U.K. Fund Liquidity Rule Breaches Soared in Covid Early Days

British money managers ran afoul of liquidity regulations 13 times at the height of this year’s market volatility, exposing their investors to the kinds of risks that can trap billions of pounds for months.

Nine funds, whose names were kept confidential, breached the 10% limit on holdings of unquoted securities between March and May, according to Financial Conduct Authority data obtained by Bloomberg through a public records request. Most of the breaches occurred in March, when Covid-19 spread to Western economies and the value of investors’ more easily tradeable securities plunged.

While the breaches subsided by June, the revelation may increase pressure on investment managers to reduce their stakes in upstart companies and thinly-traded shares, which became more popular in an ultra-low-interest-rate environment. More attention has been paid to the issue after illiquid investments tripped up money managers Neil Woodford and H2O Asset Management.

“Should funds that offer daily liquidity have 10% in unquoted stocks in the first place? My answer is no,” said Ben Yearsley, investment director at Shore Financial Planning. “It comes back to a failure of regulation. It’s been 18 months since Woodford blew up and still nothing has happened.”

U.K. Fund Liquidity Rule Breaches Soared in Covid Early Days

The FCA and Bank of England have spent months looking into whether investment funds are a risk to the financial system if they offer investors the ability to pull their money on a daily basis despite holding assets that can take a long time to sell. The authorities are considering whether to require more notice for redemptions, similar to a proposed measure for property funds, where investors would have to inform managers up to 180 days before they want their money back.

The FCA, which regulates 4,300 funds, said in a statement that many of the breaches would have been disclosed at the time to a fund’s depositary -- an independent firm, in charge of holding a fund’s assets, that plays a key governance role in any move to halt redemptions.

“FCA rules require depositaries to ensure that any managers breaching any rules resolve these in a timely manner, and in the best interests of investors,” the regulator said. “The FCA’s role is to ensure that these depositaries report the breaches to the FCA and resolve them properly.”

European regulators have exhibited similar concerns. The European Securities and Markets Authority said in a report Friday that fund managers need to be better prepared for liquidity and valuation shocks, after market volatility in the pandemic saw some firms suspend redemptions.

In the U.K., Woodford’s problems came well before this year’s market swoon. After building his reputation at his former employer by successfully calling trends involving big companies, his focus shifted gradually to smaller and less liquid securities after he struck out on his own. After the fund suffered poor results, investors began demanding their money back, but Woodford, stuck with the hard-to-sell assets, took the rare step of halting redemptions.

Read More: Cold Comfort for Woodford’s Trapped Investors

The Woodford debacle indirectly ensnared London’s H2O Asset Management, which suffered outflows on concern it was vulnerable to similar risks. This year, regulators forced H2O to segregate the illiquid investments that were pushed too high as a proportion of its funds during the Covid-19 swoon.

“In recent years, the multi-billion dollar examples of Woodford, property funds and H2O demonstrate one clear point,” said Gina Miller, co-founder of wealth manager SCM Direct. “Unquoted or thinly-traded securities should not be held within retail funds full stop.”

©2020 Bloomberg L.P.

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