Understanding the FCA consultation paper

The consultation paper from the FCA is to be applauded. It is asking all stakeholders in open-ended funds holding illiquid assets, “Is there anything we can do to help these funds be managed in the best interests of all, in a way that avoids systemic risk?” That should be acknowledged up front as constructive and welcome. But when one reads the paper, it seems to me that the key question to ask ourselves is, “Why did investors react so quickly and strongly to the UK vote to leave the EU by withdrawing their clients’ money from open-ended property funds?” The answer is fear. Those who witnessed the 45% fall of commercial property values during the financial crisis were concerned we were going to see major valuation falls caused by market stress. Many commentators thought commercial values were going to fall by as much as 20% or even more if the property was in the City. Valuers were attaching uncertainty clauses to their portfolio valuations, saying they could not be relied on with the same degree of certainty that they were before the referendum. The FCA paper makes a compelling case for a review of the tools available to managers and operators of these funds by summarising the experiences of open-ended property funds affected by Brexit.  Let’s put this in context. Using the FCA’s analysis, UK open-ended property funds account for around £35bn of UK commercial property investments and liquidity holdings (cash or listed securities such as REITs), equating to 4% of the investible universe of UK commercial property, which is estimated to be around £871bn. The nine open-ended property funds, anecdotally, needed to sell £2bn to £3bn of assets to meet redemptions and replenish their liquidity balances. While estimates vary, in the UK the rule of thumb often quoted is that on average around £40bn of UK commercial property assets are sold each year. So the value of assets required to meet redemptions and replenish liquidity was 5% to 7.5% of the open-ended property funds, or 0.2% to 0.3% of the investible universe. Really? So why did we get a plethora of panic-stricken news stories about commercial property funds last summer after the referendum vote? The answer to that is also contained in the report. It points out that redemptions were concentrated on the largest funds and that liquidity levels were between 5% and 15%, and across 15 of the larger funds redemptions averaged 4% over eight business days and some saw redemptions as high as 8%. To meet redemptions at those rates clearly requires a lot more liquidity to be accumulated in advance. (Incidentally, the Kames Property Income Fund had a good level of liquidity and remained open throughout the Brexit “shock” period.) Over the next few months, we will clearly debate the pros and cons of the existing liquidity tools and the other options highlighted by the FCA. But why the mass withdrawal by investors in the first place? Is the issue one of information and dissemination of well-analysed sector data? In the same way as the Vision for property finance report has focused on this theme within the context of how lending institutions approached the market risks pre- and post-2007, is there a dimension here that requires the industry to create a common dashboard of analysis that gives a much more robust view of where markets are in their cycles and what the impact of certain events may be? I believe there is, and I think it is more complex than just saying, “Investors need to remember that commercial property should be a long-term investment owing to the high costs of investment.” Whatever the responses to the FCA paper, the fact that it is essentially saying, “How can we help [the stakeholders]?” is a very constructive starting point for a post-match debate by all those that will be engaged in this industry-wide debate. And it is absolutely right that the regulator should also be at the heart of this debate. Phil Clark is head of property investment at Kames Capital