UK watchdog admits 7 investment funds breached ‘trash ratio’
Revelation raises pressure on Andrew Bailey ahead of parliamentary grilling
The UK’s financial watchdog has revealed for the first time the extent to which fund managers breached European rules designed to limit the liquidity crunches behind scandals involving high profile fund managers, including Neil Woodford and GAM.
Funds that allow investors to withdraw their capital daily but hold hard-to-sell assets were said to have been “built on a lie” last year by Mark Carney, outgoing governor of the Bank of England. Regulators across Europe have since scrutinised how closely fund managers adhere to so-called Ucits fund rules that limit holdings in unquoted securities to 10 per cent of their portfolio, often referred to as the “trash ratio”.
Responding to a Freedom of Information Act request by the Financial Times, the Financial Conduct Authority disclosed that seven UK funds had breached the 10 per cent limit, a total of eight times — not including breaches made by Mr Woodford’s now defunct Equity Income fund — since June 2017.
The admissions come at a delicate time for Andrew Bailey, head of the FCA who is due to replace Mr Carney at the BoE this month, as he prepares to answer questions on his suitability for his new role from parliament’s Treasury select committee on Wednesday.
Mr Bailey’s record at the FCA has been criticised by the likes of John McDonnell, Labour’s shadow chancellor, and campaigner Gina Miller, over the number of prominent scandals under his watch, including the suspension of funds run by Mr Woodford and GAM, the Swiss group, after they invested heavily in unlisted securities and could not pay back fleeing customers.
The latest figures also revealed that Mr Bailey previously understated the number of breaches in testimony to the committee.
“There needs to be tighter rules on fund illiquidity,” said Stuart Alexander, chief executive of Gemini Investments, a fund services company. “Ucits funds should not be allowed to hold illiquid assets — it does nobody any favours and adds unnecessary risk.”
The FCA initially declined to provide information under the FOI Act, but relented after the FT called for an internal review of the decision. The regulator refused to provide names of the funds that breached.
Half of the breaches in the FCA’s disclosure were defined as passive, meaning they resulted from market moves such as falling public share prices or rising valuations of private companies. But the four other cases were classed as active, where fund managers make investment decisions that tip the portfolio over the 10 per cent threshold.
Fund managers are required to inform the FCA of breaches as soon as they happen and are generally given six months to fix passive breaches. But in one example, the fund manager did not inform the FCA for 10 months.
“If a fund manager makes an active breach it should not take more than six months to fix, it should be done in six hours,” added Mr Alexander.
In previous testimony to the select committee last June, Mr Bailey said just one fund other than Mr Woodford’s flagship vehicle had breached the limit in the previous 12 months, which he described as a “very small fund”. The latest figures provided by the FCA show two funds breached in that period, in July and August 2018.
The FCA did not respond to a request for comment on this point.
Sean Tuffy, head of market and regulatory intelligence at Citigroup’s custody and fund services business, said regulators were taking a greater interest in how managers were using the 10 per cent ratio. “Are they using it as a buffer, which is how it was intended to be used, or are they using it to access asset classes they shouldn’t be investing in? That’s a big question for regulators right now.”
In January, the regulator admitted to the FT it had no central database to keep track of funds that suspend trading, despite carrying out several reviews of the sector’s robustness.