The Bank of England (BoE) is set to launch a review into the £1.2 trillion open-ended fund market to see if rules are required to minimise the risks to financial stability.
The moves comes after star fund manager Neil Woodford was forced to suspend trading on his £3.7bn Equity Income fund in June after a string of redemption requests.
The BoE warned the increasingly global role open-ended funds have to play and the liquidity mismatch some funds have has “the potential to become a systemic issue”.
Along with the Financial Conduct Authority (FCA), the BoE’s Financial Policy Committee (FPC) will look to assess how open-ended funds may be better aligned with the liquidity of their underlying assets.
Adding to his comments last month that mutual funds were “built on a lie”, BoE governor Mark Carney said: “The more important open-ended funds become, and the more illiquid their underlying assets are, the greater risk to financial stability.”
The Bank noted how the Financial Stability Board, in 2017, had noted how a fund’s assets and investment strategies should be consistent with their redemption terms.
The FPC said: “However, subsequent work by IOSCO did not prescribe how this should be achieved.”
“The Bank and FCA review will examine the costs and benefits of aligning redemption terms, including pricing and notice periods, with the typical time it takes to realise market prices for funds’ assets in normal and stressed market conditions.”
The mutual fund structure has come under fire since Woodford suspended his fund last month. It is worth noting the creation-redemption mechanism is flawed as the issuer is always a forced seller when investors want to withdraw their money.
If you are invested in illiquid holdings, such as the Woodford fund, this means the issuer is unable to sell and is then forced to suspend trading when a run on the fund occurs.
The BoE said the review “will also assess the effectiveness of measures that are already used to deal with misalignment of redemption terms and asset liquidity, such as swing and fair value pricing and suspensions”.
On ETFs, the FPC concluded “the majority of ETFs do not appear to present material financial stability risks” however, noted products that are leveraged or are synthetically-backed need to be monitored if they grow further from here.