European update

United Kingdom Publication April 2020

The developing COVID-19 crisis has seen extreme stock market falls and volatility, dislocation of normal economic and social activity and mounting concerns for the health of the global economy.  This is a very testing time for all, and whilst the situation may present a number of opportunities for asset managers and for particular investment strategies and asset classes, most managers will be focused on taking stock of current circumstances, ensuring the well-being of their staff, communicating with stakeholders and seeking to assess and protect against the impact on their financial condition and that of funds they manage.

Asset managers and fund boards who manage to develop and implement a coherent and robust strategy for dealing with the economic effects of the COVID-19 outbreak (including through the review of their risk management systems and internal governance processes), whilst keeping their regulatory obligations under close review, will give themselves an opportunity to mitigate some of the consequences of this largely unprecedented situation.

Later in this edition, Iain Hawthorn and John Coley consider some of the considerations that boards will want to assess at the present time. In a related point, on March 12, 2020, the International Corporate Governance Network published a paper on COVID-19 as a new systemic risk and assessing the implications for corporate governance and investor stewardship including a focus on ethical considerations.

Below we identify a few selected themes which may be of particular relevance to funds, their managers and, where relevant, their boards of directors.

First, the developing economic crisis will, in many cases, have a direct impact upon the investments of the fund. For example, for those funds directly invested in operating businesses, are an investee company’s debt covenants with third-party lenders under pressure, what is its balance sheet and cash flow position, and are insurance claims or government support available to an investee company? Will an investee company require the injection of further capital and what form should that take and how should it best be structured? Will the investment policy of the fund require amendment to facilitate that investment? What is the position of any representatives on the boards of investee companies which might be approaching financial distress or restructuring and how do they exercise their directors’ duties in these circumstances?

A related pertinent issue is going to be how funds value their investments at a time of such volatility and uncertainty. How easy it going to be to ascertain a “true” value for underlying investments?  Would it be prudent for fund managers to review their valuation policies and increase the frequency of valuations? Much will depend on the type of asset class, the availability of information and the particular current economic exposure.

Second, asset managers and certain fund types will need to carefully monitor their regulatory obligations. This will include continually assessing the adequacy of their capital and liquidity requirements, notification obligations to the FCA or other regulators and the impact of illness or absence of key staff in areas such as the compliance function. A listed investment company must always bear in mind its obligations under the Market Abuse Regulation to announce inside information which directly concerns them to the market as soon as possible. For example, in the context of COVID-19, an investment company should consider whether an investee company’s distress (or a proposed action to be taken by the investment company in response to such distress) impacts upon the fund’s financial position and thus requires announcement. In its recent Primary Market Bulletin, the FCA made it clear that it expects issuers to continue to comply with the MAR announcement obligations in the context of COVID-19.

In the current financial results season, a number of listed investment companies will be grappling with the logistics of holding their annual general meetings at a time of heightened health and safety concerns and social distancing. Each investment company will need to review its articles of association to check whether it has the power to hold general meetings remotely, but most companies do not currently have this authority and so may need to consider whether to propose appropriate amendments to the articles. Recent proposed statutory changes in the conduct and processes for shareholder meetings may assist.

Third, managers and fund boards will need to keep a careful handle on their own working capital requirements and the potential tensions that may arise for example in the context of future dividend payments and investor expectations. A number of investment companies will have published “target dividends”, “target total returns”, or similar. Although not binding, investors will be measuring an investment company against the achievement of such targets. Investment companies will need to consider whether the effects of COVID-19 are that such targets are no longer realistic, and whether in those circumstances it is appropriate to revise such targets. Funds which have investment trust status will also have to take into account the requirement to distribute 85 per cent of their investment income to shareholders.

Fourth, given the major market volatility caused by COVID-19, open-ended investment companies may need to consider whether shareholder value is best protected by taking the drastic step of suspending redemptions where permitted in accordance with the constitutional documents of the fund. Although suspensions will typically be poorly received and attract very negative press comment, investment companies should note that the FCA is prepared to publicly state when, in its opinion, suspensions of dealing in certain funds are likely to be in the best interests of investors. The FCA did precisely this on March 18, 2020 in relation to the suspension of dealings in units in several large commercial real estate funds. In this example, managers of those commercial real estate funds suspended dealings as a direct result of the unusual difficulty in valuing commercial real estate assets in the volatile market caused by the COVID-19 outbreak. A number of listed funds have seen significant investor sell-offs, particularly those whose shares are relatively liquid, which has also negatively affected the share price. Significant falls in the share prices for listed funds may also trigger in-built discount management provisions.

Fifth, whilst the current crisis has all but put an end, at least for the moment, to new issues for listed investment companies, listed fund managers and, funds may, like other companies, need to access additional capital to mitigate the effects of COVID-19. In many cases, listed investment companies can raise capital quickly by utilising existing shareholder allotment authority to launch a “tap issue”, placing shares with institutional investors on a non-pre-emptive basis. This can be completed in a matter of days. This will of course depend on the availability of investor demand for listed investment vehicles which is questionable in present circumstances and one might see capital raised through private subscription.

Sixth, fund boards will need to keep a careful eye on the impact of the COVID-19 outbreak on their key external service providers (including the provision of investment management by their manager).    This could involve, for example, a review of service provider agreements for “force majeure” clauses which may be applicable and an overall consideration of service levels and potential pressure points.

Finally, as we hinted above, the crisis is likely to present opportunities for certain strategies. Private equity funds have considerable dry powder and could be among the main beneficiaries of opportunities to acquire assets at very attractive valuations. Many PE fund managers will be seeking out M&A opportunities to deploy capital that they have raised from investors such as sovereign wealth funds, pension plans and family offices who very much take a long term view.

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