The issue of ‘regulatory arbitrage’ was raised by the head of the UK’s financial services regulator at a parliamentary hearing into the suspension of the LF Woodford Equity Income Fund.
As a UK fund, it is regulated by the Financial Conduct Authority. The suspended Woodford fund also has holdings in securities listed on the Guernsey-headquartered International Stock Exchange – and this area was discussed at length at the Treasury committee hearing yesterday.
FCA chief executive Andrew Bailey told MPs that he thought the suspended Woodford fund was ‘sailing close to the wind’ and potentially using loopholes in European Union rules.
Under EU UCITS [Undertakings for Collective Investment in Transferable Securities] rules, fund managers can designate exchanges as ‘approved exchanges’ – with TISE designated in this way.
This structure allows up to 10% of the portfolio to be invested in transferable securities which are not dealt in an ‘eligible market’.
But fund manager Link Fund Solutions, and Woodford Investment Management faced claims of bundling up illiquid unlisted assets and listing them here.
‘They don’t have to tell us they’re listing things on an approved exchange,’ said Mr Bailey. ‘The main listing took place on 21 March. The Guernsey exchange suspended the listings on 11 April.
‘Now as we understand it, they did that – and we’re still waiting to get more details from them I should say on this – because they were concerned that it was, to coin a phrase, a regulatory arbitrage. Which it was.’
He added: ‘They actually lifted those suspensions, I think between 23 April and 14 May. They didn’t do them all at once. My sense with that is because whether or not it was a regulatory arbitrage it is allowed under the UCITS rules.’
Mr Bailey, seen as a front-runner to replace Mark Carney as the Bank of England governor, added that managers of the suspended fund used the rules ‘to the full’.
He also did not believe the Woodford suspended fund followed the rules for how many tradeable, or liquid, shares it held, due to listing some holdings on TISE.
‘Listing something on an exchange where trading doesn’t happen, as far as I can see, doesn’t actually count as liquidity.’
With the suspension due for review next week, Mr Bailey said the FCA would take a view based on what was the best outcome for investors.
Nicky Morgan, the Tory MP who chairs the Treasury committee, asked Mr Bailey whether there had been a failure of the rules or of FCA supervision.
She also asked why the listing on the Guernsey exchange did not send ‘some red flags’ to somebody in the FCA.
The FCA chief executive again stressed that the fund manager was not required to inform his organisation about listing on an approved exchange, describing it as a ‘flaw’ in the UCITS rules.
There was a failure of the rules, said Mr Bailey, who agreed changes were needed.