H2O auditor flags rule breach during summer liquidity squeeze
Fund manager suffered redemptions after FT reports of ties to racy German financier
H2O Asset Management broke rules governing open-ended funds during a liquidity crisis in June, according to newly published accounts that reveal that the fund manager blew through limits on counterparty risk.
The London-based firm, a subsidiary of French bank Natixis, saw clients take out €8bn from its funds over the summer after the Financial Times detailed the scale of its illiquid bond holdings linked to the racy German financier Lars Windhorst.
While H2O met all of these redemptions and its chief executive Bruno Crastes vowed to never halt withdrawals, the firm still came under scrutiny. Influential ratings group Morningstar downgraded one of the key funds, Allegro, a bond and currencies vehicle, citing H2O’s “loose risk controls”.
The €1.5bn-in-assets fund recently filed annual accounts covering the year ending June 28, in which auditor KPMG disclosed that Allegro breached French rules implementing Ucits — an EU-wide framework governing funds that allow retail investors to withdraw money on a daily basis.
H2O’s breach was because of “transactions with a single counterparty that is not a financial institution”. KPMG said those transactions represented 9.9 per cent of the Allegro fund’s net assets, far in excess of the 5 per cent limit set out in French law.
A person close to H2O said the firm had since corrected the breach and that its funds were now in compliance with these regulations.
Governance of Ucits funds has been in the spotlight since the meltdown at the flagship investment fund run by Neil Woodford, the UK stockpicker. Mr Woodford chose to freeze withdrawals, a move that sparked fury among investors.
In a section of Allegro’s annual report detailing the fund’s exposure to bonds related to Mr Windhorst, H2O explains that it conducted a number of “purchases followed by deferred settlement sales”, transactions commonly referred to as “reverse repos”, on these securities with a single counterparty.
The report then explains that the fund had a receivable with the same counterparty representing 9.9 per cent of its net assets, because it was owed €111m under “deferred payment sales”. This disclosure is included in the French-language version of H2O’s accounts, but is missing from the English version.
H2O declined to comment on the identity of the counterparty and the discrepancy in disclosures.
This is not the first time H2O has breached Ucits rules this year. In March, an equities-focused fund exceeded the 10 per cent threshold that caps holdings of illiquid assets, often referred to as the “trash ratio”, because of its holdings of unlisted shares linked to Mr Windhorst. H2O later rectified this breach.
Natixis said last week that it had taken measures to increase its oversight of its asset management division, following the furore over H2O.
KPMG’s audit report also includes an “emphasis of matter” related to the uncertainty around H2O’s valuations of illiquid bonds linked to Mr Windhorst. Audit firms include such notices to flag matters that are thought to be fundamental to readers’ understanding of the financial statements, but not sufficiently serious to merit a “qualification”.
Allegro was previously audited by firm PwC, which included a qualification in its 2016 audit of H2O’s separate Adagio fund. That related to “significant discrepancies” in the valuation of bonds from Mr Windhorst’s flagship investment vehicle.
These same bonds were referenced in litigation from several parties alleging that the German financier reneged on repurchase agreements, including a lawsuit linked to the former energy minister of Russia that was later settled. Mr Windhorst has often turned to a close network of trusted brokers, including London’s Shard Capital, to help carry out these repo transactions.