Northern Trust had front row seats for brewing Woodford storm

Depositary had a ‘very specific role’ to play in Guernsey listings

Questions are being raised about whether Northern Trust did enough to intervene in the months leading to the gating of Neil Woodford’s equity income fund, as commentators point out it would have been able to see a storm brewing and had a “very specific role” in relation to the listing of companies on the Guernsey stock exchange.

Link Fund Solutions, the fund’s authorised corporate director (ACD), has been put under a microscope in the weeks since the fund was gated and has had to fend off accusations of being asleep at the wheel.

Far less has been said about Woodford Equity Income’s depositary, Northern Trust, charged with safekeeping the assets in the fund.

The depositary plays a key role in the checks and balances of running an authorised fund. While the ACD is tasked with monitoring the investment manager appointed to the mandate, the depositary ensures the ACD is sticking to the rules when it comes to unit pricing, dealing, portfolio valuation and following investment or borrowing restrictions.

They would have spotted ‘issues brewing’

As such Northern Trust would have seen the shape of the portfolio changing as Woodford began selling down his most deeply liquid positions in order to cope with more money pouring out of the fund, says Jon ‘JB’ Beckett, ambassador for the Transparency Task Force.

“The depositary tends to sit with all the rich data of the trade flow, the redemption flow, the cash movement. They really do have day-by-day, minute-by-minute access to the data that would indicate issues brewing.”

Beckett says Northern Trust will be facing a similar line of questioning as Link from the Financial Conduct Authority. “What did they know, when did they know it and what actions did they take?”

FCA tight-lipped on Northern Trust

The FCA declined to comment when Portfolio Adviser asked if it was investigating Northern Trust in connection with the Woodford blow-up and would not say if it had been in contact with or contacted by Northern Trust in the months leading up to the fund’s suspension.

FCA chief executive Andrew Bailey revealed in a letter to chair of the Treasury committee Nicky Morgan that the regulator had been in contact with Link for over a year about Woodford Equity Income’s “deteriorating liquidity position”. Link contacted the regulator twice at the start of 2018 when the fund breached the 10% limit on owning unquoted companies.

Brandon Horwitz, principal consultant at NomBon Consulting, says that there should be regular dialogue between the ACD and the depositary.

“In any well-functioning authorised fund, you have that regular dialogue between your depositary and your ACD, passing information back and forth.”

Horwitz says the external advisers would likely have service level agreements in place to flag certain items as business as usual or extraordinary, and would typically meet on a monthly or quarterly basis.

On an operational basis Northern Trust would have been talking to the ACD and possibly Woodford Investment Management more frequently, maybe even on a daily basis as they saw various trades being executed, says former Investment Association senior adviser Philip Warland.

Unglamorous work

Alongside overseeing the ACD’s activities, the depositary is also charged with protecting the interests of incoming, outgoing and continuing investors, as well as keeping tabs on the assets within the fund.

This separation between who manages the fund’s assets and who owns them is frequently lauded as one of the benefits of investing in authorised vehicles.

“That’s what you pay for when you go into an authorised fund,” says Horwitz.

“Part of what you pay in your management fee will be for your star fund managers but actually, there is a good few basis points you are paying for your depositaries and your custodian because they are doing a very unglamorous job, which is making sure your assets are still there and making sure they are valued correctly.”

The decision to suspend Woodford Equity Income would have come from both Link and Northern Trust.

Who is liable?

Beckett says that in his eyes the main players in the asset management value chain – the ACD, depositary and appointed investment manager (Woodford) – are “jointly and separately liable” but says they are not usually treated as such by the regulator.

“The depositary will want to make clear that they were flagging issues up to the fund manager and showing that they were prepared to take action on it,” says Beckett.

Depositaries have fronted up to compensate investors of funds that have gone bust, suggesting the blame does not lie at the foot of the ACD alone.

In the Arch-Cru blow-up, which saw some 20,000 investors trapped in a group of suspended funds, depositaries BNY Mellon and HSBC voluntarily agreed to chip into the £54m pay-out scheme for those affected alongside Link, then Capita Financial Managers, which was the ACD in charge.

Northern Trust Guernsey tie-in

Warland says that as the ACD Link would have been mainly responsible for making sure Woodford Equity Income was liquid but that Northern Trust would have been more concerned with the valuations of the portfolio holdings.

This would have been especially important in the Woodford scenario given the fund’s weighting toward unlisted holdings, which the FCA has revealed were as high as 20%, double the Ucits limit, in February this year.

Duff & Phelps, the adviser who valued start-ups in Woodford Patient Capital Trust, was abruptly fired by Woodford Investment Management last year and replaced by IHS Markit.

“The listed stuff is easy, you can take it off the Bloomberg screen, but when you’ve got unlisteds, you have to find a price that is acceptable, and the depositary would have been involved in that.”

To that extent, Northern Trust would have had a “very specific role” in the listing of the Guernsey shares, says Warland.

“The FCA does not provide a list of designated markets which is okay to use. That is a decision which is made between the investment manager, the ACD and the depositary, and both of them have to satisfy themselves that the market is an appropriate place,” he says.

Woodford’s decision to quietly list a trio of unquoted companies on the Guernsey exchange did not go down well with investors and drew the eye of the International Stock Exchange Authority (TISEA) which temporarily suspended the shares.

A spokeperson for Northern Trust told Portfolio Adviser: “In its capacity as depositary to the LF Woodford Equity Income Fund, Northern Trust performs its responsibilities in accordance with the Ucits Directive and COLL (the Collective Investment Schemes Sourcebook). Northern Trust continues to work closely with the FCA in an open and cooperative manner, responding promptly to any requests for information.”

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