Liquidity has continued to be a key concern for the investment funds industry and its regulators globally and in Europe in recent years. In 2018, the International Organisation of Securities Commissions (IOSCO) published its recommendations for liquidity risk management, and more recently, on 2 September 2019, the European Securities and Markets Authority (ESMA) issued guidelines on liquidity stress tests for investment funds. The pressure is mounting.
Read more on the ESMA guidelines in our article here
Amongst this global scrutiny, the UK is a market that has seen particular volatility in the open-ended investment fund sector. The UK has seen the second-highest number of property fund suspensions since the start of the coronavirus pandemic (both in terms of fund manager location, and fund domicile) - and this is certainly not a new topic. With the prevalence of daily dealing funds that invest in property and/or real estate in the UK, the mismatch between fund liquidity and investor redemptions is an issue that has played out since the European Referendum in 2016.
The journey so far
June 2016: EU Referendum sparks mass redemptions
Following the UK’s ‘Leave’ vote, several large property funds are suspended as investors rush to withdraw assets.
June 2019: the Woodford Equity Income Fund suspended
An increase in redemption requests leads to this once £10. 2bn fund reducing to £3.7bn by May 2019. The fund is unable to meet redemptions due to a high level of holdings with low liquidity and is suspended.
October 2019: Woodford Equity Income Fund to be wound up
The fund’s Authorised Corporate Director advised that progress had not been sufficient to allow 'reasonable certainty' about when repositioning would be fully achieved and the fund could be re-opened, so a decision was made to terminate the fund.
December 2019: uncertainty leads to a major property fund suspensions
Investor uncertainty arising from UK events including the Brexit extension and General Election lead to increased outflows. A large property fund is gated to allow the fund to raise cash levels.
March 2020: COVID-19 causes record outflows
‘Material uncertainty’ about property values leading up to the UK lockdown causes eight fund managers to suspend dealing in open-ended property funds.
The FCA step in with a new fund classification
As part of the FCA’s drive to improve liquidity monitoring, and in order to implement the lessons learned from the property fund suspensions in 2016, the FCA issued Policy Statement PS19/24 in September 2019. BNP Paribas Securities Services contributed to this discussion as part of the Depositary and Trustee Association’s response.
The rules and guidance in PS19/24 create a new category of non-UCITS retail scheme (NURS), namely ‘a fund investing in inherently illiquid assets’ (FIIA). An FIIA is defined as:
- A NURS which has disclosed to its investors that it is aiming to invest at least 50% of its scheme property in inherently illiquid assets, or
- A NURS, which has invested at least 50% of the value of its scheme property in inherently illiquid assets for at least three continuous months in the past 12 months, whether or not it has disclosed its intention to do so. (the definition of ‘inherently illiquid assets can be found in the FCA’s policy, section 2.13)
Any NURS classified as an FIIA will be subject to additional requirements, including enhanced depositary oversight, standard risk warnings in investor-facing documents, increased disclosure of liquidity management tools and liquidity risk contingency plans. The rules supplement existing guidance in three areas:
- Increased disclosure: the fund manager needs to explain the liquidity profile of any fund and associated risks of funds that invest in less liquid assets in client-facing documents. A fund’s prospectus should also be clear on the arrangements for any suspension of dealing.
- Suspension: a NURS must suspend the fund, where its standing independent valuer expresses material uncertainty over the value of 20% of the scheme property. This requirement extends to funds investing indirectly in funds that invest in property. A fund may continue to deal in exceptional circumstances, with the depositary’s agreement, where there is reasonable basis for deciding that suspension is not in investors’ best interests.
- Liquidity risk management: managers of FIIAs must produce contingency plans for dealing with liquidity risk. Depositaries will be required to oversee the processes used to manage fund liquidity.
Although this policy will not take effect until September 2020, the FCA has written to fund managers and boards making it clear it expects them (and their depositaries) to adopt the practices before then, if appropriate. The recent wave of fund suspensions in the wake of the coronavirus pandemic is one example of this early adoption; uncertainty around asset prices was the driving factor causing many funds to suspend in March 2020.
What is your depositary doing?
The depositary’s role in overseeing and monitoring fund’s cash flows and holdings has been brought to the fore with these recent developments. As one of the ten largest depositaries of UK-regulated funds (both by assets, and by number of funds), BNP Paribas Securities Services is working to ensure asset managers implement the FCA’s new FIIA policy appropriately, as well as providing oversight of managers’ monitoring and analysis so that they can meet redemptions and manage their liquidity.
At BNP Paribas Securities Services, we supplement reviews of asset managers’ processes, controls and risk management, with reviews of fund information that analyse whether redemptions can be met in a stressed environment. The analysis also highlights any large concentrated holdings which may need close supervision.
Following the Covid-19 outbreak, the FCA have requested specific, additional reporting from depositaries in certain areas. Consequently, we report on any of the following:
- Funds with signs indicative of imminent suspension;
- Funds in difficulties due to margin calls and/or abnormal level of failed trades;
- Funds experiencing a >10% single day drop in NAV (through outflows and/or market movements, or driven by other factors);
- Any concerns we have regarding the application of Fair Value Pricing;
- Any funds breaching the borrowing limit of 10% of the value of scheme property.
As the coronavirus pandemic continues to affect fund trading and asset prices, it is clear that liquidity mismatch is not an issue that can be solved overnight. Equally, the debate around the types and appropriateness of UK fund structures continues, with several proposals (including the Investment Association’s ‘Long Term Asset Fund’) that call for a larger-scale overhaul of the open-ended market.
For the time being, fund suspensions may remain a recurring part of life for both investors and managers in the UK. Close partnership with depositaries, as well as with other market participants, will be vital for fund managers in navigating this changing landscape.
 Source: Recommendations for Liquidity Risk Management for Collective Investment Schemes, IOSCO, February 2018
 Source: Final Report: Guidelines on liquidity stress testing in UCITS and AIFs, ESMA, September 2019
 Source: “European Mutual Fund Gatings Rise as Coronavirus Spooks Markets”, Fitch Ratings, April 2020
 Source: Illiquid assets and open-ended funds and feedback to Consultation Paper CP18/27, FCA, September 2019
 Monterey Insight United Kingdom Fund Report 2019
 Source: 2025 Vision, The Investment Association, June 2019