The Financial Conduct Authority (FCA) is looking into UK property funds in light of an array of suspensions after the Brexit vote last year. This was headline news when many funds were forced to suspend trading because of liquidity issues as investors ran for the hills. While these types of situation occur very rarely the FCA is looking to see how changes can be made to avert similar issues in the future. So, how will the FCA tackle the problem of property fund liquidity?
Liquidity always an issue
These open-ended investment funds have always had an issue with liquidity but they have been able to manage this by keeping aside liquid assets in years gone by. It was the deluge of redemptions which caught the industry unawares last year and unable to access sufficient liquidity to fulfil redemption orders. The simple fact is that property investment is seen as a long-term asset although the buying and selling of open-ended property fund units does offer at least some liquidity in normal market conditions.
One of the other problems last year was the fact that property prices were seen to be falling and buyers were shying away. In many ways the asset value associated with these funds just prior to the Brexit vote was misleading and not only would it take some time to revalue the assets but also to find buyers at the “right price”.
What are the options for the FCA?
While there was a suggestion that a ban on illiquid assets could be enforced this has very quickly been dismissed by the FCA. The fact is that property fund investments in the property sector play an integral role in the overall UK market with some £14 billion tied up in the major property funds. To ban investment in “illiquid assets” in the future would have reduced funding opportunities for new developments and also caused a raft of properties to be listed for sale.
The simplest solution is to ensure that open-ended property investment funds have sufficient liquidity or near-cash assets available to cover unusual circumstances. There may also be a cap on the amount of funds which can be invested in illiquid assets such as certain types of property. It also looks as though the FCA will consider recommending the separation of private investor and institutional investor assets into different investment vehicles. The reasoning behind this is because private investors and institutional investors often have very different timescales and investment strategies.
At this moment in time there is no secondary market in open-ended property fund shares which are bought and redeemed directly with the fund manager. There is a suggestion that a secondary market could be created whereby buyers and sellers of property fund shares could be matched. This is an interesting idea but the fact is whatever the FCA recommends there will be short-term consequences for the property investment market.
It is quite right that the FCA is looking at how to handle similar scenarios to that seen after Brexit if they were to occur again in the future. There are a number of potential solutions but each have their pros and cons and it is difficult to see a clear way forward. Even though the Brexit situation was “once-in-a-lifetime” it is an issue because if investors are unable to redeem their assets this can have a knock-on effect to their personal life and other investments.