FCA proposes up to 6 month notice period for open-ended property funds

On 3 August 2020, the FCA published CP20/15, "Liquidity mismatch in authorised open-ended property funds", putting forward plans to require 'funds predominantly investing in property', or 'FPIPs', (see below) to operate a notice period before processing redemption requests received from an investor.

Who does this affect?

The CP primarily affects managers and depositaries of UK authorised property funds set up as non-UCITS retail schemes (NURS), and which offer investors daily, monthly or quarterly valuation points.

It will also be of relevance to - among others - master and feeder funds which invest in property.

What would the new rules do?

The FCA is proposing that a 'fund predominantly investing in property', or 'FPIP' (see below), would have to operate a notice period before it processes a redemption request received from an investor.

When a FPIP received a redemption request:

• it would be recorded, then processed at the end of the notice period (see below)

• the investor would receive the value of its investment, based on the fund's unit price at the first valuation point following the end of the notice period.

Redemption requests would be irrevocable - an investor would not be able to place an order then withdraw it before the end of the notice period if market conditions change.

What's a FPIP?

A FPIP would be a newly defined term in the FCA Glossary and (broadly speaking) would be a NURS that

• invests at least 50% of its assets in property related assets and

• where it operates limited redemption arrangements, these provide for a dealing frequency of more than once every 90 or 180 days (the final figure will depend on where the FCA comes out at the end of the consultation - see below).

Existing funds which offered limited redemption and dealt no more frequently than monthly would not be classed as FPIPs and would fall outside the scope of the new rules.

Once the FCA's new rules came into force, new NURS property funds (including those dealing monthly or quarterly) would be classified as FPIPs and would have to have a notice period.

How long would the notice period be?

This is one of the key areas up for debate in the CP.

The notice period would need to be long enough to allow the manager to plan sales of property assets in order to meet redemptions as they fall due. (It would also send a signal to investors in such property funds that they are intended for medium-term to long-term investment rather than truly offering daily, monthly or even quarterly liquidity.)

The FCA will look to set a period which takes into account:

• how long it takes to sell commercial property

• how long ahead a consumer might look ahead when planning its financial affairs and

• the level of market risk that a consumer would be taking on.

From the consumer's perspective, then, the FCA regards 90 days as likely to be an acceptable timeframe in which to plan financial affairs.

On the other hand, a longer period - say, 180 days - would give the manager more time to get the best price for any property sold.

The FCA is inviting views on both options but is open to others, too. (The one parameter it flags up is that a NURS has to redeem investors at least once every 185 days, so notice periods can't be longer than that.)

What else do I need to consider?

• Changes to instruments and prospectuses

A change to a fund's dealing terms would require the manager to amend the instrument constituting the fund and prospectus and to give written notice of the proposed changes to the FCA.

A change to the instrument and prospectus would normally be regarded as a 'fundamental' change, subject to the COLL 4.3.4R requirements (prior approval from unit holders by extraordinary resolution). However, if the new rules proceed as proposed, the FCA confirms that funds wouldn't have to go through the fundamental change process. Instead, it would regard this as a 'significant change', under COLL 4.3 and would expect managers to notify investors before any change comes into effect.

Managers would still need to

• obtain FCA approval for any changes to the instrument and prospectus and

• consider any fund-specific requirements that arise because of changes to the instrument or prospectus which the new proposals would trigger.

• Significant changes

Applying a notice period would have an impact on any future changes to the fund that the fund manager decides to make.

Under COLL 4.3.6R(3), where a fund manager makes a significant change to the fund, unitholders must be given at least 60 days' notice in which to consider the change and sell their units if they disagree with it.

For property funds, the FCA considers that the notice given to unitholders should include the notice period for redemptions - so, for a fund operating a dealing notice period of 90 days, the 'significant change' notice period would be at least 150 days (90 + 60).

• Interaction with incoming FIIA rules

In PS 19/24, the FCA set out rules (coming into force on 30 September 2020) which, among other things, created a new category of NURS, the Fund Investing in Inherently Illiquid Assets (FIIA).

For our summary of PS 19/24, see here.

FIIAs are subject to additional requirements including enhanced depositary oversight, standard risk warnings on financial promotions, increased disclosure of liquidity management tools and liquidity risk contingency tools.

Under the FCA's new proposals in CP 20/15, property funds which meet the conditions for being both FIIAs and FPIPs will be considered FPIPs. FPIPs would be subject to all the FIIA rules except for the prescribed risk warning for retail investors (COBS 4.5.16R and 4.5A.17R).

Since the FCA thinks that the FIIA risk warning wouldn't be appropriate for property funds with notice periods, it will require these funds to include different warnings to retail investors, covering

• the market risk investors will be exposed to during the notice period

• the length of the notice period associated with their investment and

• the irrevocable nature of redemption requests.

The FCA will not be prescribing the wording to be used in these warnings.

• Tax treatment for investors in a FPIP

One possible downside of the proposals is that the introduction of notice periods could lead to property funds losing their status as qualifying investments for a Stocks and Shares ISA, meaning that the tax treatment for investors could change.

The FCA is in discussion with HM Treasury and HMRC to confirm whether the funds would remain eligible for ISAs if its rules do change and this aspect will be taken into account when it makes its final decision.

What happens next?

The consultation period closes on 3 November 2020.
The FCA intends to publish its policy statement and final handbook rules 'as soon as possible' in 2021.