The proposed changes from the Financial Conduct Authority (FCA) designed to reduce the potential for harm to retail investors in funds that hold illiquid assets, will “enhance risk-management capabilities, transparency and resilience”, Moody’s Investor Services has said.

The firm also stated that, over time, the benefits of implementing these types of policy changes should increase earnings stability and lower reputational risk, a key element in assessing asset managers’ creditworthiness.

Furthermore, while the proposals do not prohibit open-ended funds from investing in illiquid assets, Moody’s has said they will help to mitigate the “inherent liquidity mismatch between their illiquid investment and their daily redemption terms”, while also supporting market integrity.

The firm acknowledged that the recommendations will increase costs and potentially act as a small drag on fee revenue, but highlighted that large asset management firms such as Standard Life Aberdeen and Legal & General Investment Management are “better positioned to absorb such pressures”. Despite this, Moody’s claimed that all asset managers should benefit from a safer investment fund industry “that continues to generate strong margins with less volatility”.

Although the FCA is not proposing a fundamental change to their supervisory approach, it is calling for more stringent liquidity risk management and greater transparency, therefore increasing investor confidence in the funds and benefit long-term growth of the sector.

The note from Moody’s further stated: “In particular, the FCA recommends requiring funds to have a comprehensive and robust liquidity risk-management framework and practice in place, especially contingency plans and dealing suspension mechanisms to reduce the risk of harm to retails clients in stressed conditions.”

However, the proposals should not prove too difficult to implement, as Moody’s explained that, “to a great extent”, the monitoring and reporting recommendations are an extension of large asset managers’ existing liquidity risk-management capabilities.

“The FCA expects only a mild increase in the funds’ ongoing costs, amounting to 0.02% of the net asset value. Moreover, the FCA did not advance the idea of imposing any minimum cash-buffer requirements or caps on the proportion of investments a fund could make in illiquid assets, which would have acted as a drag on investment returns, potentially causing funds to lose assets under management,” it said.

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