The Financial Conduct Authority has told authorised fund managers (AFMs) that liquidity management is a “central responsibility” in the aftermath of the Woodford Equity Income fund suspension, which has ultimately led to the fund winding up.
In the aftermath of the suspension of Woodford Equity Income, Neil Woodford’s investment firm emphasised that the fund’s authorised corporate director (ACD) Link was ultimately responsible for making sure the fund was liquid enough to meet redemptions.
Nick Miller, head of the asset management department at the FCA, appeared to echo that line of thinking when he wroteto authorised fund managers (AFMs) chairs in a letter dated 4 November.
“As an authorised fund manager (AFM), ensuring effective liquidity management in funds is a central responsibility for you, and it remains your responsibility even if you have delegated investment management to another person,” Miller said in the letter sent to managers on Monday. “Good fund governance ensures the liquidity of your funds’ underlying assets is appropriately considered.”
Regulator warns on hard to trade listed securities
The letter urged AFMs to “consider your obligations on portfolio composition, asset eligibility, and liquidity management” and said fund groups should compare the controls they have in place for measuring liquidity with the regulator’s own good practice guidelines.
AFMs should consider whether the assets they invest in are appropriate and are easy to trade in practice and not simply assume that because they are listed on an exchange they can be sold.
Months before Woodford’s flagship fund was frozen, the former star manager attempted to list several unquoted stocks on the Guernsey stock exchange, in a move Andrew Bailey would later say flouted the spirit of the FCA’s rules.
The FCA was sharply criticised for not stepping in sooner when it was already revealed to be keeping tabs on the liquidity profile of Woodford Equity Income. The International Stock Exchange (TISE) which began looking into Woodford’s Guernsey-listed assets said it took the regulator over a month to respond to its enquiries.
Avoiding the Woodford pitfalls
The FCA has received blowback for shunning Ucits funds like Woodford Equity Income from its liquidity rule change, due to come into effect by September 2020, which introduced stricter measures for non-Ucits retail schemes (Nurs).
Though the regulator admitted its liquidity rules were limited in scope it stressed in the letter that “firms should recognise that effective liquidity management is an irreducible, core function for all open-ended funds”.
The FCA said open-ended funds are not always able to liquidate assets “sufficiently quickly” in order to meet redemption requests, adding this issue can be more acute in daily dealing funds which make up the bulk of the retail market.
But it said firms can avoid this pitfall by engaging in “suitable portfolio composition,” understanding the investor base and their redemption rights as well as using liquidity tools appropriately especially in times of market stress.
Effective fund governance
The regulator also highlighted effective fund governance, which includes oversight from independent directors, as an important tool to avoid a liquidity trap.
Since 30 September, fund boards have needed at least two independent directors to fund boards or have at least a quarter of the board made up of non-executive directors, depending which is higher.
While to bring more independent voices to the table has , commentators have queried whether more independent oversight would have made a difference in Woodford’s case or could prevent the next fund blow-up.
Jon ‘JB’ Beckett, ambassador for the Transparency Task Force, for one said “very few” fund directors understand complex topics like liquidity risk.
In closing out the letter, the FCA recommended AFMs and their boards consult reports on liquidity management and the IOSCO 2018 liquidity recommendations.
“We have provided details of good practice for liquidity management in your authorised funds, which are particularly relevant during times of volatility and stress. Please review your firm’s practices as soon as practicable to ensure you and your fellow AFM board members are comfortable they are appropriate.”
