Following on from Britain's decision to leave the EU, and the week in which at least nine of the largest fund managers temporarily halted redemptions from their flagship open-ended property funds due to the exceptional level of redemption requests, the Financial Conduct Authority (FCA) issued guidance on fund suspensions on 8 July 2016.
What does the FCA's guidance address?
The guidance essentially aims to remind fund managers of their obligations to investors. The guidance also clarifies the FCA's expectations of fund managers when suspending dealings in their funds in challenging market conditions.
The guidance is high level. The FCA notes that the ability to suspend is entrenched into the structure of certain funds to enable the fund manager to undertake an orderly process when unusual market events occur. The FCA says that it will continue to keep the situation under review.
What obligations are highlighted as important in the FCA's guidance?
The FCA reminds fund managers that they have an overarching duty to act in the best interests of all investors. In difficult market conditions, they must consider how to ensure the fair treatment of all investors in their funds.
The FCA highlights that fund managers have a range of tools available to manage their funds through periods of market disruption and to ensure they safeguard the best interests of all investors. The FCA expects all fund managers to not only understand what those tools are, but also to have a clear understanding of how and when such tools might be used. These tools, and the arrangements in place, will largely depend on the terms set out in the documents establishing the fund (such as the prospectus and the instrument constituting the fund).
The FCA is particularly concerned that all investors in a fund are treated fairly and equally, with no preferential treatment. Failure to do so may lead to some investors gaining at the expense of other investors in the same fund. By way of example, by imposing restrictions or suspensions on redemptions, fund managers must ensure that those who cash out of their funds early do not leave the rest of the investors to bear the burden of price falls in the market.
What are the obligations of alternative investment fund managers?
The FCA's guidance serves as a reminder of the duties that alternative investment fund managers (AIFMs) have under the Alternative Investment Fund Managers Directive (AIFMD) (as implemented in the UK). In particular, a full scope UK AIFM must, for each alternative investment fund (AIF) it manages:
- act honestly, fairly and with due skill, care and diligence in conducting its activities;
- act in the best interests of the AIF it manages, or the investors of the AIF it manages, and the integrity of the market;
- treat all investors fairly; and
- not allow any investor in an AIF to obtain preferential treatment, unless such preferential treatment is disclosed in the relevant AIF's instrument constituting the fund.
Commission Delegated Regulation (EU/231/2013) supplementing AIFMD sets out additional rules on liquidity management. In summary, an AIFM must:
- consider, and put into effect, the tools and arrangements, including special arrangements, necessary to manage the liquidity risk of each AIF under its management;
- identify the types of circumstances where these tools and arrangements may be used in both normal and exceptional circumstances, taking into account the fair treatment of all AIF investors in relation to each AIF under management;
- use such tools and arrangements only in these circumstances and if appropriate disclosures have been made.
- consider the adequacy of the liquidity management policies and procedures, the appropriateness of the liquidity profile of the AIF's assets and the effect of atypical levels of redemption requests;
- regularly conduct stress tests, under normal and exceptional liquidity conditions, which enable them to assess the liquidity risk of each AIF under their management; and
- act in the best interest of investors in relation to the outcome of any stress tests.
For the purposes of AIFMD, the investment strategy, liquidity profile and redemption policy of each AIF managed by an AIFM is considered to be aligned when investors have the ability to redeem their investments in a manner consistent with the fair treatment of all AIF investors and in accordance with the AIF's redemption policy and its obligations.
What are the obligations of authorised fund managers of UCITS Schemes?
Similarly, authorised fund managers of Undertakings for Collective Investment in Transferable Securities (UCITS) schemes or a UK UCITS management company of a European Economic Area (EEA) UCITS scheme must, pursuant to the rules and guidance in the Collective Investment Schemes Sourcebook:
- ensure that the unitholders of any such scheme they manage are treated fairly;
- refrain from placing the interests of any group of unitholders above the interests of any other group of unitholders;
- apply appropriate policies and procedures for preventing malpractices that might reasonably be expected to affect the stability and integrity of the market;
- ensure that fair, correct and transparent pricing models and valuation systems are used for each scheme they manage, in order to comply with the duty to act in the best interests of the unitholders;
- be able to demonstrate that the investment portfolio of each such scheme they manage is accurately valued;
- act in such a way as to prevent undue costs being charged to any such scheme they manage and their unitholders; and
- in carrying out their functions, act:
- honestly, fairly, professionally and independently; and
- solely in the interests of the UCITS scheme and their unitholders.
What are the FCA's expectations in relation to the suspension of fund redemptions?
The FCA, in its recent guidance, reminds fund managers of their continuing, and overarching duty, to ensure that:
- all their customers are treated fairly and equally;
- assets are valued fairly and accurately; and
- any subscriptions or redemptions of units take place at a fair price.
If a fund has to dispose of underlying assets in order to meet an unusually high volume of redemption requests, the FCA reminds fund managers that they must ensure these disposals are carried out in a way that does not disadvantage investors who remain in the fund, nor those who are newly investing in the fund.
Suspension of dealings and close co-operation with the FCA
In exceptional circumstances, the FCA says fund managers should consider whether it would be in investors' best interests to suspend dealings in a fund or range of funds.
The FCA specifically asks that managers of authorised funds contact the FCA in advance of any proposed decision to suspend redemptions from investors. This obligation sits alongside the authorised firm's duty to deal with the FCA in an open and co-operative way.
Resumption of dealings
Once fund managers have taken the decision to temporarily suspend dealings in their funds, they will then need to consider when to resume dealings "in the interest of investors".
The FCA suggests that funds holding a large proportion of illiquid, or hard to value, assets may wish to consider lifting their dealing suspensions and allow investors the opportunity to redeem their units at a revised valuation of the units in the fund.
The new redemption price offered to unitholders might reflect the price at which the illiquid assets can be realised in a shorter than usual timeframe. In these circumstances, the FCA says fund managers should ensure that:
- the revised redemption price and the opportunity to cancel are clearly communicated to investors who have submitted a request to redeem their investment before or during the fund's suspension;
- the communication explains the options that are available to investors and includes details of how to cancel the redemption requests; and
- investors are given sufficient time to make their decision and to seek appropriate advice. The FCA says the timeframe should take into account the types of investor in the fund and whether communications to these investors need to take place through an intermediary.
What is the status of the FCA's guidance?
The guidance sets out the FCA's expectations of fund managers when suspending dealings in their funds in challenging market conditions. While the guidance is not binding, the FCA will expect fund managers to comply with it (or provide an explanation if they fail to do so).
What does this mean for open-ended fund structures?
Current rules governing the spread of investable assets in UCITS and non-UCITS retail schemes are intended to diversify risk and address issues of liquidity.
However, the design of open-ended funds may be scrutinised again, by the FCA, from the point of view of conduct and systemic stability. Recent events have highlighted the liquidity mismatch around funds that hold assets that cannot be sold quickly, yet offer investors same-day redemptions.
In addition, liquidity pressures raise inherent conflicts of interest for fund managers. In particular, fund managers will potentially be acting against the interests of long term investors by selling properties to pay out redemptions or acting against the wishes of short-term investors by suspending withdrawals.
Fund managers considering a suspension on dealings should now review their rights and obligations in light of the FCA's guidance, alongside the fund's terms and the other regulations that address this difficult issue (notably the Alternative Investment Fund Managers Directive and the UCITS Directive).