The FSA is warning firms against using the word ‘cash' when naming Money Market Funds (MMFs), saying it is "potentially misleading".
It says the word cash implies little or no risk to investors' capital when in fact the current low interest rate environment, combined with annual management charges, has created negative yields for some funds.
The warning follows an FSA ‘project' looking into MMFs - considered an ultra-safe alternative to cash - in August.
"If there is a risk to an investor's original capital investment, then we feel that firms should reconsider use of the word ‘cash' and the impression this gives to consumers," the regulator says.
It adds warning clients of the threat of a negative yield is especially important when they will be locked into funds or have few alternative options.
"Firms should consider how to draw customers' attention to the risks both upon sale and when they have a real possibility of crystallising, such as when there is a low interest rate environment," it said.
The study also identified concerns relating to the governance and oversight of MMFs. Poor monitoring practices and, in some cases, a lack of criteria about permitted underlying investments were found, the FSA reports.
"Some firms specified no criteria around what the fund could and could not invest in," it said.
"This was instead left to fund manager discretion. Firms should consider specific criteria to set out acceptable boundaries in terms of the types of instruments appropriate for a MMF, such as concentration limits, creditworthiness of counterparties, liquidity etc..."
The FSA says it will provide feedback to firms and take remedial action where necessary.
It follows a number of high-profile cases in recent years involving big name asset managers and providers, including Threadneedle and Standard Life.
In 2008, the Threadneedle UK Money Securities fund lost millions of pounds after putting small investors' cash in investments whose value slumped because of the credit crunch.
That followed Standard Life's declaration, also in 2008, its profits would take a £37m hit after it was forced to bail out the £2.4bn Pension Sterling fund, which had invested in toxic mortgages.
In January of that year, the company wrote to the fund's 97,000 investors warning them their average £19,100 deposit would be cut to £18,200 as a result of losses on mortgage-backed securities held in the fund.
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