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The impact of Covid-19 on UK authorised funds

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Lora Froud

Macfarlanes, London

lora.froud@macfarlanes.com

Tiffany Cox

Macfarlanes, London

tiffany.cox@macfarlanes.com

The Covid-19 outbreak has raised a number of questions for UK authorised fund managers (AFMs) relating to the operation of their UK authorised funds. Organisations’ responses to Covid-19 have also thrown into the spotlight the social aspect of sustainable investing, as the outbreak continues to test the resilience of company policies relating to measures such as working from home, sick leave and furlough.

The Financial Conduct Authority (FCA) has addressed some of these issues directly as part of its online information for firms. This article shares our thinking on some of the key operational issues facing AFMs and the broader impact of Covid-19 on the operation of UK authorised funds.

AFMs should take steps to ensure they are prepared to meet the challenges that Covid-19 poses to UK authorised funds. In many cases, the only option for an AFM will be to take an approach that is reasonable and pragmatic in the circumstances. The key message during this challenging period is that investors’ interests must always be: (1) at the heart of all decision making; and (2) considered above the commercial interests of the AFM.

FCA operations

Turnaround times

The FCA authorisations team is working remotely and is able to process applications within standard FCA timeframes. The only noticeable change is that the FCA is expecting firms to provide responses to its questions within shorter timeframes than usual.

Signing FCA forms

The FCA is accepting e-signatures on applications to authorise funds or approve changes to funds where it is not possible to obtain ‘wet ink’ signatures from relevant authorised signatories. In all cases, the FCA needs to be satisfied that the signatory has seen and agreed with all the information in the application form.

Proposed changes to a fund

Keeping the FCA informed

If a decision is taken to postpone, or not to implement, certain changes to a fund that have already received FCA approval, it may be appropriate to update the FCA.

In particular, if approval has been obtained for the termination of a fund, it may no longer be appropriate to proceed right now if terminating now would result in poor outcomes for investors – for example, due to concerns regarding the low valuation of the fund’s assets. In such circumstances, it may be preferable to postpone the termination, having first notified both the FCA and investors. It should not be necessary to re-apply for FCA approval to terminate the fund provided there have been no material changes and it has not been a significantly long time since the initial application.

Proceeding with fund change events that require investor approval

AFMs should proceed with a change event if it is considered to be in the best interests of investors in the current market.

Given the uncertainties around how long the current situation may last, a change event considered to be in investors’ best interests should not be postponed purely on the basis that it would be operationally challenging to hold an extraordinary general meeting (EGM) and to implement the change.

Virtual extraordinary general meetings

Whether to hold a virtual EGM

The FCA rules do not preclude holding virtual EGMs, and the FCA has confirmed that it does not have a supervisory concern with EGMs being held in a virtual format.

Fund constitutional documents are typically silent on this point. Provided nothing in the constitutional documents prevents a virtual EGM, and so long as the investor circular convening the EGM clearly sets out that the EGM will be held virtually and includes the process for holding the meeting and how investors can attend (and vote) remotely, a virtual EGM should be possible.

However, the investor demographic is important here and must be considered carefully. If the investor base is retail, as opposed to institutional, there may be more procedural and operational factors to consider, and AFMs may conclude that a virtual EGM is not in the best interests of the fund’s investors.

Holding a virtual EGM

There are various different audio/visual or online conferencing systems that could be used to hold a virtual meeting. Whichever technological solution an AFM uses, it would be well advised if possible to undertake a few rehearsals, to ensure the technology works as intended and any glitches are identified and fixed in advance.

Broadly, a virtual EGM could proceed as follows:

  • the circular convening the meeting specifies the chosen conferencing system as the ‘place’ of the meeting and provides investors with the details necessary to join and participate (log-in details, passwords/PINs);

  • the AFM and the depositary open the meeting using the chosen conferencing system;

  • investors who choose to participate in the meeting in person (as opposed to by proxy) cast their votes by using the voting options built in to the conferencing system or perhaps by email to a specific inbox that is appropriately monitored; and

  • investors who choose to participate by proxy submit their proxy forms ahead of the meeting by email.

It may be sensible to allow time before the start of the meeting for participants to flag any technical difficulties and have a technical support available to fix any issues. AFMs should also consider an online Q&A or dedicated page on the fund’s website, to allow investors to ask questions ahead of the EGM.

Requisition of EGMs by investors

Under the FCA rules, investors have the right to requisition an EGM by depositing a written notice at the head office of an open-ended investment company or with the depositary of a unit trust. AFMs should therefore ensure that post delivered to these addresses is being monitored, to avoid missing important communications from investors.

Updates to fund documents

We do not believe AFMs need to make any general updates right now. However, specific tweaks may be needed in particular circumstances (eg, AFMs whose fund documents require, explicitly or implicitly, EGMs to be held physically may want to make amendments allowing virtual EGMs). Some AFMs are also looking to introduce pandemic-related risk factors, but typical market risk factors may well be sufficient to cover the types of Covid-19 issues funds are facing.

If there will be any operational changes as a result of the current situation (eg, changes to dealing procedures) then, after having considered whether FCA approval is required, we suggest such changes are implemented as follows:

  • discussing the change with the depositary;

  • where relevant, discussing the change with the administrator/transfer agent, ensuring they are fully briefed as to any changes that must be communicated to investors before they invest;

  • communicating the change to investors on the AFMs website; and

  • adding a ‘notes’ cover page to the front of the prospectus as an interim measure to flag any particular changes to standard dealing arrangements.

Dealing

Dealing as usual

AFMs should engage with their transfer agents to ensure that there are no obstacles preventing them from acting on dealing requests in a timely fashion, for example, ensuring that, where applicable, the transfer agent is continuing to monitor the PO Box to ensure it receives and processes the dealing applications received by hard-copy application form.

Accepting electronic dealing requests

In our view, the FCA rules do not prevent email dealing, so it should be possible to accept electronic dealing requests. The key issues to consider are:

  • whether the transfer agent is able to offer an email dealing service (considering any associated AML implications);

  • whether the prospectus permits email dealing;

  • whether FCA approval is required to enable email dealing; and

  • the investor communications around the change.

COLL 5 breaches

Potential breaches of COLL investment and borrowing power restrictions

During these unsettling times, it is possible that redemptions may be exhausting liquidity in the portfolio and starting to cause diversification issues. For example, the ‘bucket’ of unlisted transferable securities may be approaching the 10 per cent limit. To try to control this, it may be worth considering imposing ‘soft limits’ on the investment and borrowing powers. For example, in this scenario, it may be prudent to run the unlisted bucket at 8 per cent rather than 10 per cent.

Liquidity management

Deferred redemptions and suspensions

Fund documents typically permit deferred redemption (and for some types of funds, limited redemption), and AFMs should consider these options before suspending the fund.

Typically, deferred redemption provisions for daily dealing funds are not particularly helpful, as they only allow the AFM to defer redemptions to the next dealing day (ie, typically the next day). However, if the deferred dealing threshold is reached repeatedly on consecutive days, it may, in theory, be possible to defer redemptions for longer than one dealing day. If the AFM is in this position and wishes to defer redemptions for more than one dealing day, care should be taken regarding communication of this position to investors – particularly where the investor base is predominantly retail.

Dilution adjustment/levies

Dilution adjustment or levies may help with liquidity management, but should only be used to cover the impact of dilution and not as a tool to deter the submission of redemption requests.

Redemption charges

A typical prospectus gives the AFM the power to charge redemption fees, but then states that the AFM has no intention to use the power, or that the current redemption fee is zero.

AFMs that currently do not exercise this power but want to start doing so would need to seek FCA approval (providing a full justification for why the application of the redemption charge is considered appropriate, and in what circumstances it would be applied) and provide 60 days’ notice (ideally) to investors. This means that there is potentially a three-month lead-in time to introduce a redemption charge.

Reporting obligations

Annual and half-yearly reports and accounts

If possible to do so within the usual time limits without compromising the quality of the reporting and in line with the current health guidelines, the FCA expects AFMs to publish reports on time.

However, at the date of writing, the FCA is allowing temporary relief of an additional two months (so six months in total) from the end-of-year accounting date to publish annual reports and an additional one month (so three months in total) from the half-yearly accounting date to publish half-yearly reports, provided AFMs inform the FCA that they are using the extension.

Assessments of value

If AFMs need to make use of the temporary reliefs outlined they have six months from the end of the financial year to publish the statement of value.

Covid-19 and ESG

The social aspect of Covid-19

It is anticipated that Covid-19 will increase the relevance and materiality of social factors in environmental, social and governance (ESG) investing, as companies are put under more scrutiny in relation to decisions that impact employees, customers and society. The pandemic has drawn particular focus on safe working conditions and the financial challenges posed to employees and customers as a result of Covid-19 disruption. This is raising awareness among companies of the opportunity to consider ESG factors more systematically in their business planning, in additional to purely financial factors, and what policies and actions they could and should take to bolster social credentials.

As well as potentially accelerating corporate sustainability practices, Covid-19 may have an impact on investors’ engagement with funds and companies whose ESG policies and programmes do not sufficiently account for social factors. AFMs may wish to consider whether their messaging and priorities with respect to ESG initiatives would benefit from reconsideration after the pandemic.

Conclusion

The FCA acknowledges the significant challenge presented to AFMs in the current environment. However, AFMs should be doing all they can to ensure business as usual for their investors. This may require AFMs to make transient or permanent changes to their operation of UK authorised funds. It is important to keep investors’ interests at the heart of decision making and to communicate any consequential operational changes to investors as soon as possible.

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