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Britain's investment funds face scrutiny as Bank of England's Carney blasts liquidity 'lie'

Key Points
  • Bank of England Governor Mark Carney's comments concerned the suspension of a flagship fund from Britain's best known fund manager, Neil Woodford, due to a lengthy spell of poor performance and a slew of investor withdrawals.
  • While this type of "open-ended" fund can usually be traded easily, a number of funds hold significant proportions of illiquid assets which can be difficult to sell in the event of increased demand for redemptions.

The U.K. fund industry is facing calls for new regulation with Bank of England Governor Mark Carney telling lawmakers that some investment funds are "built on a lie."

Carney's comments concerned the suspension of a flagship fund from Britain's best known fund manager, Neil Woodford, due to a lengthy spell of poor performance and a slew of investor withdrawals.

The Woodford Equity Income Fund was revealed to have twice breached the 10% limit for illiquid holdings imposed by U.K. watchdog the Financial Conduct Authority (FCA), and listed a number of small and illiquid holdings in the nearby island of Guernsey to circumvent regulation.

Carney told the Treasury Committee (a cross-party group of U.K. lawmakers) on Wednesday that the rise of funds promising liquidity while holding illiquid underlying assets could create "a potential systemic issue," and has led to investors viewing them as "not that different from having money in a bank."

"These funds are built on a lie which is that you can have daily liquidity for assets that fundamentally aren't liquid," he said.

The gating of the Woodford Equity Income Fund meant investors could not access their cash following the recent surge in redemptions. While this type of "open-ended" fund can usually be traded easily, a number of funds hold significant proportions of illiquid assets which can be difficult to sell in the event of increased demand for withdrawals.

"Something that better aligns the redemption terms with the actual liquidity of the underlying investment is infinitely preferable to the situation that we have today," said Carney.

Carney's comments echo those of FCA Chief Executive Andrew Bailey, widely touted as his successor at the central bank, who told the committee that a move to a principles-based regulatory system rather than the rules-based framework stipulated by the European Union would make it easier for the FCA to intervene at an earlier stage.

Andrew Bailey, chief executive officer of the Financial Conduct Authority (FCA).
Jason Alden | Bloomberg via Getty Images

Bailey explained that Woodford Investment Management was able to designate a portion of unlisted holdings as listed based on an "intention to list" within a year. With the deadline approaching, the fund was able to list them on the Guernsey Stock Exchange without an obligation to inform the regulator.

Bailey said Woodford Investment Management was "using the rules to the full and they were not telling us they were doing that," suggesting that a principles-based system mandating conversations about the fund's holdings in full would have "brought this all out much more clearly" and "led to the fund being suspended earlier."

Rules governing UCITS (Undertakings for Collective Investment in Transferable Securities) funds, Bailey said, "demonstrated the problem with an exclusive rules-based system" operated by the EU. He suggested a move to an enforceable principles-based set of rules ensuring overall management of liquidity.

"Listing something on an exchange where trading doesn't happen does not actually count as liquidity," he added.