Author: Nicola Sharp
12 November 2019
4 min read
Nicola Sharp of Rahman Ravelli considers the problems suffered by those who invested with Neil Woodford, criticism of the FCA’s approach to the crisis and the value of new FCA rules on liquidity.
With plenty of headlines and no shortage of recriminations, high-profile investment manager Neil Woodford was sacked from his Equity Income fund, which is to be wound up, and quit as manager of his remaining two funds. Equity Income’s shutdown announcement came four months after Woodford was forced to block investors from withdrawing their money from the fund when a series of ill-judged investment bets led to a sudden rise in redemptions that could not be fulfilled. At its peak, the fund was worth more than £10 billion. Recent figures state it is now worth less than a third of that.
Campaigners have argued that there should be a Treasury investigation into the Financial Conduct Authority’s (FCA’s) activities during the collapse of Woodford’s financial empire. Conservative MP Kevin Hollinrake – who could become the next chairman of the Treasury select committee – has said that a thorough, independent review of the FCA’s capabilities and powers is needed in light of the problems facing those who invested in Neil Woodford's funds.
When the Woodford Equity Income Fund was suspended in June, the FCA had stated that “where the FCA believes there are circumstances suggesting serious misconduct or non-compliance with the rules, it may open an investigation’’. Weeks later it began an investigation into the suspension of the fund. The FCA said that the fund had breached the 10% limit on unquoted stocks twice, in February and March last year.
The FCA had said its “preliminary supervisory inquiries’’ suggested that Woodford Equity Income's exposure to unquoted stocks, including those listed in Guernsey, stood at 20% in February. By then, media reports had already revealed that Woodford had listed some of his stakes in unquoted companies in Guernsey in order to keep his fund below the 10% limit.
It is a series of events that has led to the FCA facing scrutiny over its perceived lack of action in relation to the unravelling of Neil Woodford’s funds. The central issue in any investigation that is conducted into the FCA will be whether the agency fulfilled its obligations to regulate what was happening.
The FCA confirmed in October that it will not commission an independent review of its actions in relation to Neil Woodford. But commentators have argued strongly that the FCA and others need to be held to account. Some have pointed the finger at financial services company Hargreaves Lansdown for continuing to recommend Equity Income to its clients even as the fund's risk profile was becoming worse. Others have accused Link and Northern Trust, who were the overseers of Woodford Equity Income, of failing in their duty to protect the interests of investors.
Observers believe that Equity Income's problems were due to it investing in unquoted or illiquid stocks that could not then be sold quickly enough when investors wanted to take their money out of the fund.
Speaking before the Treasury Select Committee in June, Andrew Bailey, the head of the FCA, said a loophole in the UCITS [Undertakings for Collective Investment in Transferable Securities] rules had enabled Woodford’s fund to exceed the threshold for investment into illiquid company shares by disclosing the proportion of previously private companies that were now listed but not mentioning they were listed on the Guernsey stock exchange and rarely traded, if at all.
Yet in September – three months after Mr Bailey’s explanation to the select committee – the FCA’s newly-introduced measures to address the risk of liquidity in retail funds did not include UCITS.
The rules were instead restricted to non-UCITS retail schemes; even though the FCA had delayed publication of its findings because of the suspension of the Woodford Equity Income fund.
Under the new guidance, managers of non-UCITS retail schemes must provide investors with “clear and prominent information on liquidity risks” and highlight situations in which access to funds may be restricted. The FCA believes that this places an extra obligation on fund managers who invest in inherently illiquid assets to ensure they make provision to manage liquidity risk; reducing the chances of runs on funds that ultimately harm investors. The FCA’s approach aims to protect investors’ interests, especially during stressed market conditions.
The FCA is implementing stricter rules for open-ended funds that invest in illiquid assets such as commercial property. But it is not going to prevent them from holding high levels of cash, even though this can cause a drag on investment returns. The FCA will require relevant funds to suspend trading if there is material uncertainty regarding the value of immovable assets that represent 20% or more of a fund’s investments. However, a fund manager ignore this requirement if they have what the FCA calls “a reasonable basis’’ for believing that suspending trading is not in the best interests of investors. Yet the fact that these new rules do not apply to UCITS fund such as Woodford Equity Income makes them far from comprehensive when it comes to investor protection.
This could, of course, be explained by the fact that the original consultation on rule changes was never meant to cover UCITS funds. But given that publication of the consultation’s findings was pushed back because of the Woodford Equity Income problems, this has to be seen as a missed opportunity - not least because most investors are involved with UCITS funds and it is daily-dealing UCITS funds that have been involved in recent liquidity crises.
Just how – and how well – the FCA enforces its new approach remains to be seen. But for many this move by the FCA falls short, regardless of how rigorously it is enforced.
This article was also featured on Lexology and can be viewed here.
Nicola is known for her fraud, civil recovery and business crime expertise, her experience of leading the largest financial disputes and multinational investigations and her skills in devising preventative measures and conducting internal investigations for corporates.