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8 May 2017
Mark Glibbery
Strategy & Competition Division
Financial Conduct Authority
25 The North Colonnade
Canary Wharf
London E14 5HS
Submitted via email to: [email protected]
RE:
Discussion Paper (“DP”) 17/1 – Illiquid assets and open-ended investment
funds
Dear Sirs,
BlackRock, Inc. (BlackRock)1 is pleased to have the opportunity to respond to DP 17/1 – Illiquid
assets and open-ended investment funds issued by the Financial Conduct Authority (“FCA”) (the
“Discussion Paper”).
About BlackRock
BlackRock supports a regulatory regime that increases transparency, protects investors, and
facilitates responsible growth of capital markets while preserving consumer choice and assessing
benefits versus implementation costs.
We welcome the opportunity to comment on the issues raised by this Discussion Paper and will
continue to contribute to the discussion around liquidity risks in funds and any ancillary issues
that may assist in the outcome.
BlackRock’s asset management business incorporates numerous ranges globally and involves
the provision of investment management and advisory services under multiple regulatory
regimes. We have drawn on experience through discussions with regulators globally, including
the SEC and IOSCO in responding to the Discussion Paper.
Executive summary
BlackRock supports the engagement of the FCA with fund managers to assess the impact of less
liquid assets in open-ended investment funds and to ensure an appropriate liquidity management
‘toolkit’ continues to be available to managers.
BlackRock believes that fund managers are well equipped to manage both market liquidity risk
and fund redemption risk. The existing measures available to managers are wide-ranging and
include both ongoing measures such as pricing mechanisms to reflect the cost of liquidity, market
value adjustments, anti-dilution measures and exceptional measures such as in kind
redemptions, deferrals and suspensions. We recommend that managers are permitted to retain
full flexibility to combine the full toolkit of measures in a way which allows them to react most
effectively to a wide range of market circumstances and/or investor actions. The experience of
recent market events shows the benefit of managers having the ability to choose from multiple
tools when it comes to managing liquidity.
We also highlight that early engagement (where possible) with the regulator is welcome, however
the primary task of managing the liquidity of less liquid holdings in open-ended funds should
remain the task of the manager, with appropriate principles-based guidance from the regulator.
1
BlackRock is one of the world’s leading asset management firms. We manage assets on behalf of institutional and
individual clients worldwide, across equity, fixed income, liquidity, real estate, alternatives, and multi-asset strategies.
Our client base includes pension plans, endowments, foundations, charities, official institutions, insurers and other
financial institutions, as well as individuals around the world.
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•
‘Less liquid’ versus ‘illiquid’
The duty of the fund manager is to seek to invest the cash of investors in pursuance
of the fund objectives within stated investment and risk parameters and, when
requested, effect investor redemption requests within stated parameters. We
recognise that different assets present differing levels of liquidity. Managers should
implement appropriate processes to deal with times of market turbulence where
sources of liquidity to meet redemption requests may be less readily available or only
available at a higher cost. Managers of open-ended funds should seek to invest in
permissible assets with sufficient liquidity to meet the fund’s redemption profile and
so we consider it is more appropriate in the context of this Discussion Paper to refer
to ‘less liquid’, as opposed to ‘illiquid’, assets.
•
Ensuring appropriate access to less liquid assets to meet long term
investment objectives
BlackRock believes that consumer choice is paramount and that as an industry we
must ensure that both retail and professional investors can continue to choose to
access less liquid assets through investment in funds. Less liquid assets can provide
regular, long-term income (taking Real Estate and Infrastructure investments as
examples) that can be used to meet investors’ long term investment needs, such as
retirement. This is increasingly important in the current environment of low yields on
many traditional and more liquid asset classes.
•
Product governance - recognising that open-ended funds do not have to offer
daily dealing
BlackRock believes that the liquidity of assets and the structuring and operational
model of open-ended funds should be assessed and reviewed as part of the fund
approval and set-up process. This is the responsibility of the manager and should be
discussed in conjunction with the trustee/depositary (where applicable) and regulator
as part of the authorisation process. As an example, this should include an
assessment of the funds’ operational attributes, such as dealing and settlement
cycles and notice periods, in order to reflect the liquidity of the underlying
investments, as well as the ability to be able to manage investor expectations for
liquidity. It is key to ensure that a fund’s liquidity terms are sensibly set and consistent
with the underlying assets.
•
Consistent application of liquidity risk management
Liquidity risk management is an important tenet of fund management and we
emphasise the importance of ongoing liquidity risk management throughout the life
of a fund, regardless of the level of liquidity of its underlying. This process typically
involves multiple stakeholders, including fund managers, independent risk
monitoring functions and the fund boards.
We also support the development of mechanisms to encourage feedback from
platforms to managers on the composition and liquidity requirements of a fund’s
underlying investor base. This could in turn enhance communication between
managers and end investors on the appropriate methods for liquidity risk
management. This would allow enhanced liquidity risk management models to be
developed by managers, as well as facilitating enhanced communication with
investors.
•
Regulator engagement
BlackRock welcomes early engagement with the FCA where binary outcome market
events such as Brexit can be foreseen. However, BlackRock sees mandated action
from the regulator as part of its product intervention powers, such as imposing fund
suspensions, to be inappropriate. Investors expect fund managers to manage
liquidity as part of the service they provide. Furthermore, the FCA is engaged during
the authorisation of UK authorised funds and are notified of the launch of AIFs
managed by UK AIFMs. This should be used by both the manager and the regulator
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as an opportunity to discuss any concerns regarding the liquidity profiles of funds.
This could be complemented by targeted ongoing supervisory engagement.
We also believe there is opportunity to review existing rules in the FCA’s COLL
Sourcebook on the operation of deferred redemptions to allow a more tailored range
of actions to be taken, for example by differentiating between subscriptions and
redemptions.
•
Role of investment platforms
We note that much of the drive for daily dealing comes from the operational
requirements of investment platforms serving direct retail clients, professional clients
such as discretionary fund managers or Defined Contribution (“DC”) platforms. The
majority of platforms currently require daily dealing for both subscriptions and
redemptions even though the COLL rules allow for a more flexible approach. We
support further cross industry initiatives to encourage the development of alternative
dealing cycles for daily dealing for funds invested primarily in less liquid assets.
•
Investor disclosure
Risks, such as potential issues with liquidity or liquidity risk management tools,
should be clearly disclosed to investors in relevant fund documentation. The manner
in which firms expect to deploy the tools at their disposal can result in different
outcomes for clients. BlackRock would welcome the development of guidance from
the FCA on standardising disclosures across open-ended funds, to ensure that
investors can compare funds and understand liquidity risks and mitigating tools in a
standardised format.
We welcome further discussion on any of the points that we have raised.
Yours faithfully,
Martin Parkes
Government Relations
[email protected]
Ben Nye
Strategic Product Management EMEA
[email protected]
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Responses to questions
Q1: Do you have any comments on our description of the types of inherently illiquid
assets that might be held in open-ended funds? Are there others you would consider
inherently illiquid?
We agree with the FCA’s description of less liquid assets and recognise there is no generic
regulatory definition. Rather than an exhaustive list of inherently less liquid assets, we believe
a better approach would be to consider the criteria which an investment should meet to classify
it as less liquid. This may include, but not be limited to, the following criteria:
-
-
Assets which do not regularly trade on a multilateral exchange or organised market;
Assets where traded prices are not broadly disclosed in a timely manner;
Assets traded privately;
Assets with long settlement cycles (for example bank debt – this may be considered
liquid if traded regularly, but the fund’s unit settlement terms should reflect that of the
underlying asset under normal market conditions);
Assets with no or low degree of standardisation; and
Assets which trade very sporadically or by appointment.
Furthermore, if there is to be a requirement to define less liquid assets then this will need to
be continually monitored and updated in the advent of new asset classes coming to market or
as a result of changes in market infrastructure.
It is important to consider the potential impact of limiting access to less liquid products in openended funds. Investments in assets such as infrastructure and real estate, both through private
shares and debt, are beneficial for both investors and for the ongoing long-term economic
development of UK capital markets. Limiting the potential to invest in either of these classes
could be detrimental in many ways and should be avoided.
In the context of the events following on from the Brexit vote in June 2016 it is also important
to consider the impact on indirect holdings of funds invested in less liquid assets, which is
discussed in detail in the Association of Real Estate Funds (“AREF”) report2. For example,
certain funds or model portfolios sold through advisors could potentially hold underlying funds
investing in less liquid assets. If these daily-dealing fund solutions have a significant
component of their underlying building blocks in less liquid funds and/or assets and see
widespread redemptions, those redeeming could effectively be exiting at historic (suspended)
prices for the underlying illiquid portion of their investment.
Q2: Do you have any observations on our analysis of liquidity management tools? Are
there other factors affecting the liquidity management of open-ended funds investing
in illiquid assets that we should take into account?
Liquidity and redemption risk management are critical components of fund management,
particularly for open-ended funds that seek to provide regular subscriptions and redemptions
for investors. One of the responsibilities of a fund manager is to manage market liquidity risks
to ensure that funds are constructed in ways that allow them to respond to potential
redemptions within the timeframe outlined in a fund’s constitutional documents. However,
given that it is impossible to anticipate and regulate for all potential market outcomes during
periods of stress, the best strategy to mitigate the impact of potential large, correlated
redemptions is to seek to ensure that are funds are structurally resilient, regardless of the legal
structure under which they are regulated.
2
A review of real estate fund behaviour following the EU referendum - A Report for The Association of Real Estate
Funds – April 24, 2017
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Extraordinary liquidity measures are an important and necessary power for a fund manager to
have at its disposal. A fund should have access to a wide array of tools and these should be
well explained to all investors. However, the existence of these tools cannot compensate for
inappropriate redemption terms or significant liquidity mismatches in normal markets. It is
therefore important to distinguish between truly extraordinary situations for which these
measures are designed, and more normal conditions in markets that always display a lesser
degree of liquidity. The underlying aim of these measures should always be to ensure all
investors, both redeeming and remaining, are treated fairly. As many funds investing in less
liquid assets are intermediated, it is important to recognise that intermediaries also have an
important role to play in ensuring that the existence of liquidity risk management tools is
disclosed and presented in a comparable way. BlackRock supports industry efforts such as
those driven by the Investment Association to develop common terminology to aid
comprehension.
Liquidity risk management
Fund managers should have the ability to tailor liquidity risk management programmes to the
individual characteristics of each fund they manage. Rather than adopting a ‘one-size-fits-all’
approach, discretion should be left to fund managers and risk managers to determine the
appropriate use of these tools for the funds that they manage. Effective programmes for openended funds should ideally incorporate the following procedures, regardless of the liquidity
profile of the underlying assets:
(i)
Dedicated individuals responsible and accountable for investment risk
management who are independent from fund management;
(ii)
Assessment of a fund’s liquidity risk based on the unique characteristics of the
fund’s investment strategy and investor profile;
(iii)
Policies on the use of in-kind redemptions;
(iv)
Analysis of available back up sources of liquidity;
(v)
Outline of how a fund intends to meet redemptions in various circumstances; and
(vi)
Liquidity stress testing of both assets and liabilities using several scenarios.
A ‘toolkit’ for managers
We agree that there are multiple tools at a manager’s disposal and this is a positive for
managers. This toolkit can and should be utilised at the discretion of the manager, depending
on the market situation. Different tools may be required to be used at different periods
depending upon the market environment.
BlackRock has previously commented upon the manager’s liquidity management toolkit, in the
‘Addressing Market Liquidity’ paper published in July 20153. Key points include:
• Enhanced disclosure regarding liquidity risks associated with a fund;
• Pricing mechanisms for subscriptions and redemptions to allocate transaction costs to
redeeming investors to provide a price signal for the price of market liquidity and to
reimburse or buffer a fund’s remaining investors; and
• Consideration of the use of redemptions in-kind for large professional investors.
A further consideration for managers in managing liquidity is the use of temporary borrowing
for short-term purposes (e.g., repurchase agreements, bank credit lines), a concept which is
not included in the Discussion Paper.
Another measure which may be considered is the ability to defer redemptions. Ahead of
imposing fees and suspensions managers can choose to defer redemptions where
redemptions exceed a certain portion of the fund’s total assets under management. However,
we agree that there are the potential pitfalls (i.e. the queuing of orders) which are covered
within the Discussion Paper and merit consideration. Market infrastructure also needs to
develop to facilitate the use of deferrals by investment platforms and initiatives to support
greater access to funds which do not offer daily dealing but rather less frequent periodic dealing
BlackRock Viewpoint – ‘Addressing Market Liquidity’ - https://www.blackrock.com/corporate/enus/literature/whitepaper/viewpoint-addressing-market-liquidity-july-2015.pdf
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cycles. Non-UCITS authorised funds in COLL permit dealing up to every six months but this
regulatory flexibility is not usually reflected in the operating model of investment platforms.
Outside of the manager’s toolkit, we believe there are several other ongoing processes which
assist with the monitoring of liquidity within a fund – not just in a stressed market scenario.
These are considered during the scoping, launch and ongoing running of our funds:
Independent risk monitoring
Fund managers can benefit from a formal and well-defined firm-wide risk governance
framework that starts at the top of the organisation with the management company/board of
directors (or other governing body) and includes a dedicated risk sub-committee, as well as
control committees that focus on key risk control issues across the organisation. The risk
governance process should include a risk management function that is independent of fund
management (for independent oversight of investment, liquidity, counterparty credit,
operational, and technology risks) with direct access to the fund management company board
of directors (or other governing bodies of the fund manager). This is essential to ensuring that
all risks, including liquidity risks in a fund, are properly managed. In addition, the risk
governance framework should include other control groups, such as portfolio compliance and
valuation oversight, that are responsible for elements of the independent risk management
process.
Furthermore, we believe it is fundamental for a manager to monitor liquidity risk daily, not just
in the run-up to anticipated periods of market stress. In order to conduct this monitoring, daily
liquidity risk reports that capture key metrics for risk managers and fund managers to assess
liquidity risk in individual funds should be utilised. Key risk metrics that should be monitored
include, but are not limited to, the following:
• External factors, such as the market trading environment, capacity, and the
estimated market costs to liquidate a portion of the fund or the entire fund in normal
or stressed markets;
• Mandate/fund factors, such as performance and historical flows;
• Asset factors, such as fund composition based on the relative liquidity (i.e., liquidity
tiers) of fund holdings; and
• Investment factors, such as investor concentration and turnover.
Trustee/depositary engagement
Where a fund has a trustee/depositary these functions should be engaged to review liquidity
risks and any decisions impacting investors during times of market stress (i.e. the decision to
suspend dealing in a fund). The decision to invoke any changes to the liquidity profile of the
fund should be agreed with the trustee/depositary (where applicable).
Fund board oversight
We strongly support fund board engagement, oversight, and awareness of liquidity risk
management practices and issues. Fund boards can, and should, provide oversight of a fund
manager’s management of fund assets. Liquidity risk management is an important aspect of
the fund management process so the fund board’s oversight of investments should include
liquidity risk management practices. It is however important to note that the distinction between
oversight and management is not blurred and that the fund board’s role is one of approving
the overall liquidity risk management framework by providing ongoing oversight rather than
day-to-day management so that changes to the application of the liquidity risk management
policy to reflect changing market circumstances and or investor sentiment can be promptly
implemented. Rather, material changes should be noted and discussed on a periodic review
basis.
Decisions regarding the liquidity classifications of fund holdings and the minimum amount of
cash or liquid assets held by a fund are day-to-day fund management decisions, supported by
oversight provided by the fund manager’s independent risk managers. As noted above, we
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recommend the submission of ongoing periodic reporting to fund boards regarding liquidity
matters and board notification of material liquidity issues that arise while managing a fund.
Fund boards also have a role in ensuring that the manager has implemented appropriate
internal escalation procedures and an external communications plan in the event that
extraordinary liquidity measures have to be invoked.
Stress testing
Our independent risk management function stress tests liquidity coverage of adverse
redemption scenarios under European regulatory guidance (i.e., Alternative Investment Fund
Managers Directive (“AIFMD”)). We have been vocal proponents of regulation that would
extend similar stress testing at the individual fund level across jurisdictions and we are working
to expand the scope of existing stress tests across all of our funds globally.
Like any ex-ante risk measure, stress testing is limited by data availability and relies on model
assumptions. As such, precision on any liquidity stress test must be qualified based on the
availability of market data and the inherent limitations of historical observations to predict future
investor behaviour. To this end, liquidity stress testing does not result in a precise answer, as
our ability to understand what future adjustment processes for market prices would be in
stressed market conditions is necessarily limited based on: (i) what has happened historically;
and (ii) available data to analyse price behaviour. Since this data is often either incomplete or
limited to small quantities of traded amounts during normal markets versus large quantities in
disrupted markets, it is difficult to infer all outcomes that are possible. As such, monitoring by
risk management professionals who understand the appropriate uses and limitations of the
analysis is needed to correctly interpret liquidity stress testing results. The results of liquidity
stress testing are best suited for internal use and for regulators; they are not appropriate for
public dissemination.
Q3: What are your views on these, or other, possible approaches to the treatment of
professional investors? Would these approaches be fair to retail investors in the same
fund?
The comingling of professional and retail investors is a pooling method in which funds can gain
scale with various entry points for different investors. This is also a way in which a diverse
client base can be achieved. Funds can accommodate both professional and retail investors
in the same vehicle by using share classes. Share classes enable managers to differentiate
clients using criteria such as minimum investment amounts and charging structures. While this
structure enables a variety of clients to invest in funds, it is important that conflicts of interest
between client groups are managed to ensure all clients are treated fairly.
There are other considerations discussed within the paper, comments on which can be found
below:
Notice Periods
Although the COLL rules potentially allow different dealing and notice periods within a fund
(and share classes) depending on the type of investor, we believe that in practice it is difficult
not to discriminate against certain types of investors unless consistent dealing terms are
implemented and so this flexibility is of limited benefit.
Liquidity Profiles of Funds
Selling funds through intermediaries continues to be a key distribution channel for retail funds.
Real estate and infrastructure are examples of comparatively less liquid asset classes where
there are daily dealing funds, which in turn can lead to a mismatch of liquidity profile between
the underlying assets and the dealing cycle of funds.
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However, daily liquidity is a key requirement of certain intermediaries from an operational
perspective as noted above and this can serve to encourage products where dealing cycles
do not match the liquidity profile of the underlying investments. Incentivising the development
of a less frequent dealing cycle should be supported as this would enable retail investors to
invest in funds focussed on less liquid asset classes in a more suitable (albeit less frequent)
manner. This development would also serve to increase the stability of the structure of the
funds, i.e. by linking the frequency of fund dealing cycles to the liquidity of underlying assets.
It is important to consider the potential impact of funds which misalign daily subscription and
redemptions with much longer settlement and dealing periods on their underlying assets as in
certain market scenarios these funds may be prone to becoming unstable. As an example of
this, see the significant problems experienced by the German open-ended commercial real
estate sector in 2005 and 20064.
Client engagement
The points raised in section 3.34 of the Discussion Paper around engagement with clients
(where suitable) is certainly correct, and is a method which can be utilised effectively to
potentially dampen the impact of any large redemptions of certain funds. BlackRock, for
example, has an investment oversight team whose role is, inter alia, to act as an interface
between clients and investment professionals. This team helps focus attention in regard to
potential large scale client redemptions and can discuss potential liquidity considerations with
investors in advance of a stressed market scenario.
Understanding the characteristics of a fund’s investors
Understanding the characteristics of a fund’s investors, including the concentration of retail
and professional investors, is useful in assessing a fund’s liquidity risk. We therefore believe
that additional data transparency that would be useful to help fund managers better assess
redemption risk. We note comments in FCA Policy statement 13/01 that ‘… selling products
through a platform can often mean that the product provider has no knowledge of the
consumers buying their products. It is important that platforms are able to feedback good
quality management information to the product provider.’ We support regulatory initiatives to
incentivise the provision of this data.
It should also be noted that retail clients who access such funds through intermediaries may
be influenced by the views of the intermediaries – for example, should a certain fund fall out of
favour with an intermediary this could lead to widespread redemption requests from underlying
retail investors. In this case, understanding the asset allocation strategy of the manager and
initiating discussions on how to implement a phased redemption process would be more
important than understanding the characteristics of the underlying investors.
Dealing cycles
The Discussion Paper suggests that retail clients often subscribe and redeem in smaller
amounts, and therefore a more regular dealing cycle could potentially be implemented in
alongside a longer cycle for professional investors. We believe this is counterintuitive, and
could potentially provide more of a reason for retail investors to redeem from funds. The less
liquid asset classes noted in the paper, such as real estate and infrastructure, have long-term
investment horizons and thus incentives for frequent redemptions should be avoided. As noted
above a more beneficial route would be to encourage the inclusion of funds with less frequent
dealing cycles on relevant consumer platforms with appropriate disclosure.
IPE, March 2006 - An open-ended fund dilemma – Harmut Leser - https://www.ipe.com/an-open-ended-funddilemma/18768.fullarticle
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Q4: What are your views on these, or other, possible approaches to the portfolio
structure of funds?
Product Structuring
Funds should be structured with various considerations in mind, including both the asset class
(and its associated liquidity) and the investors to whom the fund is expected to be marketed.
It is the responsibility of the manager to structure funds with these considerations in mind, and
to ensure that appropriate liquidity management provisions are in place. The structure of notice
periods, dealing frequencies and settlement cycles should be clearly explained, and the
resulting liquidity available to investors should mirror the liquidity of the underlying holdings.
Many of these requirements already form part of the requirements of AIFMD.
While the Discussion Paper focuses on the structuring of open-ended funds, managers should
not ignore the potential benefits of closed-ended funds such as Real Estate Investment Trusts
(“REIT”) as an alternative to balancing the interests of ongoing and redeeming holders and
should consider the relative merits of both types of fund as part of their product development
process.
Defined Cash Holdings
A proposal to implement mandated defined cash holdings or mandatory liquidity buffers and
to hold a specified amount of cash in the fund is contrary to the aim of investing within a fund
and maximising investor returns. A fund manager has discretion to invest with the constraints
of the investment objective and cash can play a part in a wider strategy depending on market
conditions. The level of cash held is a decision of the fund manager and is a key part of the
ongoing investment process. There are a number of reasons why mandated defined cash
holdings would be either difficult to implement or potentially negative for the fund:
1. Performance - Excessive cash holdings could potentially be better deployed
elsewhere and may potentially create a performance drag on the fund.
2. First mover redemption advantage - Should a fund holding less liquid assets be
required to hold a cash buffer then this would benefit the first investors to redeem their
holdings, thus creating a first mover advantage. In this case, initial investors who
redeem up to the initial cash limit will be able to receive their proceeds without any
fund assets being sold. As this limit is reached and passed, assets will then need to
be sold. Should redemptions continue then a fund manager will move to selling off less
liquid assets at potentially lower prices, in turn eroding the value of the fund for those
redeeming later than those who redeemed when the cash buffer had not yet been
eroded.
If the above is the case, then this could cause managers to focus on investing in assets
based upon their liquidity profile, as opposed to for the wider benefit of the fund.
Although this is a key consideration, it should be reviewed alongside other factors and
should not be a key factor in an investment decision.
3. Rigidity of classification - Prescriptive rules would be required to define whether a fund
should be classed as less liquid as a result of holding a defined level of less liquid
holdings. Absolute tolerances could be implemented; however, this would be difficult
to monitor on an ongoing basis in the case that a fund experiences higher turnover
and/or wishes to re-allocate - this could in turn lead to funds moving in and out of the
definition of being a less liquid fund.
Liquidity Tiering
BlackRock has previously and continues to recommend that a categorical approach of liquidity
“tiering” be adopted to assess the overall liquidity of funds. This is an approach which
BlackRock risk managers and fund managers use for internal purposes when they are
assessing the liquidity risk of a fund’s assets.
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Liquidity tiering categorises fund holdings into one of several tiers based on asset type (e.g.
asset class, credit quality, etc.) instead of classifying holdings based on the unique attributes
of a position (e.g. position size, valuation, etc.). While the assignment of asset types to liquidity
tiers is necessarily subjective, the underlying tiering matrix can be easily made transparent
and potentially even be standardised across market participants. Once a tiering matrix is
agreed upon, liquidity tiering eliminates the vast majority of subjectivity and inconsistency
associated with other approaches, such as days-to-liquidate bucketing, by removing
references to and false precision around price, position size, and days to trade and settle.
Instead, the descriptions of each liquidity tier refer to attributes of fund holdings based on the
general characteristics of the asset type represented by each holding (e.g. investment grade
versus high yield bonds). Further details of liquidity tiering can be found in BlackRock’s
response to the SEC request for comments on Open-End Fund Liquidity Risk Management
Programs5.
Q5: What are your views on these, or other, possible approaches to the valuation of
illiquid assets?
Fair valuation
We agree that fair valuation is a useful tool for managers and that there should be appropriate
disclosure within any associated fund documentation of such processes. Mangers should have
the option to use fair value pricing when they believe that no reliable price exists for one or
more underlying securities at a certain valuation point. In these circumstances managers may
value an investment at a price which they believe reflects a fair and reasonable price for that
investment. Circumstances which may give rise to a fair value price being used include
instances where there is no recent trade in the security concerned; or the occurrence of a
significant event since the most recent closure of the market where the price of the security is
taken.
With less liquid securities, it is also the case that third-party valuation agents can be used to
provide a price. However, as is recognised in the AREF report published in April 20176, during
the referendum third party valuation agents often caveated valuation opinions due to the
uncertainty caused by the vote. BlackRock agrees with the report’s opinion that there should
be a review of the reliance placed on valuation reports.
Price swinging
We have consistently supported permitting open-ended funds to have mechanisms to allocate
transaction and market impact costs associated with the sale (purchase) of fund assets to
redeeming (subscribing) investors to reimburse or economically buffer a fund’s remaining
investors, while at the same time providing a price signal to subscribing and redeeming fund
investors of the genuine economic cost of obtaining liquidity.
Swing pricing is a useful mechanism which has been used effectively in several jurisdictions
in Europe for many years. BlackRock currently manages many European domiciled funds
whose investors benefit from the application of swing pricing. Swing pricing provides a
mechanism for attributing the estimated cost of investing or disinvesting to the active investors
causing that activity, thereby minimising the dilution impact. All of the benefit is received by the
fund. As such it is not an additional service charge. Swing pricing is based on estimated
underlying fund trading costs and is designed to reduce the dilution impact while not
necessarily providing 100% protection.
BlackRock, Comment Letter, Open-End Fund Liquidity Risk Management Programs and Swing Pricing – January 13,
2016 - https://www.blackrock.com/corporate/en-at/literature/publication/sec-liquidity-risk-management-proposal011316.pdf
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A review of real estate fund behaviour following the EU referendum - A Report for The Association of Real Estate
Funds – April 24, 2017
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Price Discovery through Brokers
There is currently a mechanism by which units in open-ended funds can be valued privately
by the use of brokers. However, the impact on the registrar/transfer agent and tracking the
beneficial owner of units must be considered.
Q6: What are your views on these, or other, possible approaches to the fund manager’s
use of specific liquidity management tools?
Prescribing when to use certain tools is not likely to give the best results. Rather, clearly stating
the objective of fair treatment of all investors, and laying out what this means in practice, gives
fund managers the right framework to assess each situation on its own merits. Again, the
application of such processes should be overseen by the funds’ management company and
trustees (where applicable).
Q7: Do you think our analysis of the possible benefits and risks of direct intervention
by the regulator is correct? Do you think the FCA should be more proactive about
directing the actions of fund managers in a stressed situation, and if so how?
We believe that the FCA has a role to play in engaging with fund managers in stressed market
situations. Early bilateral discussion (where possible) with fund managers on potential action
is welcomed and should form the basis for regulatory intervention.
Fund managers manage liquidity risk on a daily basis and consider fund and asset liquidity as
part of the development, implementation and day-to-day running of a fund. As mentioned in
question 2, we believe that independent risk management and stress testing, along with the
available toolkit should suffice to manage liquidity in an adverse market scenario.
Many funds managers engage with regulators as part of the fund authorisation process,
whereby the regulator has the chance to review documentation and the structure of a fund.
BlackRock believes that this is a useful opportunity for the regulator to be made aware of and
to review any non-standard features of a fund.
It is important to note that following the Brexit vote in June 2016 not all impacted funds were
suspended. If the regulator were to have primary responsibility for directing funds to suspend
dealing in the future this could have the consequence of catching funds which are not directly
affected and imply that there are wider systemic issues than may actually be the case. There
are also issues with suspending funds investing in a particular asset class, particularly where
there is significant crossover between the definitions of asset types as is in the case of
infrastructure and real estate investments (for example an airport could be termed as both a
real estate and an infrastructure investment) – it would be difficult to force suspend one
category but not the other.
Furthermore, as mentioned previously, it will be difficult to prescribe rules which define whether
a fund can be classed as investing in less liquid assets.
Q8: What are your views on these, or other, possible approaches to requiring enhanced
disclosure for funds investing in less liquid assets?
Risks, such as potential issues with liquidity, should be (and are) clearly disclosed to investors
in relevant fund documentation. The relevant risks and toolkit should also be
explained/disclosed to distributors of funds.
BlackRock also believes that better understanding the liquidity dynamics of an investment
strategy employed by a fund would be beneficial for investors. Investors should understand
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how funds can meet redemptions, in normal and stressed market conditions. Greater
disclosure of liquidity risk management processes and procedures that are in place to help a
fund meet redemptions will enhance understanding of these important investor protections.
Our experience is that managers routinely include a number of provisions and warnings within
fund documentation such as the fund prospectus and simplified prospectus (where
appropriate) or the forthcoming PRIIPs KID on the associated risks of investing in less liquid
assets, along with standard warnings that funds may have fees or gates applied and that there
is a risk of suspension. It may be beneficial to focus further on disclosure around the manager’s
valuation process, and particularly the process for valuing less liquid securities in the
prospectus of the fund.
BlackRock would welcome guidance from the FCA on standardising disclosures across openended funds, to ensure that investors can compare funds and understand liquidity risks in a
standardised format.
Q9: What is your view of the benefits and risks of a secondary market in the units of
open-ended funds investing in illiquid assets? Should the FCA do more to encourage
the development of such a market?
We agree that a potential solution is to offer a marketplace for investors to sell or purchase
interests in the long-term vehicles at prices which are openly negotiated.
We would advise against attempts to provide standard liquidity terms across a range of funds
liable to hold assets with differing liquidity profiles: investor liquidity terms should be driven by
a detailed assessment by the manager of the liquidity of the investment assets and the
expected investment horizon of the strategy. For funds with limited redemption terms, midterm liquidity could be provided explicitly through secondary market-type of solutions (for
example as seen with listed closed-ended funds).
A ready market in secondary shares (although not always efficient) can lead to better and
faster price discovery. In the listed REIT market participants will often derive and assess the
underlying capitalisation rate of the properties within the fund using the market price of the
securities, and will not necessarily be driven by the official valuation. One drawback to the
greater liquidity that the REIT market may provide is greater volatility, but the structure does
overcome the difficult task of balancing the interests of ongoing and exiting holders when
values are uncertain and dealing windows are sporadic, and also avoids the need to sell at
distressed prices to meet redemptions.
A secondary market in the units of open ended funds could capture some of these benefits but
could also create different problems arising from the uncertainty about how the buyers in the
secondary market should most accurately value the units in their own subsequent valuations:
if purchased at a discount it may not be appropriate immediately to revalue upwards but having
both an official and market-derived price for the same units would be problematic.
We are supportive of an active secondary market, but note that in extremis, finding willing
buyers at anything other than fire-sale prices is unlikely.
Q10: Are there any other issues related to the subject?
None of note.
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