In light of the challenges posed by COVID-19, on March 11th 2020 the European Securities and Markets Authority (“ESMA”) issued recommendations to financial market participants on dealing with the impact of the virus. In its summary, ESMA described four key areas of focus for financial market participants. These include the following:
- Business Continuity Planning
- Fund Management
- Financial Reporting
This note focuses on these four key areas, which management companies (“ManCos”) and self-managed funds may wish to consider.
Business Continuity Planning including Board Governance
On March 4th 2020, the Central Bank of Ireland (“CBI”) released a press release statement on COVID-19, which referenced Business Continuity Planning. The CBI stated that it expects regulated firms to have appropriate contingency plans in place to be able to deal with major operational events. It further indicated that it is working with the industry to ensure that firms are responding effectively to the evolving situation.
ManCo and fund boards are advised to review and invoke existing business continuity plans and, where appropriate, create new measures in order to address operational continuity and adherence to both statutory and regulatory guidelines.
Items for boards to consider may include:
- Contingency planning for board meetings and other significant meetings, such as audio or video conference
- Ensuring all potential risks resulting from COVID-19 are identified and categorised in terms of their materiality and likelihood of occurrence
- Putting in place a reporting structure to ensure a timely and accurate flow of information from external sources to the board, thus enabling it to make informed decisions
- Conducting a review of any outsource arrangements with external provider(s) that may be impacted
- Reviewing the robustness of contingency planning and IT infrastructure at delegates to ensure continuity of service if most, if not all, staff are working remotely
- Planning for the possibility of directors or designated persons contracting COVID-19
- Reviewing the possibility of using electronic signatures
With such large market disruption, ManCos and funds will need to assess how fund performance is impacted and whether any adjustment to investment strategies is required. An assessment of whether the relevant fund can continue to operate within its risk limits should also be made. This may include monitoring compliance with VaR limits, such as the absolute VaR limit of 20% of NAV.
However, the most important consideration at this time is likely to be liquidity risk management and the management of redemption requests. Before taking any action(s) in relation to the management of liquidity, ManCo and fund boards should consider a number of factors:
- The requirement to treat investors fairly
- What is currently set out in the fund’s prospectus and constitutional documents
- The requirement to comply with the fund’s investment policy
- Whether any prior engagement with investors or the CBI is required
A brief summary of a number of liquidity management tools is set out below:
Amendment of Dealing Dates
A board may consider, where applicable (in the case of a UCITS fund), reducing the frequency of dealing to the minimum of once every two weeks. This would require a board resolution and a notice to shareholders.
Temporary Suspension of Redemptions
Whilst it could cause reputational risk, a fund may decide to temporarily suspend redemptions. This requires disclosure to the CBI.
Use of Redemption Gates
In order to allow assets to be liquidated in a reasonable manner (and to apply a more gradual level of redemptions), a redemption gate may be applied. It should be noted that redemption gates are only possible in UCITS funds where redemption requests amount to 10% of NAV in a single dealing day.
Offering In-Specie Redemptions
An in-specie redemption may be offered to an investor as an alternative to paying cash proceeds for their redemption request. Underlying portfolio assets are transferred to the redeeming investor. The depositary is required to approve such in-kind transactions.
Application of Anti-Dilution Levy or Redemption Fees
A fund may apply an anti-dilution levy to mitigate against investors seeking to redeem and benefit from a “first mover advantage” redemption request. With this option, the trading costs of selling portfolio assets to fund redemption payments are passed on to the redeeming investors.
Use of Side Pockets
An AIF board may, where stated in the fund documentation, avail of side pockets. The use of side pockets enables a form of segregation in the portfolio through the creation of separate share classes, which hold illiquid or difficult to value assets. Such separation may prevent the sale of illiquid assets to meet redemption demands at heavily discounted prices. Illiquid assets in the side pocket cannot be redeemed until they become liquid in the future. It should be noted that UCITS funds cannot avail of this option.
Possible Disclosure Requirements
Listed funds have obligations under the Market Abuse Regulation (“MAR”) to disclose inside information without delay. Listed funds should consider whether any relevant information about the impact of COVID-19 on the price of their listed securities, which has not yet been made public, could constitute inside information under MAR. Stock exchange listing rules also require the immediate disclosure of any decision to suspend the calculation of net asset value, or a suspension of the redemption of shares of listed funds.
In addition, the Synthetic Risk and Reward Indicator (“SRRI”) volatility indicator disclosed in the UCITS KIIDs may need to be amended as a result of current market volatility.
As outlined above, consideration should also be given to any investor or CBI disclosures required as a result of any liquidity management tools put in place.
Financial Reporting Implications
Many ManCos and funds will soon approve their financial statements for the year ended December 31st 2019, and should consider including a disclosure on the impacts of COVID-19 under the note headed “post year end events”. The director and investment manager reports should also refer to the COVID-19 impact.
You can download a copy of The Impact of COVID-19 on Management Companies and Self-Managed Funds here
KB Associates Services
KB Associates provides a range of services to investment funds including:
- The provision of UCITS ManCo/AIFM services
- The provision of designated persons to perform UCITS business plan/AIFMD PoA functions
- The provision of operational and compliance services to both UCITS and AIFMD compliant structures
If you would like to discuss the contents of this note further, please contact: