KPMG warns that accounts at six H2O funds ‘impossible to certify’
Auditor could not collect enough data on funds, all of which had exposure to Windhorst-linked securities
KPMG has warned that accounts at six of H2O Asset Management’s funds are “impossible to certify”, citing a number of valuation uncertainties and rule breaches.
Once a star of European asset management, H2O was plunged into crisis in 2019 when the Financial Times revealed it had substantial exposure to illiquid securities tied to Lars Windhorst, a German financier and football club owner with a history of legal trouble.
In a series of audit letters this year, KPMG has stated that it could not verify that the accounts of six H2O funds — all of which were heavily exposed to the Windhorst-linked securities — gave “a true and fair view” of their financial situation. The auditor said it was “unable to collect sufficient and appropriate elements to base an audit opinion on these accounts”.
The six funds in question were all temporarily frozen in August last year, after France’s financial regulator raised concerns about their investments. H2O subsequently split these funds, setting up closed “side pockets” to house the Windhorst-linked bonds and shares, trapping more than €1bn of investor money.
Five of the audits cover periods before H2O divided the funds, while one reflects the balance sheet of one of the side pockets after the split.
The KPMG letters, the most recent of which was dated July this year, also flag activity that started in 2019 when H2O had responded to €8bn of investor outflows by trying to reduce the Windhorst exposure using a complicated series of “buy and sell back”, or “reverse repo”, trades.
Asset managers typically engage in buy and sell transactions by taking on liquid assets, such as government bonds, with the intention of selling them back again at a future date at a higher price. These in effect provide a short-term loan to the owner of the security.
In the case of H2O, the trades allowed it to reclassify some of the troublesome illiquid bonds away from its main portfolio holdings.
But the trades had a side-effect, which attracted fresh warnings from KPMG: they caused the investment firm to breach rules governing open-ended investment vehicles.
Funds that allow ordinary investors to withdraw their money on a daily basis are subject to strict rules around the assets they can hold and trade. This regulation restricts the level of illiquid investments they can hold as well as the amount of risk tied to a single counterparty.
In its audit letter for H2O’s €807m Allegro fund, KPMG noted that at the end of June 2020 the fund had breached risk limits in relation to each of the counterparties to the buy and sell transactions, which made up 29.2 per cent of the fund’s asset value.
These transactions also drew further regulatory scrutiny last year when one of the three counterparties listed in H2O’s fund filings, Antwerp-based Merit Capital, denied any involvement and threatened legal action.
H2O has since signed a settlement with Merit where the asset manager acknowledges documentation indicating that the trades had been executed by Shard Capital, a London-based brokerage with close ties to Windhorst.
The agreement, seen by the FT, also indicates that Shard carried out matching trades with Windhorst-linked entities — including his British Virgin Islands-registered company Sapinda Asia.
H2O said it was “legally bound” to not comment on the terms of settlement. Windhorst and Merit Capital did not provide a comment.
“Shard Capital does not have any open transactions of any nature with H2O,” the brokerage said. Shard last year told the FT it had acted as an “agency broker” on the transactions, without disclosing the ultimate counterparty to the trades.
While the fund risk rules state that transactions with a single broker cannot exceed 5 per cent of a fund’s assets, H2O’s Allegro fund reported transactions outstanding with Shard Capital equivalent to 13.4 per cent. It recorded a further 6.9 per cent outstanding with Merit and 8.9 per cent with Brandon Hill Capital, a London-based firm that describes itself as a “natural resources merchant bank”.
KPMG’s audit letter was signed in March 2021, before H2O’s settlement with Merit.
Asked about the settlement, H2O told the FT it would be “incorrect” to conclude that it wrongly attributed hundreds of millions of euros of trades to Merit Capital and that this therefore meant further breaches occurred.
“Following the settlement, [parties] agree that no buy and sell-back transactions exist between them at the date of the settlement”, H2O said.
Windhorst, who is a majority owner of Hertha Berlin football club, is being investigated by German authorities over suspected violation of the country’s banking act in connection with an investment vehicle through which he sought to buy back the securities from London-based H2O. Windhorst has denied any wrongdoing and said he has offered assistance to the authorities.