Liquidity a ‘systemic risk’ for open-ended funds, warns Bank of England

The Bank of England says open-ended investment funds pose a potential “systemic risk”.

The Bank of England has taken aim at open-ended investment funds, citing those with potential liquidity issues as posing a “systemic risk”.

In its Financial Stability Report for 2019, the Bank argues that the mismatch between daily liquidity and the ability of some funds to sell their assets quickly means “there is an advantage to investors who redeem ahead of others, particularly in a stress.” This has the potential to become a systemic risk, the Bank argues.

To combat this the report proposes a combination of longer redemption periods and forcing those leaving the fund in times of market stress to accept a discounted price for their units in.

The banks lays out its proposals as:

• Liquidity of funds’ assets should be assessed by reference to the price discount needed for a quick sale of a representative sample (or vertical slice) of those assets or the time period needed for a sale which avoids a material price discount. In the US, the Securities and Exchange Commission has recently adopted measures of liquidity based on this concept.
• Redeeming investors should receive a price for their units in the fund that reflects the discount needed to sell the required portion of a fund’s assets in the specified redemption notice period, ensuring fair outcomes for redeeming and remaining investors.
• Redemption notice periods should reflect the time needed to sell the required portion of a fund’s assets without discounts beyond those captured in the price received by redeeming investors.

What exactly this will mean for investors is not entirely clear.

According to interactive investor, the proposals appear to give investors in illiquid holding funds the choice between being locked in or facing discounted redemptions.

Rebecca O’Keeffe, head of investment at interactive investor, notes: “These proposals are an improvement on where we are today in addressing the question of liquidity mismatch in open-ended funds.

“However, there is a huge ‘but’. These proposals essentially give investors a choice between a lock in and a fire sale – or at least that’s how it looks to us.”

The proposals could be interpreted as bringing an end for daily trading for illiquid assets, according to Ryan Hughes, head of active portfolios at AJ Bell. This would result in investors in property funds not being able to immediately sell their holding whenever they want, as they are currently able to do.

He adds:

“The fact that the Bank of England has included vulnerabilities of the open ended fund market in its Financial Stability Report tells you just how seriously they are taking the issues that have dogged the asset management industry this year, firstly with the Neil Woodford debacle and then with the M&G Property suspension this month.”

The FCA will now consider turning the report’s proposals into new rules in 2020.

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