The Financial Conduct Authority (FCA) may need to review existing rules governing fund management, amid warnings that "investors will see the value of their investment plummet" as a result of the Woodford Equity Income fund's suspension of dealing, legal experts have said.
Professional Adviser's sister publication Investment Week reported recently that Woodford Investment Management could face legal action from investors as a result of its decision to suspend dealing while trading of the fund's assets continues.
Partner at law firm Howard Kennedy James Kaufmann explained this decision means "investors could see the value of their investment plummet but not be able to withdraw while the suspension remains in place", opening up the possibility of legal questions about the gating.
He added: "This can lead investors to challenge the application, timing, validity and operation of the suspension, and possibly even to query whether the fund was entitled to pay out redemptions immediately prior to the suspension being declared."
A spokesperson for Woodford Investment Management confirmed the suspension only applies to "buying and selling", while "daily pricing continues and income payments are being made in the normal way".
Daniel Spendlove, partner at Signature Litigation, said "until dealing resumes it will be difficult to ascertain with any degree of clarity whether investors have suffered losses, and if so how much".
He added: "It is therefore a case of 'wait and see'."
For its part, the FCA said its rules "provide for suspension in dealing in the units of open-ended funds where, due to exceptional circumstances… it is necessary to protect all the investors in a fund".
However, partner at Ropes & Gray Eve Ellis said while the FCA "has rules in place for liquidity management to protect investors" the Woodford suspension "will result in further work by the regulator to review the existing rules".
She added: "The potential issue here is the mismatch between the liquid nature of the open-ended fund product and the illiquidity in some of the underlying investments.
"If these investments do not perform or there are other concerns associated with the fund and there is a run on redemptions, this potential issue becomes a reality."
Elsewhere, the FCA itself has come under fire from chair of the Treasury Select Committee Nicky Morgan MP, who wrote an open letter to chief executive Andrew Bailey, calling for more transparency on the discussions concerning the suspension of the LF Woodford Equity Income fund.
The FCA, which does not approve suspensions but is notified of them, said gating of this kind "should seek to protect all the investors, those who remain invested as well as those seeking to redeem, by avoiding forced sales in the assets of the fund, which might be below current values".
It added: "We expect all firms involved to uphold their obligations to act in the best interests of all investors and to ensure the fund's assets are sold in an orderly manner.
"A suspension should last no longer than necessary to allow the fund to build up sufficient liquidity to meet redemptions again."
However, legal questions have also been raised about the relative impact of the suspension on small and large clients, amid concerns more sophisticated investors may have first access to their capital when the suspension is lifted.
Howard Kennedy's Kaufmann explained some institutions "will automatically respond to a suspension by submitting a full redemption request in a bid to secure their position in the queue".
Simon Hart, head of financial disputes at City law firm RPC, said "everyone will want to be at the front of the queue" when redemptions start being processed, and "investors who have not assessed their legal position may find themselves at a disadvantage to more informed investors trying to exit the fund".
He added: "[This] could have a major financial impact on their position."
"For obvious reasons, the most liquid assets are sold first when a fund in this kind of situation is looking for liquidity. That exacerbates risk for those investors at the back of the queue - their source of repayment may be a rump of illiquid assets that are vulnerable either to fire sale price dynamics or, to seek to avoid that, further and longer gating periods on redemptions.
"Institutions invested in the Woodford funds will rightly be looking to protect their own positions and the position of their customers.
"Given some of the concerns around this fund's less liquid positions, which have been aired over the last year, if institutional investors suffer losses, there will be close scrutiny of whether the fund has adhered to its investment mandate."
Illiquid assets consultation
The FCA is monitoring the gating and has confirmed it is "in discussions" with Woodford IM and its authorised corporate director Link Fund Solutions over the listing of illiquid holdings on Guernsey's stock exchange.
However, the affair has also raised questions as to the outcome of the regulator's consultation on illiquid assets and open-ended funds, with the FCA set to publish a policy statement with final rules and guidance imminently.
With the aim of reducing "the potential for harm to retail investors in funds that hold illiquid assets", the consultation was initially focused on open-ended property funds as a result of high-profile gatings.
However, Kaufmann said: "In light of the Woodford fund suspension, I would expect the FCA to expand their rules to expressly cover a broader range of assets that may be illiquid, such as unlisted securities, and assets which are rendered illiquid - for example constituents of an otherwise liquid portfolio which are practically illiquid due to the sheer size of the fund."
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