Staying forward of the curve – what the FCA’s Pricey CEO letter means for fund managers

Staying ahead of the curve - what the FCA’s Dear CEO letter means for fund managersBy Patric Foley-Brickley, Managing Director, Apex FundRock UK.

Whereas there are indicators rising that inflation might have peaked, central banks nonetheless stay cautious and rates of interest proceed to rise. Market volatility and these rising rates of interest proceed to spook buyers, resulting in better redemptions being sought.

With a watch on avoiding a repeat of the Woodford scandal of a number of years in the past, wherein many buyers misplaced cash, the FCA earlier in the summertime revealed a ‘Pricey CEO’ letter reminding funds to implement adequate liquidity oversight, administration and procedures to reply to any enhance redemption situations.

It is a rising concern, with the price of residing making disaster many individuals rebalance their portfolios, searching for better liquidity of their investments by transferring cash into lower-risk, rate of interest pegged financial savings autos which have immediately grow to be extra enticing.

So, what new element did the FCA letter comprise, and what are the implications for fund managers?

With ongoing inflation and the fallout of the pandemic nonetheless working its method by the economic system, the FCA not too long ago undertook a multi-firm evaluation of liquidity administration by Authorised Fund Managers (AFMs). The FCA’s letter referred to as on asset managers and managers of Various Funding Funds to think about the implications of the evaluation’s findings for his or her companies.

For some, the evaluation will make for uncomfortable studying. It discovered “a large disparity” in how companies adjust to regulatory requirements almost about liquidity and within the depth of their liquidity danger administration experience. It was additionally found that almost all funds fell quick in some elements of their liquidity administration framework. And regardless of the dangers and the high-profile reputational fall-out of the Woodford case, many companies had been discovered to not be giving liquidity administration the precedence it deserves in governance constructions.

Feeling the stress

The evaluation additionally found large variance when it got here to emphasize testing with some companies finishing up detailed and complex modelling, whereas others handled stress testing as little greater than a field ticking train. Of specific concern, the FCA discovered that at some companies, few funds ever failed stress assessments. This may counsel that stress thresholds is probably not difficult or stringent sufficient, particularly given elevated market volatility and macroeconomic uncertainty.

Many companies operated fashions on the idea that essentially the most liquid belongings can be bought first, making a false sense of safety. If enacted, this technique would additionally result in destructive outcomes for remaining buyers within the funds. The FCA as a substitute recommends a pro-rata method the place a proportionate ‘slice’ of each asset within the portfolio is bought to accommodate the redemption.

The FCA additionally discovered that, on the subject of redemptions, many companies solely triggered enhanced governance at a big redemption threshold. This may imply that a number of smaller redemptions – and their cumulative impression – might go comparatively unnoticed. In gentle of the forthcoming Shopper Responsibility adjustments, the FCA is looking on companies to make sure buyers perceive the impression of redemption in careworn market situations. This shall be notably necessary in instances the place companies are providing extra illiquid funds (e.g. long-term asset funds) to retail buyers.

Subsequent steps

So, what are the implications of this evaluation for fund managers and the way can they meet the FCA’s expectations on liquidity administration?

The FCA outlines a variety of ideas for actions fund managers can take. These embody the next; the introduction of a liquidity administration committee; reviewing present liquidity danger administration frameworks; creating a spread of liquidity playbooks to be activated ought to varied liquidity stress occasions happen; take into account engagement of third events comparable to delegated funding managers and third-party directors, to help the design and implementation of applicable liquidity danger administration protocols and processes.

On the final level, many managers are searching for third impartial companions – like FundRock and Apex Group – which can assist companies keep forward of FCA regulation and guarantee stress testing and liquidity administration is strong, and leaves companies ready for any and all situations. The broader view of a 3rd social gathering, and the power to see a enterprise objectively and from the surface, offers a a lot clearer image of present danger administration methods which can preserve each buyers, and regulators, reassured.

Following the FCA letter, it’s probably that different regulators throughout Europe will even be wanting extra intently at liquidity administration. The FCA’s multi-firm evaluation findings have fed into the FSB and IOSCO’s work on liquidity with regard to open-ended funds. On July 5, 2023 the FSB consulted on its suggestions to handle structural vulnerabilities from liquidity mismatch in open-ended funds, and IOSCO consulted on steering on anti-dilution liquidity administration instruments. Whereas the FSB and IOSCO suggestions will not be but relevant to companies, they point out a transparent route of journey for international regulatory priorities on this regard.

In conclusion, it’s clear that managers may have vital work to do over coming months, to make sure their liquidity administration method is on a agency footing and able to face up to any potential financial shocks. Regulators are targeted on proactively managing any fall-out from macroeconomic uncertainty, and crucially, avoiding a repeat of what was seen with Woodford. Fund managers ought to act now to make sure they will face up to regardless of the wider economic system may throw at them and provides buyers and the FCA confidence within the prudence of their liquidity operations.

The FCA is more likely to scrutinise fund liquidity administration preparations simply as intently going ahead and demonstrating the event, testing and implementation of strong liquidity administration preparations will even be important for companies to indicate dedication to making sure good investor outcomes beneath the forthcoming Shopper Responsibility requirements.