First Post-Brexit Bailout Looms As Bank Of England Mulls UK Property Fund 'Measures'

Who could have seen that coming? While many have questioned the "suitability of daily-traded, open-ended property funds that are giving investors access to an illiquid asset," all the time the price is rising, no one wants to rock the boat. However, now that Brexit has rocked the boat, spoiling the party for UK property investors and asset managers alike, it's time for Carney to ride to the tax-payer-funded bailout rescue to ensure Bear Stearns 2.0 does not become Lehman 2.0...

Following the gating - or forced haircuts - of eight large UK property investment funds this week, fears have grown rapildy of the risk of contagion, which, as The FT reports, is much greater than first feared, with detailed analysis showing that a wide pool of funds have been caught up in the gates imposed on investors withdrawing cash.

The worry is that this will trigger systemic problems for the marketplace, which is already reeling from the UK’s decision last month to end its membership of the EU.

 

A prominent UK fund manager, speaking on condition of anonymity, said: “When you start getting daily trading funds-of-funds investing in daily trading funds that are invested in illiquid assets, that seems to be layering up potential liquidity risks. “[Investors need to] consider the impact on funds that are caught with material investments in the gated property funds.”

 

Three multi-asset funds run by Henderson also have around 3.5 per cent of their assets in the company’s own suspended property fund, while Aviva Investors’ multi-asset product has a 4 per cent stake in its gated property fund.

 

Many other multi-asset funds — one of the fastest-selling investment strategies of the past 12 months — run by rival investment managers have also been caught out by the property fund suspensions.

And so, as The Telegraph reports, financial regulators are considering bringing in a raft of emergency measures to stem the flood of money out of Britain’s biggest property funds that caused fresh market panic last week.

It is understood Bank of England officials are considering the introduction of enforced notice periods before redemptions, slashing the price for investors who rush for the door, or additional liquidity requirements for funds.

 

The funds, which invest in offices, warehouses and retail parks, offer daily liquidity, meaning investors can buy and sell freely despite the fund being unable to sell properties  quickly except at  knockdown prices.

When large numbers of investors pull out, fund managers slash prices and dump property on the market, and have to close the funds to further trading to prevent a run on the fund.

 

...

 

Andrew Bailey, the new head of the Financial Conduct Authority, said he was looking into changing the way the funds work. “Suspension is designed into these structures, it’s not a panic measure, it’s designed to deal precisely with that situation, where there’s been some shock to the market,” he said.

 

"It does point to issues that we will need to look at in the design of these things from the point of view of conduct and systemic stability.”

 

One option could be to limit liquidity to more closely match the assets, for example by forcing investors to give a notice period, typically 30 days to six months, to access their cash.

 

Funds could also be forced to increase their liquidity buffers, such as holding more property-related shares and bonds, which can be more easily sold off, as well as more cash.

 

Regulators are also expected to look at steps the US Securities and Exchange Commission has considered, including swing pricing, where investors who suddenly sell large holdings must accept a lower price.

As is now obvious, these are all measures that exist in the fine print now and limiting investor liquidity will merely create the same contagion discussed above. The Bank of England's 'strawman' here is likely the first step down the road of a full-blown bailout - a slush-fund to promise to buy UK property from the funds... with the hope that once they even mention it, investors will stop their selling and pile back in.

Of course, we have seen and heard all of this before (about 9 years ago) when any number of government backstops, bailouts, partnerships, and direct buying did nothing to stop the contagious collateral chain collapse following the gating and liquidation of two Bear Stearns funds. We will never learn and this time is no different for as one major fund manager warned...

“This throws up all sorts of questions about the suitability of daily-traded, open-ended property funds that are giving investors access to an illiquid asset.”

But all the time investors believe a central bank has their back, this is not a problem... until it is THE problem, and the walls come thundering down.