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Swing pricing and notice periods

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20 March 2020

AIC responds to FCA speech on less liquid assets in open-ended funds.

Today the Association of Investment Companies (AIC) issued its response to a speech given by Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, to members of the Investment Association.

The speech highlighted joint work between the FCA and the Bank of England on the liquidity mismatches within open-ended funds that hold less liquid assets. It comes after the suspension of open-ended property funds this week over valuation uncertainties.

Ian Sayers, Chief Executive of the Association of Investment Companies (AIC), said: “We welcome this positive contribution to the debate over the problems of holding illiquid assets within open-ended funds that offer daily redemption.

“While previous suspensions of open-ended funds, including Woodford Equity Income, were due to the volume of redemption requests, the speech highlights that these latest suspensions were caused by uncertainty over the valuations of underlying properties. It is essential that any regulatory response addresses both these factors.”

The speech explores two measures that could be used to address these problems: swing pricing and notice periods.

Ian Sayers, Chief Executive of the Association of Investment Companies (AIC), commented: “We remain sceptical about the ability of swing pricing to protect investors, particularly with very illiquid assets such as physical property. The FCA is right to highlight the issues of fairness and transparency. Simply put, how can we ensure that prices are fairly set for all investors in a fund, both those who wish to exit, and those who wish to stay?  However, just as importantly, swing pricing creates an incentive for investors to exit early to avoid the impact of a pricing adjustment, which could destabilise the fund.

Notice periods, on the other hand, could be a more effective tool to protect investors and should be part of the solution. They are easier to understand than swing pricing, which is inherently complex, and if long enough should ensure that open-ended funds have sufficient time to sell their assets without adding to market stress.  Setting the right length of the notice period will be all-important.  Too short a notice period will not prevent suspensions and fire sales which could have been avoided.”

The AIC’s solution: reliable redemption

The AIC believes that all open-ended funds should be required to offer reliable redemption to match the redemption terms of the fund (the promise made to investors as to when they can get their money back) to the liquidity of the underlying assets (the time taken to sell holdings without a fire sale). Notice periods would be a fundamental part of delivering reliable redemption.

Reliable redemption means:

  • The basis on which an investor can leave the fund (in timescale, volume or price) should not change, irrespective of the level of redemptions;
  • Redemption processes must not rely on assets being sold cheaply to raise cash to meet redemption requests;
  • Redemption arrangements must operate in both normal and foreseeable stressed market conditions.

Reliable redemption is further explained in the Association of Investment Companies (AIC) report, ‘Square peg in a round hole’, which calls for urgent action from regulators and policymakers to tackle systemic risk in the financial system.

 

 

 

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Notes

  1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment.  Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. As at the end of February, the AIC had 362 members and the industry had total assets of approximately £196 billion.
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