Reforming 'deferred redemptions' into an effective liquidity tool
UK funds have a number of options in the toolkit for managing fund liquidity. The ultimate tool, the suspension of a fund, is a valid investor protection mechanism, but arguably occurs too frequently and perhaps too bluntly. AFMs have the current alternative option of the deferral of redemption instructions but it is not commonly used and so we are currently working on a new concept, ‘delayed redemptions’, as a more useful tool.
Deferred redemption allows an AFM to defer investor requests to the next daily valuation point, where those requests exceed a stated proportion of the fund’s value (usually 10%). All investors who wanted to redeem at a valuation point where redemptions are deferred must be treated consistently (all deals must be deferred or pro-rated). Subscriptions can continue where redemptions are deferred, which allows the Manager to build liquidity ahead of the next valuation point. The tool is generally unused, for three main reasons:
timescales - daily dealing funds only have the ability to defer redemptions to the next valuation point, which is the next business day. This short timescale is insufficient as a 24-hour period is unlikely to see a marked change in the liquidity stress.
pro-rata requirements - the requirements around the pro-rating of redemption instructions received are unclear and can be interpreted in a range of ways, from using full or different forms of pro-rata deferral.
operational challenges – the first two reasons mean that operational processes and IT systems are generally unable to cater for deferred redemptions. Pro-rating, in particular, is difficult to achieve and is open to interpretation meaning firms have been reluctant to develop solutions.
Our working group is currently refining its proposals having had fruitful discussions internally and with other stakeholders such as depositaries, transfer agents and platforms. At present we intend on proposing that the one-valuation-point aspect of the rule be extended to five, and that the pro-rating elements be excluded. AFMs are therefore provided with a significant additional timescale to realise sufficient liquidity to return the fund to normal operations. In the event that this is not possible, the fund may need to suspend, providing investors at least with certainty on the longer-term outlook.
Discussions within the membership and with other stakeholders will continue in Q4. As part of the wider discussions ongoing within the industry on fund liquidity, we hope to be able to position our proposals to the industry as a meaningful new mechanism for AFMs to be able to use to protect investors without needing to resort immediately to fund suspension.