longer if the dealing notice period is 180 days.
- Interaction with the new FIIA rules
On 30 September 2020, the new FIIA (funds investing in inherently illiquid assets) rules come into force, creating a new category of NURS which will include property funds.
Clients are already prepared for these new rules, which include enhanced disclosure requirements and increased depositary oversight.
The FCA proposes that funds which satisfy the conditions to be both an FIIA and a FPIP will be considered as FPIPs, being subject to all of the FIIA rules with the exception of the prescribed risk warning for retail investors.
The FCA considers that this risk warning isn’t relevant for property funds with notice periods, FPIPs will be required to include different disclosures explaining:
- the length of the redemption notice period;
- the market risk investors will be exposed to as a result of that notice period; and
- that redemption requests will be irrevocable.
The FCA’s consultation period will end on 3 November 2020. A related webpage states that the FCA aims to publish a policy statement in early 2021.