Fitch: UK Property Funds Liquidity Pressures Could Accelerate LTAF Adoption

In a research note published on Monday (10 October), the ratings agency said that a new regulatory framework on redemption notice periods could improve the property fund sector's liquidity management and financial stability. 

However, it noted that the option to readily redeem cash from funds is a key factor in investors' allocation decisions and long redemption periods could deter investors from contributing to funds, leading to further fund closures.

In March 2021, the UK's financial watchdog proposed a notice period of between 90 and 180 days for redemption requests, as part of a discussion that is still in progress. 

At the same time, the FCA launched the LTAF, a new fund structure specifically for illiquid assets, which also includes a minimum 90-day notice period for redemptions.

AIC warns selling LTAFs to retail investors is 'an accident waiting to happen'

The policy discussions on redemption periods combined with the introduction of the LTAF structure have "fuelled industry uncertainty over open-ended property funds", the agency said. 

Several open-ended UK property funds have been liquidated in recent years, such as Janus Henderson UK Property PAIF in April 2022, which cited outflows as well as the LTAF framework for its decision.

Fitch noted that the investor run from open-ended UK property funds caused by market volatility and rising interest rates has exposed the sector's long standing liquidity mismatches, which the agency has long viewed as a structural flaw of the open-ended property fund market. 

The ratings agency said that funds run the risk of having to temporarily suspend redemption- known as ‘gating'-if available liquidity is insufficient to meet redemption requests, or if market volatility means they cannot realise assets effectively. 

Last week, Schroders, Columbia Threadneedle and BlackRock had to restrict withdrawals from its UK property funds, delay payments or switched from daily to monthly dealing to limit liquidity pressures caused by rising interest rates, an FT report said. 

IMF warns funds holding illiquid assets risk undermining financial stability

However, much of the redemption demand is from pension funds and retail open-ended property funds dodged the liquidity restraints imposed on their institutional counterparts, with none of the UK-focused funds planning to restrict withdrawals, Investment Week revealed.

This is by far not the first time UK property funds have had to limit withdrawals. In 2020 at the onset of the Covid-19 pandemic, several funds had to restrict redemptions to both retail and institutional investors, Fitch noted.

"Contagion risk has been contained so far, but increasing redemption requests may cause some funds to make forced sales, pushing down asset values. This could lead to knock-on effects for other funds, through weaker returns, potentially triggering more widespread withdrawals," the agency wrote.

The IMF highlighted this risk in its October 2022 Global Financial Stability Report, noting the role of open-ended funds holding illiquid assets in magnifying losses during times of stress.

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