The Financial Conduct Authority (“FCA”) has launched a review of the role of authorised corporate directors (“ACDs”) after widespread scrutiny of the service providers following the Woodford scandal. The FCA has confirmed that it has written to funds notifying them that changes will be adopted following the collapse of Woodford Investments Management. The review, though understood to be limited to a few ACDs, may widen as the FCA seeks to increase regulatory standards in the asset management market.
ACDs work to ensure that funds stay within regulation rules and are managed in line with the best interests of investors. ACD functions can sometimes be delegated to an external provider, or if preferred, kept in house.
The Woodford Scandal
In 2019 investigations into the conduct of Mr. Neil Woodford led to the cessation of trading of Woodford Investment Management’s largest fund, the Woodford Equity Income fund, and a termination of Mr. Woodford’s contract to act as an investment manager for the fund. This scandal brought ACDs greater prominence. The ACD for Mr. Woodford’s Equity Income fund, Link Fund Solutions, was widely criticised for its perceived lack of proper oversight of his funds, and, in particular whether it had sufficient resources and authority to deal with the complex investment portfolios undertaken by Mr. Woodford. Mr. Woodford had been criticised earlier in 2019 by fund research group Morningstar for a “relentless willingness to push the portfolio to its liquidity limit”, in respect of his fund Woodford Equity Income. This related to Mr. Woodford’s significant holdings in hard-to-trade unquoted investments combined with an investor base of sizeable institutions with the capacity to trigger large withdrawals.
In the wake of England’s largest fund scandal for a decade, regulators are understandably keen that lessons are learned, and that ACDs perform proper checks on funds to avoid risky investments and potentially troublesome outcomes for investors. The FCA has subsequently taken a broad approach to its review, looking into the specific actions of the parties involved but also exploring more generally the existing governance regime of UK investment funds with expectations that changes to the system will result.
The FCA review is understood to focus on the relationships and potential conflict of interests between ACDs and their respective investment managers. On 20 January 2020, the FCA issued a letter to asset managers outlining “the key risks of harm” managers pose to their customers or the markets in which they operate. The FCA drew out criticism of these potential conflicts, stating issues “may arise if the ‘host’ ACDs cannot oversee the fund properly because, for example, it is concerned to avoid a loss of revenue from the investment manager if it were to offer more assertive challenge.” The regulator noted that its review, predicted to be completed by early 2020, will help it gather evidence that the providers can properly manage risk and fulfill their responsibilities.
Many in the industry still consider the use of external ACDs to be best practice given that an in-house function is believed to generate a further conflict of interest if the oversight function is performed by parts of the same business. The Woodford scandal has, however, caused some fund managers to reconsider using external providers, owing to concerns that external ACDs lack the understanding and expertise required of the role.
It is likely that this diversity in opinion over the best kind of ACD will continue, given the specialised nature of their employment and capabilities. Regardless of their type, asset managers should exercise appropriate due diligence when seeking to engage ACDs, focusing, in particular, both upon the knowledge, experience, and strength of an ACD business as well as also examining the investment management of the fund.
As the FCA review into the work of ACDs continues it remains to be seen what direction the FCA will move in to ensure proper oversight of the service providers, however, its recent actions and statements demonstrate a tougher attitude to regulatory compliance and changes to the existing regulatory standards.