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Bank of England to tackle vulnerabilities in Woodford-style funds

Edmund Heaphy
Finance and news reporter
The Bank of England in London, England. Photo: David Cliff/NurPhoto via Getty Images

The Bank of England said on Thursday that it will review the way open-ended funds like the one operated by Neil Woodford might be better aligned to minimise risks to financial stability.

Open-ended funds, which allow investors to withdraw money daily even though they may not be invested in assets that can be sold quickly, are a “global issue” and have the potential to become a “systemic” problem, the Bank said.

The assessment will be carried out by the bank and the Financial Conduct Authority, which may jointly make recommendations for Treasury rule changes.

“The more important open-ended funds become, and the more illiquid their underlying assets are, the greater the risk to financial stability,” Bank of England governor Mark Carney said on Thursday, as the bank launched its half-year financial stability report.

These types of funds were thrust into the spotlight in June, when prominent investor Neil Woodford suspended trading in his £3.7bn equity income fund.

The fund had been flooded with withdrawal requests earlier this year, even though a significant proportion of its assets could take months to sell.

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Under EU rules, Woodford was limited to investing 10% of the fund in illiquid assets, which are difficult to convert into cash.

But around 25% of the fund was invested in stocks that would have taken as much as 180 and 360 days to sell as early as April 2018.

This kind of “mismatch” between redemption terms and the liquidity of assets, the Bank of England said, can create an “incentive for investors to redeem when they expect others to do so.”

This has the potential to have a knock-on effect, leading to so many withdrawals that “funds have no choice but to suspend all redemptions,” the Bank said.

But the Bank noted the vulnerabilities “go beyond any single market or fund type”.

The Woodford suspension, Carney said, was “symptomatic of a broader problem.”

“We have been looking at this issue for a few years,” he said. “It’s a global issue and it’s also a collective action issue. It’s something that affects funds in the UK, funds in the US, funds in Europe, etc and many of them invest in each other’s economies.”

Other high-profile examples of recent liquidity crunches include the suspension of several UK-focused property funds in the wake of the 2016 Brexit vote and the suspension of Swiss-asset manager GAM’s absolute return fund, which had struggled to offload exotic private bonds.

Meanwhile, investors last month pulled more than €2.5bn from French asset manager H2O over concerns it had too many illiquid bonds.

The Bank of England said it had previously supported the Financial Stability Board’s recommendation that the assets of funds and investment strategies be “consistent with their redemption terms”.

It noted, however, that “subsequent work by the International Organization of Securities Commissions did not prescribe how this should be achieved.”

The review, the bank said, will also look at the effectiveness of measures already used to deal with the mismatch, such as swing and fair value pricing and suspensions.

Oscar Williams-Grut contributed reporting.