Bank of England considers longer redemption times for investment funds

12 July 2019

The Bank will look into the costs and benefits of introducing longer redemption periods for funds

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The Bank of England is considering new rules to help open-ended investment funds cope with waves of redemptions.

In its Financial Stability Report, the Bank said that it would work with the Financial Conduct Authority to look at the risks associated with the liquidity mismatch of open-ended funds that invest in illiquid assets.

Specifically, the Bank of England is worried about the ability of open-ended funds to meet investor redemptions. Open-ended funds allow investors to buy in and sell out of funds relatively quickly and easily.

When an investor sells out of a fund, the fund sells part of its underlying assets and returns the money to the investor.

However, if the fund sees a lot of investors head for the exit at the same time, it can struggle to sell the assets quickly enough to meet redemptions.

This mismatch in liquidity has come to light following the suspension of Woodford Equity Income at the start of June. The fund held a large number of unlisted and illiquid stocks, which it was unable to sell following a wave of redemptions, prompting the fund to suspend withdrawals. 

The Bank of England, however, is worried that “the mismatch between redemption terms and the liquidity of some funds’ assets has the potential to become a systemic issue”.

The report says that both the Bank of England and the Financial Conduct Authority (FCA) will look into the costs and benefits of introducing longer redemption periods for funds with hard to sell assets.

Recently, the Investment Association proposed a new fund structure with less frequent redemption periods, called a long-term asset fund.

The review will also look into the typical redemption time for certain assets in both normal and stressed market conditions.

The Bank of England is particularly concerned about the liquidity of corporate debt, emerging market debt and property.

The Bank of England has previously warned over the liquidity problem of open-ended funds. Speaking before the Treasury select committee in June, governor Mark Carney claimed: “These funds are built on a lie, which is that you can have daily liquidity for assets that fundamentally aren't liquid.”

Speaking in the wake of Woodford Equity Income’s suspension, the governor also warned: “Over half of investment funds have a structural mismatch between the frequency with which they offer redemptions and the time it would take them to liquidate their assets.

“Under stress they may need to fire sell assets, magnifying market adjustments and triggering further redemptions, a vicious feedback loop that can ultimately disrupt market functioning.”

This article first appeared on our sister website Money Observer

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