In October 2018 the UK Financial Conduct Authority (FCA) issued a public consultation paper (CP18/27) containing proposals for amending the regulations for open ended funds primarily invested in illiquid assets, such as commercial real estate, infrastructure or unlisted securities. The headline proposal was to require funds to suspend trading if the fund’s Standing Independent Valuer (SIV) indicated that more than 20% of a fund’s assets are subject to "material valuation uncertainty".
The proposals were driven by the experience of a spike in redemption requests that followed the referendum result on the UK leaving the EU in 2016, which led to the temporary suspension of dealing by some funds as they tried to manage their liquidity.
There was also a more controversial proposal to enable the fund manager and SIV to agree a formula or method for determining a reasonable discount in advance of a rapid sale being required.
In principle we supported the main proposal as it helps prevent the procyclical effect of prices that are reduced because a fund needs to sell an illiquid asset quickly feeding through to further reductions in the market value of such assets. This has to be in the interests of medium to long term investors. However, we had a number of reservations:
In our experience the concept of "material valuation uncertainty" and when a valuation should be subject to a caveat because of it is still widely misunderstood. Chris Thorne discussed this in his blog The future is uncertain – what’s the problem? Previous RICS guidance has not always been clear and confused the issue by failing to make the distinction between market risk and valuation uncertainty. Although the latest guidance in VPGN 10 is improved, it still lacks a clear definition of valuation uncertainty and criteria to assist the valuer judge whether it is material.
We were concerned at the proposal that the Fund Manager should agree a reduced price to achieve a rapid sale with the SIV. While consultation with the valuer is clearly desirable, making the SIV party to the agreement on price involves them in a management decision of the fund that it not only outside their normal remit but also potentially conflicts with the Fund Manger’s responsibilities under the AIFMD.
We considered the proposal that a Fund Manager and SIV agree a mechanism for determining an appropriate discount to achieve a quick sale in advance of the situation that causes the need for a quick sale being known to be conceptually flawed and inoperable in practice. It is also contrary to the Red Book and IVS.
NEW POLICY STATEMENT
The FCA issued its response to the comments received during consultation on 30 September 2019, along with the revised policy which becomes operational on 30 September 2020. We are pleased to note that it has modified the requirement for a fund to be suspended if the SIV declares more than 20% of the fund's property to be subject to material valuation uncertainty so that the fund manager may keep the fund open subject to the consent of the depository. This element of discretion will help remove pressure that might otherwise have been applied to the SIV as regards a decision to declare material valuation uncertainty.
The FCA has retained the need for the fund manager to consult with the SIV regarding a rapid sale as it regards this external input as an important protection for investors. However, it has heeded feedback that a reduced price should not be confused with value and has modified the provision accordingly. It has also dropped the proposal for the SIV and fund manager to agree a methodology for determining discounts for a rapid sale