When was the last time a UK open-ended fund used Guernsey stock exchange listings to avoid UK regulations?
Arch Cru springs to mind- its holdings of Guernsey cell companies enabled it to include a raft of highly illiquid assets in its, supposedly secure, UK-authorised funds. Arch Cru collapsed in 2009 and UK investors lost over £140m.
In March Woodford transferred £73 million of unquoted stocks from his Woodford Equity Income fund to his Woodford Patient Capital investment trust. Before that point the level of unquoted stocks in the fund was up to 18 per cent but did not technically breach the FCA’s 10 per cent limit because of the proportion which had committed to float imminently.
The FCA was well aware of the role the Guernsey cells played in the Arch Cru debacle. And plenty of evidence came out during the Arch Cru case that the Guernsey listings were largely a fiction.
No dealings in the Arch Cru cells other than by the Arch Cru managers ever took place. The listings provided no liquidity. They were nothing more than a successful attempt to dodge the intended effect of UK regulations. The Channel Islands Stock Exchange itself was fined for its role in the debacle.
You would imagine that regulators with access to all those Arch Cru files would not need reminding about the complete absence of liquidity for most Guernsey share listings. And the intent of the 10 per cent limit on unquoted companies for open-ended funds is also clear. So Woodford is now effectively thumbing his nose at the FCA.
If the FCA lets Woodford get away with his manoeuvre, it opens the door to other managers seeking to circumvent the 10 per cent rule.
Woodford’s shuffling of his holdings to beat the rules is hideously reminiscent of Jim Slater’s behaviour with the Britannia unit trusts in the early 1970s. Britannia became notorious as the ‘dustbin’ for stakes the financier was unable to deal on at a profit. Those misdeeds were one of the prompts for tighter regulation of unit trusts in the mid-1970s from which investors have benefited.
However talented a fund manager is, the rules are there for the purpose of protecting investors. Woodford’s strategy has blown up, and the regulator should intervene and impose a solution rather than let Woodford play fast and loose with the rules.
In my opinion, the 10 per cent limit on unlisted companies is a mistake. Open-ended funds should not be permitted to hold any unlisted investments. The valuation of such investments always includes a subjective element, even when there has been a recent fund-raising.
The kind of liquidations Woodford has had to make as his fund has suffered huge redemptions create situations in which there is a clear risk that some investors in a fund will win and others lose. This is a result of causing the unlisted investments to form a rising percentage of the fund’s portfolio. Good regulation should prevent such risks arising in the first place.
The FCA has a dismal record in regulating open-ended funds. If it rolls over on this issue, its credibility as a fund regulator will be well and truly shot.
Chris Gilchrist is director of Fiveways Financial Planning