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Gated Funds: When the champagne goes flat

Risk & Analytics

By Henry Keville | July 5, 2019

As a corporate governance best-in-practice, global fund managers always should be prepared for a “bad day in the office” in terms of risk management.

It was around a decade ago, during the financial crisis, that we last witnessed the type of media attention in the UK around large scale redemptions and “gates” being imposed by a fund that is currently focussed on the LF Woodford Equity Income Fund.

The latest events surrounding that fund is a reminder that many of the traditional risks haven’t been resolved by increased regulation or investor awareness. If anything, it’s almost business as usual in terms of media headlines. Common themes include dissatisfied investors, fee disputes, poor performance, liquidity issues, regulators being asleep at the wheel, conflicts of interests, suitability and related questions being asked of platform providers, etc. Sound familiar? Yup, thought so!

I am not suggesting that Woodford has done anything wrong. Rather that the investment guru, who has made his clients significant returns in the past, is having a “bad day in the office” and having to deal with the repercussions. It’s a timely reminder that all global fund managers and the funds they manage, should, as part of their desire to seek best-in-practice corporate governance, be prepared for a “bad day in the office” in terms of risk management. It’s clearly a regulatory requirement to be aware of and mitigate risks where possible, to protect investors. Indeed, European legislation such as the Alternative Investment Fund Managers Directive (AIFMD) has sought to achieve accountability of managers with a view to ultimately protect investors, by introducing a requirement to either purchase Professional Indemnity insurance or hold “own funds”.

It is up for debate whether the amount of insurance vs “own fund” dictated by regulators is sufficient to make good investors when a fund manager is found to have been negligent. For investors, it is a reminder that they should seek confirmation that the Investment Management Insurance (IMI) held by fund managers (a suite of professional indemnity, directors and officers liability, cyber and crime coverages), meet their expectations as a point of recourse.

It is also a timely reminder that directors of funds and their investors should not only challenge the adequacy of the funds’ own insurances but also those insurances purchased by all of the funds’ appointed outsourced parties. The key is in understanding to what extent the fund, and indirectly the investors, may bear some or all of any losses.

As a side note, it might surprise a few that in some cases the exposure of the funds, where services have been outsourced can vary significantly depending on how limitations of liability operate and what liabilities the funds themselves retain or indeed take on.

For the fund managers themselves, no one can predict “a bad day in the office”, therefore it’s important to be proactive in mitigating risks and implementing corporate governance controls lest something go wrong, as demonstrated with Woodford. It is during these times that fund managers, and indeed the directors of funds as a result, being accountable to investors, become reliant on their insurance arrangements. Like all insurance policies, the devil is in the detail and therefore it pays to be proactive and select a broker and insurer(s) partners that won’t let firms and individuals be the last line of defence. Remember insurance is a reactive financial instrument and so hindsight is the judge as to whether it works or not.

Focus should be on the collectability of claims under the policy — for example, whether there is adequate pre- and actual investigation coverage to provide indemnity for costs incurred in responding to regulatory queries for both individuals and legal entities and how and when any exclusions may preclude cover.

Insurance these days should not just be viewed as the last resource to a firm’s risk management controls. Much of the coverage afforded under a well-constructed IMI policy allows firms to be in control of situations that could impact their balance sheet.

By way of further example, if you look at the Woodford incident, it would be crucial for the insurance policy to cover crisis response costs such as public relations consultants so as to ensure that communication is consistent and portrays the organisation concerned in the best light possible with a view to limiting any reputational harm.

It is also likely that lawyers will be instructed, not least to seek to ensure that legal privilege applies to documents created whilst investigations are carried out. At the same time attention should however be paid to ensure that obligations under the terms of the insurance policy contract are adhered to and insurer consent sought if necessary. In times of crisis, minimising the number of hurdles one has to jump over is important especially during what would be a stressful time for any business.

With the right insurances and therefore balance sheet protection in place, there have been countless firms that have suffered a “bad day in the office” but have survived to live another day with the aim of regaining the performance that makes champagne sparkle.


Lead relationship manager — Asset Management

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