The UK watchdog issued a report this week saying that asset managers must be better at managing liquidity. At the same time, a new UK legal structure aimed at holding long-term, more illiquid assets has been established. A question is whether retail clients will be ever be able to use it.

A report from the UK’s Financial Conduct Authority on alternative and other asset managers, which says they must improve liquidity risk control, is bad news for the retail market, an investment industry group says.

Earlier this week, the FCA set out takeaways from its study of 14 firms of different sizes. The review focused mainly on alternative fund managers and authorised funds. The FCA said its findings “can be applied to a wide variety of fund types.” Property funds weren’t covered in the review.

“While some firms demonstrated very high standards, with the review highlighting good practices seen, there was a wide disparity in the quality of compliance with regulatory standards and depth of liquidity risk management expertise. A minority of firms in the review had inadequate frameworks to manage liquidity risk,” the regulator said. 

The tone of the watchdog’s report suggests that its new entity, the Long-Term Asset Fund, an open-ended structure designed to give more access to “alternative” areas such as private equity, won’t be on retail investors’ menus, according to Richard Stone, chief executive of the Association of Investment Companies. 

“The FCA’s review casts doubt on the decision to extend LTAF distribution to the wider retail market. It’s worrying because the FCA’s concerns in this review were about funds holding liquid assets. These problems have the potential to be far greater when the assets are illiquid as they will be in an LTAF,” Stone said.

“Following these findings, it’s difficult to have confidence in the ability of LTAFs to deal with liquidity and redemption challenges,” he said.

Democratic?
At the heart of the problem is that while more firms are staying private or de-listing from public markets, rules about investment suitability for retail clients mean that areas such as private equity, private credit and venture capital, for example, are deemed off-limits. Typically, they are only available to high net worth individuals and large institutions. There’s often talk in the wealth space about the need to “democratise” access. However, regulators fear they will be criticised if a fund blows up and retail clients are hit, causing a political storm. 

Fund blow-ups and controversies have made front-page news. In 2019, for example, the Woodford Equity Income Fund was frozen by its manager after a large client pulled out money. In the property market, open-ended funds temporarily closed their doors to exits after the 2016 Brexit referendum result hit the UK property sector. Such cases raised questions about whether open-ended funds that hold illiquid assets should be open to retail clients. (People can and do own shares in listed investment trusts, which can hold all kinds of assets, and there’s often a large share price discount to net asset value as a result.)

In March, the FCA said it had authorised the LTAF structure. Work continues on the fine print of how they work and who can access them. 

Camille Blackburn, director of Wholesale Buy-Side at the FCA, said of the FCA’s new report: 'We have seen examples in the market where liquidity risk has crystallised and the impact this can have on investors. 

“This review should serve as a warning to all asset managers that they need to get this right. We expect boards to discuss our findings and assure themselves that their firms are not amongst the minority with serious gaps in managing liquidity risk.”

Among the findings of the FCA report, it said firms typically had governance and organisational arrangements in place to meet large one-off redemptions but “did not have sufficient arrangements in place to oversee cumulative or market-wide redemptions that could have a significant impact on a fund”.