Liquidity mismatch and open-ended property funds – the FCA’s feedback

Why has the FCA published FS21/8?

The FCA's work on liquidity mismatches has moved forward with the publication on 7 May 2021 of FS21/8, "Feedback to consultation paper on liquidity mismatch in authorised open-ended property funds" and a statement on its work in this area.

The effect of FS21/8, though, is largely to park the topic to one side - for the time being at least.

Its publication coincided with the launch of the FCA's consultation on Long Term Asset Funds (LTAFs) (see our response to the LTAF proposals here). Given the cross-over between the LTAF proposal and the possible introduction of notice periods for property funds, the FCA wants to take feedback on LTAFs into account before it finalises its line on notice periods for property funds.

It is unlikely, then, that its a final policy position will be known until Q3 2021 at the earliest - and, even if  it goes ahead with mandatory notice periods for property funds, the FCA confirms that it would allow a "sufficiently long implementation period" - most likely 18 months to two years - for firms to prepare before the rules come into force.

What's the background?

FS21/8 provides the FCA's feedback on responses received to its August 2020 consultation paper CP20/15 - our summary of the CP is here.

The CP's proposals looked to address potential investor harm arising from a liquidity mismatch, where the terms for frequent (typically daily) dealing in units of some property funds are not aligned with the time it takes to buy or sell the buildings in which the funds invest.

In particular, the CP affected 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.

In the CP, the FCA set out plans to require 'funds predominantly investing in property' (FPIPs), to operate a notice period before processing redemption requests received from an investor -  the FCA suggested a notice period of between 90 and 180 days, but also asked for any alternative proposals.

The consultation period ended on 3 November 2020 and FS21/8 is the FCA's first opportunity to update the industry on how its thinking has developed.

What does FS 21/8 say?

As far as a definitive steer goes, not much.

Because of its ongoing consultation on LTAFs, the FCA notes that it will not take a final decision on its policy position "until Q3 2021 at the earliest". However, it does confirm in FS21/8 that

• only 'a small number' of respondents agreed with the notice period proposals on which the FCA consulted in CP20/15
• however, 'just over half' of those expressing a clear position supported the proposals 'in principle', provided that:
  • the wider 'ecosystem' that supports and distributes investment funds (including key players in the distribution chain, such as platforms, wealth managers and unit linked providers) is operationally able to support notice periods (which the FCA believes it is) and
  • investments in funds with notice periods would continue to be eligible assets for ISA purposes
• it does not think that a relatively short notice period should fundamentally undermine the investment rationale for investors with a longer-term investment horizon and without need for daily liquidity, such as pension savings in accumulation
• it will not finalise its policy position on whether or not to introduce notice periods for property funds until it has received feedback to the LTAF consultation
• if it does decide to introduce notice periods for property funds
  • the earliest that such rules would be finalised is likely to be Q3 2021
  • it would allow a suitable implementation period before the rules come into force so firms can make operational changes - it notes feedback that 18 months to 2 years would be an appropriate period
• it is liaising with HMT and HMRC on the issue of the possible loss of ISA eligibility, which it accepts "could offset the other benefits of applying the proposed notice periods". ISA eligibility will be taken into account in the FCA's final decision.