Staying forward of the curve – what the FCA’s Expensive 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 however stay cautious and rates of interest proceed to rise. Market volatility and these rising rates of interest proceed to spook traders, resulting in better redemptions being sought.

With an eye fixed on avoiding a repeat of the Woodford scandal of a number of years in the past, through which many traders misplaced cash, the FCA earlier in the summertime revealed a ‘Expensive CEO’ letter reminding funds to implement ample liquidity oversight, administration and procedures to reply to any improve redemption situations.

It is a rising concern, with the price of dwelling making disaster many individuals rebalance their portfolios, looking for better liquidity of their investments by shifting cash into lower-risk, rate of interest pegged financial savings autos which have all of a sudden develop into extra engaging.

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

With ongoing inflation and the fallout of the pandemic nonetheless working its means by the financial system, the FCA lately undertook a multi-firm evaluation of liquidity administration by Authorised Fund Managers (AFMs). The FCA’s letter known as on asset managers and managers of Different Funding Funds to contemplate 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 corporations adjust to regulatory requirements as regards to liquidity and within the depth of their liquidity danger administration experience. It was additionally found that almost all funds fell quick in some points of their liquidity administration framework. And regardless of the dangers and the high-profile reputational fall-out of the Woodford case, many corporations have been discovered to not be giving liquidity administration the precedence it deserves in governance buildings.

Feeling the stress

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

Many corporations operated fashions on the belief that essentially the most liquid property can be bought first, making a false sense of safety. If enacted, this technique would additionally result in unfavorable outcomes for remaining traders 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, relating to redemptions, many corporations solely triggered enhanced governance at a big redemption threshold. This would possibly imply that a number of smaller redemptions – and their cumulative affect – might go comparatively unnoticed. In gentle of the forthcoming Shopper Obligation modifications, the FCA is looking on corporations to make sure traders perceive the affect of redemption in burdened market situations. This shall be notably essential in instances the place corporations are providing extra illiquid funds (e.g. long-term asset funds) to retail traders.

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 various 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 variety of liquidity playbooks to be activated ought to numerous liquidity stress occasions happen; think about engagement of third events resembling delegated funding managers and third-party directors, to help the design and implementation of acceptable liquidity danger administration protocols and processes.

On the final level, many managers are looking for third unbiased companions – like FundRock and Apex Group – which will help corporations keep forward of FCA regulation and guarantee stress testing and liquidity administration is strong, and leaves corporations ready for any and all situations. The broader view of a 3rd get together, and the flexibility to see a enterprise objectively and from the skin, provides a a lot clearer image of present danger administration methods which can preserve each traders, and regulators, reassured.

Following the FCA letter, it’s seemingly that different regulators throughout Europe can even be trying extra carefully 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 deal with structural vulnerabilities from liquidity mismatch in open-ended funds, and IOSCO consulted on steerage on anti-dilution liquidity administration instruments. Whereas the FSB and IOSCO suggestions will not be but relevant to corporations, they point out a transparent path of journey for world regulatory priorities on this regard.

In conclusion, it’s clear that managers could 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 centered 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’ll face up to regardless of the wider financial system would possibly throw at them and provides traders and the FCA confidence within the prudence of their liquidity operations.

The FCA is more likely to scrutinise fund liquidity administration preparations simply as carefully going ahead and demonstrating the event, testing and implementation of strong liquidity administration preparations can even be important for corporations to point out dedication to making sure good investor outcomes underneath the forthcoming Shopper Obligation requirements.