Matching liquidity to reality: FCA proposes new redemption rules for illiquid asset funds (CP26/35)

a) How would the 90-day notice period work?

The proposed 90-day notice period is a regulatory minimum. AFMs will need to select, and be able to justify, redemption terms that reflect the time required to realise the particular portfolio in an orderly manner, taking account of the fund’s investment objective, policy and strategy and the reasonable expectations of its target investors. The FCA says it would not expect to authorise a fund with a 90-day notice period if it intended to invest substantially in assets that would take longer to sell.

Following receipt and acceptance of a redemption request, the redemption price would be determined at the first valuation point following the end of the notice period. On acceptance, the AFM would also need to confirm the dates on which it expects the request to be effected and the appropriate proceeds paid.

An investor may therefore wait longer than 90 days, depending on the fund’s acceptance arrangements, cut-off and monthly dealing calendar. The investor will remain exposed to changes in the fund’s value during that period and will not know the eventual redemption price when submitting the request.

The draft rules also contain outer regulatory limits: for a NURS operating limited redemption arrangements, the price would have to be determined no later than 182 days, and the proceeds paid no later than 185 days, after receipt and acceptance of the redemption instruction. Those limits do not displace the AFM's obligation to select appropriate redemption and settlement terms for the fund.

b)  What does partial alignment with the LTAF framework mean?

FIIAs and LTAFs would share the same minimum redemption terms, but the two regimes would not otherwise merge. An affected fund would remain a NURS, retain the NURS investment and borrowing powers and diversification framework, and would not become a Restricted Mass Market Investment.

The FCA considers that retaining the FIIA structure preserves a more conventional route for retail investment in illiquid assets, such as real estate, with a potentially lower risk profile than an LTAF.

AFMs will therefore need to:

• explain clearly how the products differ in their investment powers, risk profile and intended role in an investor’s portfolio; and
  
  
• consider whether each affected fund would remain operationally workable, distributable and commercially sustainable with the prescribed terms. Depending on the fund and its target market, that may support retaining the existing strategy, adopting a hybrid portfolio, restructuring the product or considering whether an LTAF would be more appropriate.

c) Indirect exposure to inherently illiquid assets

The FCA proposes to expand and clarify the types of fund units treated as inherently illiquid assets when determining whether a NURS meets the 50% FIIA threshold. The changes could bring additional fund of funds and feeder structures within the regime, including where the NURS does not invest directly in illiquid assets, ie:

• LTAF units: units in an LTAF would be treated as inherently illiquid irrespective of the composition of the LTAF’s portfolio. The exception is where the LTAF is in the process of winding up or termination.
  
  
• QISs and unregulated schemes: units in a qualified investor scheme (QIS) or an open-ended unregulated collective investment scheme would broadly be treated as inherently illiquid where the underlying scheme aims to invest at least 50% of its property in specified inherently illiquid assets. Separate tests would apply to transferable securities held by the underlying scheme. The revised definition would also capture certain QIS and unregulated master-feeder structures.
  
  
• Recognised schemes: units in a recognised scheme would be added to the definition where the scheme aims to invest at least 50% of its property in relevant inherently illiquid assets, and is not in the process of winding up or termination. 

The FCA also proposes to remove the existing condition that considers whether the underlying scheme’s redemption terms reflect the liquidity of its assets. Its units could therefore count as inherently illiquid regardless of its own redemption arrangements.

The practical consequence is that AFMs should map all NURS holdings in other funds against the revised definition and assess whether those holdings cause the NURS to meet the FIIA threshold. Relatively frequent dealing at the underlying fund level should not be treated as evidence that the exposure is liquid.

d) Three-month buffer

The FCA proposes to retain the existing buffer for funds whose exposure temporarily reaches the 50% threshold. Provided the fund’s published investment objective and policy do not themselves aim to invest at least 50% in inherently illiquid assets, the fund would not become an FIIA on the basis of its holdings unless it remained at or above that threshold for at least three continuous months during the previous 12 months.

This gives hybrid funds time to restore the portfolio to its intended allocation (for example, following substantial redemptions) without moving immediately into the FIIA regime.

The buffer should not be treated as an ongoing means of avoiding the regime. If a fund is likely to exceed the threshold regularly or for substantial periods, the AFM should reconsider whether its investment strategy, structure and redemption policy remain appropriately aligned.

e) Anti-dilution and liquidity management

The proposals also interact with the strengthened liquidity and anti-dilution framework under the FCA's recent PS26/17. The FCA expects anti-dilution tools to reflect the costs of selling a representative, or 'vertical', slice of the portfolio, including the estimated costs attributable to the least liquid assets.

A notice period should make those tools easier to calibrate and reduce reliance on liquidity buffers or what should be the last resort of suspension. 

Firms will nevertheless need to consider how the anti-dilution tools available to them would operate where subscription and redemption cycles are not aligned and where incoming subscriptions can be used to offset redemption flows.

a)  Revocation of redemption requests

Under the proposals, for LTAFs and NURS operating limited redemption arrangements, an accepted redemption request would remain irrevocable by the investor acting alone. The AFM could, however, agree to its revocation if it is satisfied that doing so would not prejudice other unitholders.

The FCA would expect:  

• AFMs to specify a point after which revocation would no longer be permitted; and
  
  
• AFMs to determine how that point and the assessment of potential prejudice will be documented, communicated and implemented operationally.

b)  Redemption deferrals

The FCA proposes to extend the more flexible deferral power currently available to NURS Funds of Alternative Investment Funds (FAIFs) to all NURS operating limited redemption arrangements, including FIIAs.

This means that where requests exceed 10% of the fund’s value (or another reasonable threshold disclosed in the prospectus), the AFM could defer excess requests to the next valuation point. For a NURS with limited redemption arrangements, that valuation point must be at least one month after the point at which the request would otherwise have been executed.

The AFM should seek to execute a deferred request as soon as reasonably practicable. A further deferral could be used if the request still could not be satisfied at the next valuation point.

Prospectuses and operational procedures should address the applicable threshold, allocation of available capacity, priority of deferred requests, repeat deferrals and investor communications. Platforms and administrators will also need to track deferred requests across multiple valuation points.

c) Suspensions

Suspension would remain available where it is in unitholders’ best interests and would continue to be required in cases of material valuation uncertainty.

For a NURS operating limited redemption arrangements, the AFM would:

• have to accept redemption requests submitted during a suspension unless it had reasonable grounds to refuse them;
  
  
• be unable to execute those requests until dealing resumed; and
  
  
• count the period of suspension towards the applicable notice period.

If the suspension continued beyond the end of the notice period, the redemption price would be determined at the first valuation point after dealings restarted.

The FCA also proposes to remove existing FIIA specific guidance that may make suspension more readily available in response to liquidity difficulties.

Once redemption terms are properly aligned with portfolio liquidity, short-term liquidity shortfalls or difficulties realising assets should not normally be sufficient, by themselves, to justify suspension.

a) Disclosures

Financial promotions for any NURS operating limited redemption arrangements would need to explain clearly that:

• the investor will experience a delay in receiving the redemption proceeds; and
  
  
• the investor will remain exposed to market movements during the notice period, meaning that the amount received may be lower than when redemption was requested.

The prospectus would also need to explain the normal waiting period and applicable cut-offs, when redemptions or payments may be deferred or limited, and the effect of a suspension including that a redemption may not be completed until dealing restarts.

The proposals would interact with the Consumer Composite Investments (CCI) requirements in the Product Disclosure sourcebook. In particular, the CCI regime requires the manager of an illiquid fund, including an FIIA, to add at least +1 to the calculated risk and return score, and contains separate liquidity warning and product summary requirements.

b)  Approval and notification

A NURS voluntarily introducing limited redemption arrangements would ordinarily require prior unitholder approval. Where an FIIA is required to introduce the prescribed arrangements, the FCA instead proposes to treat this as a significant change not requiring prior approval because it would be mandated by the rules.

Existing investors would, however, have to receive at least one year’s notice before the mandatory change rather than the usual 60 days'. Once a NURS operates limited redemption arrangements, notice of other significant changes would generally need to be at least 60 days plus the fund’s redemption notice period.

AFMs should identify all constituting documents, prospectuses, financial promotions, product disclosures and investor communications requiring amendment, and plan the approval and notification process sufficiently early.

The FCA recognises that much of the UK retail distribution system was designed around daily dealt funds. It identifies particular challenges in relation to platform transfers, long deferrals, fund switches and model portfolio rebalancing.

These issues are already familiar from the LTAF rollout. CP26/35 would extend them to affected NURS and reinforce the need for scalable and market wide solutions rather than fund by fund workarounds.

• SIPPs: The FCA is seeking views on whether the proposals would create obstacles to holding and transferring FIIA units through self-invested personal pensions (SIPPs). The FCA proposes a three-year transitional provision under which, subject to specified conditions, existing FIIA units held within SIPPs could continue to be treated as standard assets for prudential purposes, pending a separate consultation on broader changes.
  
  
• Unit-linked products: The FCA is not proposing to change the permitted links rules. A NURS with a notice period would remain a permitted link, whereas an LTAF would remain a conditional permitted link subject to additional restrictions.  Insurers will nevertheless need to consider how the underlying fund’s notice period interacts with their contractual obligations to policyholders and whether they are prepared to assume any resulting liquidity or market risk.
  
  
• ISA eligibility:  Continued eligibility for Stocks & Shares ISAs remains unresolved and sits outside the FCA's rule making powers. The FCA recognises its importance and says it will take the issue into account when deciding if and when to make final rules. Its cost benefit analysis assumes that FIIAs will remain eligible. Without a corresponding change to the ISA Regulations, affected funds would instead be eligible only for Innovative Finance ISAs. The FCA acknowledges that this could result in material outflows and significant market disruption, particularly given the limited platform support for Innovative Finance ISAs.

AFMs should engage early with platforms, SIPP operators, insurers and other wrapper providers and assess whether affected funds will remain accessible and commercially viable through their principal retail channels.

The affected market is relatively small: the FCA estimates that 17 funds, including feeders, with aggregate NAV of approximately £7.22 billion would be FIIAs, and three already operate with a 90-day notice period. That may affect the commercial case for some platforms to invest in the necessary systems changes.

The two-year implementation period is intended to allow existing funds to amend their dealing terms and literature and work with administrators and distributors.

• Map affected funds. Identify NURS that currently meet (or could meet under the revised definition) the FIIA threshold, including fund of funds, feeder and hybrid structures.
  
  
• Review the product proposition. Consider whether each fund would remain commercially and operationally viable with the prescribed terms or whether changes to its strategy or structure (including use of an LTAF) would be more appropriate.
  
  
• Test and document portfolio liquidity. Determine whether the monthly dealing limit and 90-day minimum are appropriate or whether longer or otherwise more restrictive terms are needed.
  
  
• Review governance and liquidity management. Assess monitoring, contingency planning, escalation, anti-dilution, deferral and suspension procedures.
  
  
• Assess operational and distribution readiness. Engage depositaries, administrators, platforms, distributors and wrapper providers on orders, cut-offs, pricing, revocations, deferrals, suspensions, transfers and payments.
  
  
• Plan fund and investor communications. Identify required changes to constituting documents, prospectuses, financial promotions, product disclosures and investor notices.
  
  
• Develop an implementation plan. Identify dependencies, responsibilities, lead times and decision points across the AFM and its service providers.
  
  
• Consider responding. Firms should consider providing evidence on material product, operational, distribution or wrapper concerns. Responses are due by 11 December 2026.

CP26/35 seeks to address a longstanding weakness in open-ended funds - the assumption that retail access should generally mean daily or frequent redemption, even where the underlying assets cannot be sold on that basis. The FCA’s proposed approach is more realistic - start with the liquidity of the investment strategy and work outwards through redemption design, operational infrastructure and distribution.

For some existing products, a 90-day plus notice period will mark a material change for investors but may make the portfolio more resilient and less susceptible to suspension. For others, particularly those dependent on platforms, model portfolios or ISA distribution, it may alter the commercial viability of the proposition.

The LTAF experience shows that regulatory permission to operate a notice period fund does not by itself make the product distribution ready. AFMs should therefore use the consultation period to assess both whether their funds fall within the revised FIIA regime and whether the resulting product will remain workable for its intended investors and distribution channels.