Open-Ended Funds Investing in Less Liquid Assets

Edwin Schooling Latter, FCA Director of Markets and Wholesale Policy, delivered a speech to the Investment Association about open-ended funds investing in less liquid assets.

Mr Schooling Latter explored the asset liability mismatch, where daily redemptions are offered in funds in which the assets cannot be liquidated within a day without material loss of value, as well as redemption structures which encourage “first mover advantage”. 

The FCA and the Bank of England are considering two proposals to better protect investors and to address such challenges faced by open-ended funds that hold illiquid assets: swing pricing and notice periods. The first proposal seeks to decrease the number of redemptions during periods of market stress by establishing a penalty that swings with the number of investors seeking redemption at one time. He noted that “swing pricing would vary with market conditions and overall redemption pressure, and so may be difficult to calibrate in practice”, further highlighting that if swing pricing is to be used, it must be done so fairly.

Mr Schooling Latter stated that notice periods were an arguably simpler and more effective way for investors to understand the risks of investing in open-ended funds with less liquidity. He held the view that putting in place notice periods could decrease the likelihood of redemption requests during times of market stress and reduce fire sales. 

Mr Schooling Latter opined that if new regulation was to come into force which required swing pricing or notice periods to be in place, such requirements would not be appropriate for highly liquid funds. Therefore, different types of funds would need to rely on different tools. This raises the questions: at which liquidity threshold would such requirements apply and how should liquidity be measured. 

Other matters covered included how any changes would be implemented for existing funds, as well as a consideration of a possible internationally harmonised approach to liquidity risk. Mr Schooling Latter also stressed that ultimate responsibility to ensure that obligations to investors are fulfilled lies with the senior management of relevant firms, particularly in light of the Senior Managers and Certification Regime.  

To read Mr Schooling Latter’s speech in full, please click here.